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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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Form 10-K

|  |  |                                                                                                 
|- |  | ------------------------------------------------------------------------------------------------
|þ |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
| 
|  |  | For the fiscal year ended December 31,
    2003                                                 
| 
|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          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.          þ

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Exchange Act
Rule 12b-2).     Yes þ          o

As of June 30, 2003, the aggregate market
value of the voting and non-voting common equity held by
non-affiliates, based upon the last reported sale price of such
common equity of the registrant as of such date as reported by
the Nasdaq Stock Market, was $157,505,969.

As of March 8, 2004, 132,726,585 shares of
common stock of the registrant were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

None.




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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:
the volatility of the price of our common stock, par value $0.01
per share (the Common Stock); our ability to fund
future growth; our ability to become profitable; our ability to
attract and retain qualified personnel; general economic
conditions of the telecommunications market; market demand for
and market acceptance of our products; legal claims against us,
including, but not limited to, claims of patent infringement;
our ability to protect our intellectual property; defects in our
products; our obligations to indemnify our customers; our
exposure to risks inherent in international operations; our
dependence on contract manufacturers and suppliers; our ability
to integrate the operations of the businesses we have recently
acquired; our dependence on a small number of customers for
revenue with respect to certain of our products; our ability to
develop and maintain relationships with key vendors; new
regulation and legislation; 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 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
(the Company), designs, manufactures and markets
products and solutions that enable carrier, enterprise and
government entities to lower telecom costs, reduce network
complexity and optimize network resources. The Company focuses
on high growth areas within the communications market, with
specific emphasis on application-based, turn-key solutions that
leverage legacy circuit-based network investments towards
converged, packet-based networks.

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 makes available
free of charge through the Investors section of the
Companys website at www.verso.com the annual,
quarterly and current reports, and amendments thereto, which the
Company files with, or furnishes to, the SEC. Such reports and
amendments are available on the Companys website as soon
as reasonably practical after the Company has filed such reports
with, or furnished such reports to, the SEC.

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The Companys ongoing, strategic business
units consist of the Companys Carrier Solutions Group and
the Companys Enterprise Solutions Group. Each unit
includes a range of products and services designed to meet the
specific needs of a particular customer segment.

Carrier Solutions Group

The Companys Carrier Solutions Group
develops softswitch and software-based voice over Internet
protocol (VoIP) solutions that enable
telecommunications carriers to deploy highly efficient converged
communication networks which are more cost-effective to operate
than traditional circuit-based networks, and which enhance
revenues by supporting innovative, high margin services. The
Carrier Solutions Group differentiates its solutions portfolio
from those of the Companys competitors by providing a
complete, end-to-end solution that includes class 4 and
class 5 switching technologies that provide networking
infrastructure for its customers softswitch-based networks
from the central core to the edge of the network.

In the first quarter of 2003, the Company
acquired substantially all of the operating assets of Clarent
Corporation, a pioneer in VoIP technology. In July 2001, the
Company acquired NACT Telecommunications, Inc.
(NACT). Today, the Clarent® and
NACTTM product lines support a variety of diverse
business applications from enterprise managed services and
retail calling cards to wholesale Internet protocol
(IP) telephony, IP network clearing services,
international long distance and residential dial tone services.
In 2003, the Companys primary base of customers consisted
of emerging domestic and international long-distance service
providers, as well as a growing base of large, international
Tier I telecommunications carriers and Internet Service
Providers (ISPs). In an effort by the Company to
sell to larger customers and to close larger individual carrier
sales, the Company has been bundling its products into packaged
solutions, a strategy that the Company hopes will result in
larger initial sales and greater long-term opportunity. The
Company is leveraging its worldwide installed base of customers,
representing several million VoIP ports, towards sales of the
Companys newest Edge Access solutions.

For the year ended December 31, 2003,
revenue from the Carrier Solutions Group was $29,744,000, or
50%, 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 for the year ended December 31, 2003,
which statements are contained elsewhere in this Annual Report.

The Market
for Carrier Solutions Group

In todays competitive telecommunications
marketplace, carriers are increasingly challenged to lower
operating costs while enhancing service capabilities. Burdened
by the high costs of continuing to build, manage and maintain
separate voice and data networks, carriers have begun to combine
voice and data services onto converged IP based network
infrastructures that leverage the low cost delivery of IP
networks while delivering the high reliability and voice quality
standards of the circuit-switched, public switched telephone
network (PSTN). At the same time, these new
infrastructures are enabling carriers to launch new, innovative
services that help them differentiate themselves and enhance
their revenue potential. These new applications are driving
widespread adoption of VoIP technology among large, Tier 1
carriers in developed markets like North America, Europe,
Asia-Pacific and elsewhere around the world.

Meanwhile, deregulation and privatization of the
global telecommunications industry continues to drive demand for
VoIP technology from small, emerging, international service
providers who are not encumbered by massive, legacy time
division multiplexing (TDM) networks. More flexible
and more agile than larger carriers, these emerging service
providers are opening up large, previously untapped markets like
Africa and the Middle East, driving much of the worldwide VoIP
spending as they launch traditional voice services through a
variety of wholesale and retail business models.

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Carrier Solutions Group: Products and
Solutions

Clarent®Edge Access Softswitch Solution

The Companys Clarent® Edge Access
Softswitch Solution enables traditional and alternative
telecommunications service providers to deliver residential and
advanced enterprise managed services over the last
mile of any communications network, opening the door to
new business and revenue opportunities. The solution supports IP
connectivity via the legacy H.323 and newer session initiation
protocol (SIP) protocols for private branch
exchanges (PBXs) and a wide range of newer SIP
endpoints, such as SIP handsets. Additionally, the
Companys products support VOIP over newer access
technologies such as broadband cable, xDSL and wireless local
loop as well as emerging core network routing technologies such
as multi-protocol laser switching. Components of this solution
include:



| |   |                                       
| | - | --------------------------------------
| |  | Clarent Class 5 Call Manager;         
|
| |  | Clarent Command Center;               
|
| |  | Clarent Element Management System; and
|
| |  | Clarent Connect.                      

In 2003, the Company introduced Clarent
Class 5 Call Manager version 3.0, which interoperates with
most enterpriseclass hardware and allows carriers to
deploy high margin enterprise managed services and residential
dial tone services, further expanding the Companys
opportunity at the network edge.

Clarent®
PSTN Access Softswitch Solution

The Companys Clarent® PSTN Access
Softswitch Solution seamlessly facilitates the migration to
VoIP, allowing carriers to preserve and leverage existing
telecom investments to realize lower operating costs and lower
overall total cost of ownership. A significantly more
cost-effective and scalable alternative to traditional tandem
circuit switches, this Unix-based, software-centric, modular
tandem trunking solution enables wholesale transport and
termination of voice traffic over global IP networks. Components
of this solution include:



| |   |                                   
| | - | ----------------------------------
| |  | Clarent Class 4 Call Manager;     
|
| |  | Clarent Command Center;           
|
| |  | Clarent Element Management System;
|
| |  | Clarent SS7 Signaling; and        
|
| |  | Clarent Media Gateways.           

NACTTMPrepaid Solution

The Companys NACTTM Prepaid
Solution addresses the growing demand for high margin revenue
streams that can be launched quickly, easily and with minimal
ongoing management and maintenance. Packaged to include all
switching, call processing, routing, centralized card management
and accounting in a single, application-based switching
platform, this turn-key, reliable, customizable solution
delivers robust prepaid functionality for both VoIP and
TDM-based telephony networks. Components of this solution
include:



| |   |                                                            
| | - | -----------------------------------------------------------
| |  | NACT Class 4 communications applications;                  
|
| |  | NACT IPAX Intelligent Switching Gateways; and              
|
| |  | NACT NTS Provisioning and Operational Support
    Platform.

Enterprise Solutions Group

The Companys Enterprise Solutions Group
offers a comprehensive portfolio of products and services
designed to enable enterprises to more seamlessly and
cost-effectively manage the transition from disparate,

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legacy voice networks to a single,
highly-efficient converged voice and data network. The
Companys enterprise products are currently installed in
more than 14,000 enterprise networks around the world, including
in enterprise networks of approximately half of the Fortune 500
companies. In September 2003, the Company acquired MCK
Communications, Inc. (MCK), which improved the
Enterprise Solutions Groups distribution and engineering
capabilities.


For the year ended December 31, 2003,
revenue from the Companys Enterprise Solutions Group was
$29,754,000, or 50%, 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 for the year
ended December 31, 2003, which statements are contained
elsewhere in this Annual Report.

The Enterprise Market

As the global business environment becomes
increasingly competitive, enterprises and government entities of
all shapes and sizes are driven by a common desire to lower
operational costs, improve productivity, increase customer
retention and speed time to market. Many enterprises depend on
their technology infrastructures to help them achieve these
strategic business goals. To that end, enterprises are migrating
their legacy voice and data systems into single, converged
networks that enable more efficient use of resources and easier
integration of distributed, disparate resources, including
applications, equipment and people. As adoption of enterprise
VoIP technology continues, so does demand for new IP-centric
tools that enable businesses to manage and enhance the
performance, utilization and efficiency of their evolving
communication infrastructures.

Enterprise Solutions Group: Products and
Services

NetPerformer®Integrated Access VoIP Routers

The Companys NetPerformer line of
integrated access routers enables multi-site enterprises to
lower communications costs, alleviate bandwidth constraints,
reduce network complexity and extend telecom services to remote
locations with poor or non-existent telecom infrastructures.
This versatile line of products enables information technology
managers to integrate mission critical networks and applications
across their enterprise, regardless of where they are in the
VoIP migration process. In addition, NetPerformer enables
enterprises to dramatically reduce telecom costs by eliminating
monthly fees associated with tie lines that link remote offices
to corporate headquarters and eliminate the toll charges on
inter-office long distance calls. In 2003, the Company
introduced two new products to its NetPerformer product line:
the high performance, cost-effective NetPerformer SDM-9220 and
SDM-9230, two of the only VoIP devices that combine full router
capabilities with VoIP gateway functionality while supporting
legacy, current and next-generation SIP-based voice and data
equipment.

MCK
EXTender®Distributed
Telephony Devices

The Companys EXTender line of distributed
telephony devices allows enterprises to seamlessly integrate
branch offices and teleworkers onto a centralized, enterprise
voice network. The EXTender product family supports enterprise
VoIP migration by enabling the central phone infrastructure to
function as a company-wide voice server that transmits voice
services and applications to remote locations over a
companys existing voice and/or data networks.

TeleMate Voice
Network Intelligence Software

The Companys TeleMate voice network
intelligence software enables centralized management, control
and cost allocation of enterprise voice network resources.
TeleMate captures and consolidates data from any enterprise PBX,
IP-PBX, or telephony switching device and delivers intelligence
reports that help managers improve resource allocation, identify
usage trends, prevent fraud and meet regulatory reporting
requirements.

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NetSpective®Internet Content Filtering Solution

NetSpective® enables enterprises to monitor,
filter and/or report on usage of critical IP network resources.
With a comprehensive set of feature functionality that tracks
Internet activity and detects usage of a variety of web-based
applications, including peer-to-peer, instant messaging, online
chat and streaming media, NetSpective helps enterprises,
governments, schools and libraries maintain control of critical
network resources and facilitate compliance with filtering and
communications tracking regulations.

Customer
Response Services

The Companys Customer Response Center
(CRC) delivers full-service, custom technical
support to enterprise and carrier customers that want to ensure
satisfaction with each end-user/technology interaction. In 2003,
the Company moved Tier 1 support for all of the Companys
product lines to the CRC, allowing the Company to better
leverage resources, while ensuring the highest level of customer
support for all customers. The customer response team supports
the Companys customer base, as well a broad base of
external customers. The Companys customer response team
delivers 24 x 7 help desk support, Tier I, II and III
product support, in-sourcing, on-site deployment services,
hardware and software training, and project management resources
in support of over 21,000 end-users around the world.

Customers

For 2003, the Companys primary base of
customers in the Carrier Solutions Group included incumbent
carriers outside the U.S. (Tier 1), and emerging or
established domestic and international alternative carriers
(Tiers 2 and 3) in the U.S. and abroad, particularly
those service providers seeking to roll-out telecommunications
networks based on VoIP technology and/or implement a turn-key,
pre-paid solution. These customers are either buyers of the
Carrier Solutions Groups Clarent PSTN and Edge Access
solutions or NACT Prepaid Solutions.

In the Carrier Solutions Group, there was a
demand for its softswitch solutions from incumbent carriers and
competitive carriers in high-growth international markets such
as Europe, Asia, India, Africa and the Middle East during 2003.
In Asia, specifically, the Company has strengthened
relationships with former Clarent Corporation customers such as
China Unicom and China Telecom and has significantly expanded
its presence in the region with the opening of the
Companys first sales and support office in Beijing, China.
Equally significant, the Company made its first sale to Hinan
Mobile, a division of China Mobile, conducted new rounds of
integration testing with AT&T Hong Kong and added a new
Chinese distributor, which secured more business for the Company.

In 2003, the Company continued its aggressive
push to sell its NACT Prepaid Solution internationally, as it
believes that those markets are relatively under penetrated.
Domestically, the Company deployed its NACT solution for Yahoo!,
Inc. as part of Yahoo!s new prepaid calling card program,
called PayDirect, which was launched in the fourth quarter of
2003. In addition, the Company launched its new pre-paid
wireless solution during the third quarter.

In the Enterprise Solutions Group, the Company
continued expanding its largely indirect distribution channel,
both domestically and internationally. Demand for
NetPerformers integrated voice and data access over
satellite capability strengthened the Companys
relationship with satellite integrator NDSatcom and drove new
sales to TriPoint Globals Vertex RSI subsidiary, a leading
global satellite provider. Additionally, new distribution for
the Companys MCK EXTender product line was launched with
SBC Communications.

Currently, approximately 4,000 customers are
using the Companys TeleMate voice network intelligence
software to manage communications cost and network efficiency.
Typical end-user customers of the Companys TeleMate
product are domestic commercial enterprises or government
agencies with 100 to 10,000 employees. In the third quarter of
2003, the Company launched its latest version of TeleMate
product which includes support for IP-PBXs, targeting the market
leader Ciscos Call Manager Solution.

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

For the year ended December 31, 2003,
InterContinental Hotels Group PLC was the Companys only
customer that accounted for more than 10% of the Companys
consolidated revenues. In the year ended December 31, 2002,
InterContinental Hotels Group PLC and Telco Group, Inc. were the
Companys only customers that accounted for more than 10%
of the Companys consolidated revenues. The revenues from
InterContinental Hotels Group PLC represented approximately 11%
and 15% of the Companys consolidated revenues for the
years ended December 31, 2003 and December 31, 2002,
respectively. The revenues from Telco Group, Inc. represented
less than 12% of the Companys consolidated revenues for
the year ended December 31, 2002.

Sales and Marketing

The Companys sales and 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.

In the Carrier Solutions Group, sales are
accomplished via a combination of direct and indirect sales.
There are approximately 25 direct sales and sales support
personnel located throughout the United States, Canada, the
United Kingdom, France, Italy, China and the United Arab
Emirates. The indirect channel is represented by over 50
value-added resellers. The role of the direct sales force is not
only to generate revenue, but to also offer sales support to the
indirect channel. In the Enterprise Solutions Group, the
majority of the sales are indirect through partners such as
network integrators, value-added resellers, large stock
distributors, PBX dealers and agents consisting of over 300
companies. The Company has 26 sales associates that support the
indirect channel in revenue generation.

Competition

The Company believes that one of its competitive
strengths is the synergy across its product lines, which enables
it to accelerate development of new technologies, delivery of
new products and expansion into new markets. Through both
internal development efforts and strategic acquisitions, the
Company continues to add intellectual property and innovative,
patented technologies that deliver greater value to its
worldwide base of customers.

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 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 VocalTec are focusing on market
opportunities similar to market opportunities on which the
Company focuses, as are a number of smaller, private companies,
including Nuera Communications, Inc., Voiceware Systems
Corporation and iSoftel Ltd.

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Enterprise
Solutions Group

The Companys NetPerformer and
MCK EXTender product lines compete with the products of
communications solutions providers such as Cisco Systems, Inc.,
Motorola, Vanguard Systems and Memotec, as well as
telecommunications equipment manufacturers such as Avaya,
Nortel, Ericsson and Toshiba.

The Companys TeleMate product competes with
a number of products from companies such as IntegraTrak,
MicroTel International, Inc., and Veramark Technologies, Inc.

The Companys NetSpective products compete
with filtering products from providers such as WebTrends
Corporation, Elron Electronic Industries, Inc., SurfControl PLC
and Websense, Inc.

The Companys Customer Response Center
competes with those of companies that provide integrated,
multi-channel customer contact centers, including APAC Customer
Services, Inc., ClientLogic Corporation, Convergys Corporation
and SITEL 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 Software, Inc., a
wholly-owned subsidiary of the Company which the Company
acquired in November 2001 by means of merger
(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 a database of 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
networks 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.

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

On February 4, 2003, U.S. Patent
No. 6,516,061 was issued to MCK. The patent includes 60
claims, covering, among other things, a system which acts as a
digital set proxy for a PBX.

The Company also has several patent applications
pending relating to its VoIP products and to certain products
the Company acquired from Clarent Corporation pursuant to the
Companys acquisition of certain assets from Clarent
Corporation on February 12, 2003.

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Research and Development

The Company believes that one of its competitive
strengths is the synergy across its product lines, which enables
the Company to accelerate the development of new technologies,
the delivery of new products and expansion into new markets.
Through both internal development efforts and strategic
acquisitions, the Company continues to add intellectual property
and innovative, patented technologies that deliver greater value
to its worldwide base of customers.

The Companys research and development
expenses totaled $9.6 million for the year ended
December 31, 2003.

In the Carrier Solutions Group, the research and
development initiatives centered around introducing softswitch
features targeted toward carriers of broader scope, including
dynamic resource allocation, expanding interoperability and
third-party vendor integration, continuing the enhancement of
performance and reliability, and developing new applications for
the NACT solution, such as a pre-paid wireless solution. In
2003, the Company introduced Clarent Class 5 Call Manager
version 3.0, which interoperates with most enterprise-class
hardware and allows carriers to deploy high margin enterprise
managed services, further expanding the Companys
opportunity at the network edge.

In the Enterprise Solutions Group, the Company
invested in additional unique feature functionally for the
Telemate.Net Webfilter product as well as adding additional
functionality to the NetPerformer solution. 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 integrating various product lines. In 2003, the
Company introduced two new products to its NetPerformer product
line: the high performance, cost-effective NetPerformer SDM-9220
and SDM-9230, two of the only VoIP devices that combine full
router capabilities with VoIP gateway functionality while
supporting legacy, current and next-generation SIP-based voice
and data equipment.

Employees

As of March 10, 2004, the Company had 447
employees, 197 of whom are located at the Companys
headquarters in Atlanta, Georgia, 94 of whom are located at the
Companys NACT Telecommunications, Inc. subsidiary in
Provo, Utah, 44 of whom are located at the Companys
Clarent operations in Littleton, Colorado, 51 of whom are
located at the Companys MCK subsidiary in Boston,
Massachusetts, and 27] of whom are located at the Companys
Clarent operations in Montreal, Canada, 24 of whom are located
at the Companys MCK operations in Calgary, Canada and 10
international employees who conduct the Companys Clarent
operations 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 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

8



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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.

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 e-business 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 two 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 license product is currently
dormant.

In July 2001, the Company acquired all of the
outstanding capital stock of NACT. 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 by means of a merger, 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 with $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
contributed to the joint venture certain next-generation
communication equipment and software valued at approximately
$236,000 and $50,000 in cash. Additionally, the Company
contributed $25,000 on December 30, 2002, and $25,000 to
BeTrue on 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

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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 are recorded as an
equity investment rather than consolidated in the Companys
results.


On February 12, 2003, the Company acquired
certain operating assets and related liabilities from Clarent
Corporation. The assets purchased from Clarent Corporation
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. Specifically,
the Company acquired the Clarent Softswitch and NetPerformer
products in connection with this acquisition from Clarent
Corporation.

On September 26, 2003, the Company acquired
MCK by means of a merger, pursuant to which MCK became a
wholly-owned subsidiary of the Company. MCK is a provider of
products that deliver distributed voice communications by
enabling businesses to extend the functionality and applications
of their business telephone systems from the main office to
outlying offices, remote call centers, teleworkers and mobile
employees over public and private networks.

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
$119,000 per month, plus a share of operating expenses, through
February 2010. Additionally, the Company is also obligated
through January 2010 to pay rent of $31,000 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 has subleased the 13,000 square feet of
space at the Atlanta facility for $17,700 per month through
November 2006 and $12,900 per month from December 2006 through
January 2010.

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

In connection with the purchase of substantially
all of the operating assets of Clarent Corporation in February
2003, 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 Enterprise Solutions Group. The Company is
obligated to pay rent of approximately $10,400 per month through
the termination of the lease in October 2006. The Company
subsequently assigned the second lease to Clarent Canada Ltd., a
wholly-owned subsidiary of the Company which the Company
acquired pursuant to the such 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 Enterprise Solutions Group.
Clarent Canada is obligated to pay $2,900 per month, plus a
share of operating expenses, until the lease terminates in May
2007.

Also in connection with the purchase of
substantially all of the operating assets of Clarent Corporation
in February 2003, 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 purposes related
to 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.

MCK is obligated on a lease for 16,700 square
feet of office space in Dallas, Texas through August 31,
2004, at rent of $10,945 per month. MCK has subleased the entire
space for the remainder of the term of the

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lease. MCK is also obligated on a lease for
48,886 square feet of office space and research and development
facilities in Needham, Massachusetts through May 31, 2007,
at rent of $109,739 per month until June 1, 2003, and
$113,863 per month thereafter until May 31, 2007. MCK has
subleased 32,665 square feet of such space through May 31,
2007, at a rent of $57,163 per month. MCKs operations
occupy 6,145 square feet of the space originally leased in
Needham, Massachusetts, and MCK is actively attempting to
sublease the remaining 10,076 square feet of such space.


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 are not
expected to have a material adverse impact on the Companys
results of operations or financial condition. In addition, the
Company or its subsidiaries are a party to the proceedings
discussed below.

In December 2001, a complaint was filed in the
Southern District of New York seeking an unspecified amount of
damages on behalf of an alleged class of persons who purchased
shares of MCKs common stock between the date of MCKs
initial public offering and December 6, 2000. The complaint
named as defendants MCK and certain of its former officers and
other parties as underwriters of its initial public offering
(the MCK defendants). The plaintiffs allege, among
other things, that MCKs prospectus, contained in the
Registration Statement on Form S-1 filed with the SEC, was
materially false and misleading because it failed to disclose
that the investment banks which underwrote MCKs initial
public offering of securities and others received undisclosed
and excessive brokerage commissions, and required investors to
agree to buy shares of securities after the initial public
offering was completed at predetermined prices as a precondition
to obtaining initial public offering allocations. The plaintiffs
further allege that these actions artificially inflated the
price of MCKs common stock after the initial public
offering. This case is one of many with substantially similar
allegations known as the Laddering Cases filed
before the Southern District of New York against a variety of
unrelated issuers (the Issuers), directors and
officers (the Laddering Directors and Officers) and
underwriters (the Underwriters), and have been
consolidated for pre-trial purposes before one judge to assist
with administration. A motion to dismiss addressing issues
common to the companies and individuals who have been sued in
these actions was filed in July 2002. After a hearing on the
motion to dismiss the Court, on February 19, 2003, denied
dismissal of the claims against MCK as well as other Issuers.
Although MCK believes that the claims asserted are meritless,
MCK and other Issuers have negotiated a tentative settlement
with the plaintiffs. The terms of the tentative settlement
agreement provide, among other things, that (i) the
insurers of the Issuers will deliver a surety undertaking in the
amount of $1 billion payable to the plaintiffs to settle
the actions against all Issuers and the Laddering Directors and
Officers; (ii) each Issuer will assign to a litigation
trust, for the benefit of the plaintiffs, any claims it may have
against its Underwriters in the initial public offering for
excess compensation in the form of fees or commissions paid to
such Underwriters by their customers for allocation of initial
public offering shares; (iii) the plaintiffs will release
all claims against the Issuers and the Laddering Directors and
Officers asserted or which could have been asserted in the
actions arising out of the factual allegations of the amended
complaints; and (iv) appropriate releases and bar orders
and, if necessary, judgment reductions, will be entered to
preclude the Underwriters and any non-settling defendants from
recovering any amounts from the settling Issuers or the
Laddering Directors and Officers by way of contribution or
indemnification. Prior to the Companys acquisition of MCK,
MCKs board of directors voted to approve the tentative
settlement. The proposed settlement is subject to acceptance by
the other Issuers and court approval. No provision was recorded
for this matter in the financial statements of MCK prepared
prior to its acquisition by the Company because MCK believed
that its portion of the proposed settlement would be paid by its
insurance carrier. The Company agrees with MCKs treatment
of this matter.

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While a final agreement has not been executed,
MCK expects to finalize the agreement in the next several months.


MCK has been named a defendant in a lawsuit filed
in Norfolk County, Massachusetts by Entrata Communications, Inc.
(Entrata). Entrata Communications, Inc. v.
Superwire.com, Inc. and MCK arises out of a dispute between
Entrata and one of its largest shareholders, Superwire.com, Inc.
(Superwire). Pursuant to a contract with Entrata,
MCK was obligated to pay Entrata $750,000 in early 2002. In
order to take advantage of a $100,000 discount offered for early
payment, MCK paid Entrata $650,000 in November 2001, in full
satisfaction of its contractual obligations. The funds were
placed in escrow with Superwires California law firm,
Jeffers, Shaff & Falk, LLP (JSF), which
agreed not to disburse the funds until the dispute between
Entrata and Superwire had been resolved. Nevertheless, Entrata
contends that it never received the funds from MCK and that the
funds were diverted to Superwire and JSF. Through the lawsuit,
Entrata seeks to recover from both MCK and Superwire the
$750,000 that MCK would have owed in 2002. MCK has asserted
counterclaims against Entrata, and cross-claims against
Superwire, for fraud and breach of contract. On October 11,
2002, Superwire and Entrata filed cross-motions for summary
judgment against each other. The court denied both motions on
March 13, 2003. Following denial of the cross-motions for
summary judgment, MCK filed a motion to add JSF and two of its
partners, Barry D. Falk and Mark R. Ziebell, as
third-party defendants. The court had given the parties until
March 17, 2004 to complete discovery. Before the completion
of the discovery period, Entrata filed a Chapter 7
bankruptcy proceeding pursuant to the United States Bankruptcy
Code. MCK has not as of yet been notified by the trustee of
Entratas estate as to whether the trustee will pursue the
claims against MCK. If such claims are pursued, then the Company
intends to defend such claims and prosecute its counterclaims
and third-party claims. No amounts, other than the original
payment, were provided for this matter in the financial
statements of MCK prepared prior to its acquisition by the
Company. The Company believes that the claim against MCK is
without merit, and no amount has been accrued for this matter at
December 31, 2003.



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

The Annual Meeting of Shareholders of the Company
was held on December 17, 2003, in Atlanta, Georgia (the
Meeting). At the Meeting, the shareholders of the
Company voted on proposals to (i) 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; and (ii) to ratify the appointment of KPMG LLP
as the independent auditors of the Company for the year ending
December 31, 2003. The results of the vote with respect to
the election of directors were as follows:

|                      |  |     |            |                    |  |  |            | 
|--------------------- |  | --- | ---------- | ------------------ |  |  | ---------- | 
|Director Nominee      |  | For |            | Withheld Authority
|                      |  |     |            |                   
|Paul R. Garcia        |  |     | 93,084,663 |                    |  |  | 3,334,230  | 
|Gary H. Heck          |  |     | 92,634,585 |                    |  |  | 3,784,308  | 
|James M. Logsdon      |  |     | 77,455,658 |                    |  |  | 18,963,235 | 
|Amy L. Newmark        |  |     | 92,586,718 |                    |  |  | 3,832,175  | 
|Steven A. Odom        |  |     | 77,355,972 |                    |  |  | 19,062,921 | 
|Stephen E. Raville    |  |     | 92,994,878 |                    |  |  | 3,424,015  | 
|Juliet M. Reising     |  |     | 78,748,118 |                    |  |  | 17,670,775 | 
|Joseph R. Wright, Jr. |  |     | 93,000,355 |                    |  |  | 3,418,538  | 

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

The results of the vote with respect to the
ratification of the appointment of independent auditors were as
follows:

92,894,025     FOR                    3,452,969     AGAINST                    71,872     ABSTAIN

There were 27 broker non-votes with respect to
the ratification of the appointment of independent auditors.

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The foregoing proposals were set forth and
described in the Notice of Annual Meeting of Shareholders and
Proxy Statement of the Company dated November 12, 2003.

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 8, 2004, of such officer:

|                  |  |     |    |          |  |                                                                               
|----------------- |  | --- | -- | -------- |  | ------------------------------------------------------------------------------
|Name              |  | Age |    | Position
|                  |  |     |    |         
|Steven A. Odom    |  |     | 50 |          |  | Chairman of the Board and Chief Executive Officer                             
|Gary H. Heck      |  |     | 59 |          |  | President and Chief Operating Officer                                         
|Juliet M. Reising |  |     | 53 |          |  | Executive Vice President, Chief Financial
    Officer, Secretary and Treasurer

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

Steven A. Odomhas
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 Chief Executive Officer of World Access,
Inc., a provider of voice, data and Internet products and
services around the world (World Access). From June
1998 until June 1999, Mr. Odom also served as Chairman of
the Board of World Access. 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.

Gary H. Heckhas
served as the President and Chief Operating Officer of the
Company since February 23, 2004, and has served as a
director of the Company since September 2000. Mr. Heck also
served as a member of the Companys compensation committee
(the Compensation Committee) until February 23,
2004. 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, he 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.

Juliet M. Reisinghas served as Executive Vice President, Chief Financial Officer,
Treasurer, Secretary and a director of the Company since
September 2000. Ms. Reising also served as 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

13



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software development company. From August 1995 to
September 1997, she 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
Item 11  Executive
Compensation  Employment Agreements and as
disclosed in the section of this Annual Report titled
Item 13  Certain Relationships and Related
Transactions, 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 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, 2003: |                |      |   |      |  |  |   |     
|                              | First Quarter  |      | $ | 0.71 |  |  | $ | 0.40 | 
|                              | Second Quarter |      |   | 1.84 |  |  |   | 0.43 | 
|                              | Third Quarter  |      |   | 5.22 |  |  |   | 1.70 | 
|                              | Fourth Quarter |      |   | 4.70 |  |  |   | 2.86 | 
|Year ended December 31, 2002: |                |      |   |      |  |  |   |     
|                              | First Quarter  |      | $ | 1.83 |  |  | $ | 0.97 | 
|                              | Second Quarter |      |   | 1.21 |  |  |   | 0.44 | 
|                              | Third Quarter  |      |   | 0.60 |  |  |   | 0.25 | 
|                              | Fourth Quarter |      |   | 0.76 |  |  |   | 0.22 | 

As of March 8, 2004, there were
approximately 1,742 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, prohibits the payment
of cash dividends on the Common Stock without Silicon Valley
Banks prior written consent.

In connection with the private placement of
securities conducted by the Company in October 2002, during the
quarter ended December 31, 2003, the Company issued to 26
individuals an aggregate of 9,646,302

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##### 



shares of Common Stock upon exercise by such
individuals of warrants to purchase shares of Common Stock
issued in connection with such private placement. In connection
with the exercise of such warrants, the Company received payment
of an exercise price of $0.311 per share. The shares issued to
the individuals were issued without registration under the
Securities Act of 1933, as amended (the Securities
Act), in reliance upon the exemption from registration set
forth in Section 4(2) of the Securities Act
(Section 4(2)) and Regulation D
promulgated pursuant to Section 4(2)
(Regulation D). The Company based such reliance
upon factual representations made to the Company by each
individual as to such individuals investment intent,
sophistication and status as an accredited investor
as that term is defined in Rule 501 of Regulation D,
among other things.


On October 29, 2003, the Company issued to
Silicon Valley Bank (i) 350,000 shares of Common Stock upon
exercise by Silicon Valley Bank of a warrant to purchase such
shares of Common Stock and payment to the Company of an exercise
price of $0.44 per share and (ii) 352,295 shares of Common
Stock upon exercise by Silicon Valley Bank of a warrant to
purchase such shares of Common Stock and payment to the Company
of an exercise price of $0.71 per share. The shares issued to
Silicon Valley Bank upon exercise of the warrants were issued
without registration under the Securities Act in reliance upon
the exemption from registration set forth in Regulation D.
The Company based such reliance upon factual representations
made to the Company by Silicon Valley Bank as to its investment
intent, sophistication, and status as an accredited investor,
among other things.

Between October 20, 2003 and
December 1, 2003, the Company issued an aggregate of
250,000 shares of Common Stock to an investment bank and
five of its affiliates upon exercise of warrants to purchase
such shares held by such investment bank and affiliates and
payment to the Company of an exercise price of $1.00 per share.
The shares issued to such investment bank and its affiliates
were issued without registration under the Securities Act in
reliance upon the exemption from the registration set forth in
Regulation D. The Company based such reliance upon factual
representations made to the Company by each recipient of the
shares as to such recipients investment intent,
sophistication, and status as an accredited investor, among
other things.

Between October 31, 2003 and
November 14, 2003, the Company issued an aggregate of
427,584 shares of Common Stock to a registered broker
dealer and its affiliates upon exercise of warrants held by such
broker dealer and affiliates to purchase such shares and payment
to the Company of an aggregate exercise price of $1,218,225,
with exercise prices per share ranging from $2.11 to $3.09. The
shares issued to such registered broker dealer and its
affiliates were issued without registration under the Securities
Act in reliance upon the exemption from the registration set
forth in Section 4(2). The Company based such reliance upon
factual representations made to the Company by each recipient of
the shares as to such recipients investment intent and
sophistication, 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

15



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Company. The historical results are not
necessarily indicative of future results. All amounts in
thousands except per share data.


|                                                                         |  |                          |         |         |  |         |        |         |  |         |         |   |  |   |         |   |  |   |        |  
|------------------------------------------------------------------------ |  | ------------------------ | ------- | ------- |  | ------- | ------ | ------- |  | ------- | ------- | - |  | - | ------- | - |  | - | ------ | -
|                                                                         |  |                         
|                                                                         |  | Years Ended December 31,
|                                                                         |  |                         
|                                                                         |  | 2003(2)                  |         | 2002(3) |  | 2001(4) |        | 2000(5) |  | 1999(6)
|                                                                         |  |                          |         |         |  |         |        |         |  |        
|Statement of Operations
    Data(1):                                     |  |                          |         |         |  |         |        |         |  |         |         |   |  |   |         |   |  |   |        |  
|Revenue                                                                  |  | $                        | 59,498  |         |  | $       | 44,798 |         |  | $       | 29,899  |   |  | $ | 12,732  |   |  | $ | 10,017 |  
|Loss from Continuing Operations                                          |  |                          | (18,287 | )       |  |         | (2,395 | )       |  |         | (11,517 | ) |  |   | (12,532 | ) |  |   | (5,361 | )
|Loss from Continuing Operations per Common
    Share  basic and diluted |  |                          | (0.18   | )       |  |         | (0.03  | )       |  |         | (0.21   | ) |  |   | (0.48   | ) |  |   | (0.23  | )
|Balance Sheet Data:                                                      |  |                          |         |         |  |         |        |         |  |         |         |   |  |   |         |   |  |   |        |  
|Total Assets(7)                                                          |  |                          | 63,252  |         |  |         | 39,835 |         |  |         | 45,159  |   |  |   | 175,473 |   |  |   | 56,054 |  
|Long-term Liabilities, net of current portion                            |  |                          | 9,102   |         |  |         | 6,133  |         |  |         | 5,200   |   |  |   | 3,153   |   |  |   |       |  



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes the continuing operations of the
    following entities or divisions acquired by the Company from
    their respective dates of acquisition: Customer Response Center,
    a division of Encore Systems, Inc. (September 1, 1998);
    MessageClick (November 22, 2000); NACT (July 27,
    2001); Telemate.Net (November 16, 2001); and MCK
    (September 26, 2003). Also includes the continuing
    operations of assets acquired by the Company from Clarent
    Corporation on February 12, 2003.
|   
|(2) | The fiscal year 2003 loss from continuing
    operations includes $1.3 million of intangibles
    amortization, $780,000 in amortization of deferred compensation,
    $10.9 million by write-down of goodwill and $612,000 in
    non-cash interest related to the amortization of the discount on
    notes payable and convertible subordinated debentures and loan
    fees.                                                                                                                                
|   
|(3) | 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, and a $350,000 gain on early
    retirement of debt.                                                                                                                                  
|   
|(4) | 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, and a $1,640,000 loss on debt
    conversion.                                                                                                                                     
|   
|(5) | 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.                                                                                                   
|   
|(6) | The fiscal year 1999 loss from continuing
    operations includes $982,000 in goodwill amortization and
    $543,000 in merger-related transaction and reorganization costs.                                                                                                                                                                                                                                                                                                                                    
|   
|(7) | Includes $0, $0, $582,000, $153.0 million
    and $47.2 million of assets of discontinued operations, as
    of December 31, 2003, 2002, 2001, 2000 and 1999,
    respectively. The assets of discontinued operations on December
    2000 and 1999 included intangible assets totaling
    $119.2 million and $12.8 million, respectively.                                                                                                                                                                     



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

Overview

Following the acquisition of NACT in 2001, the
Company began selling products to the carrier market and
focusing its strategic direction on developing and marketing
next-generation communications products. The Companys
current business was built on acquisitions made by the Company
by leveraging the economic downturn in the telecommunications
area. In the second half of 2001, the Company acquired NACT and
Telemate.Net; Telemate.Net products are sold to enterprise
customers. Both of these companies sold products almost
exclusively in domestic markets. In the first quarter of 2003,
the Company acquired substantially all of

16



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##### 



the operating assets of Clarent Corporation,
which provided the Company with patented VoIP technologies for
both the carrier and enterprise markets (primarily serving
international markets) and significantly increased the
Companys market share in the worldwide softswitch market.
At the end of the third quarter, of 2003, the Company acquired
MCK and added MCKs integrated access routers and
distributed telephony devices products to the Companys
enterprise segment. For the year ended December 31, 2003,
78% of the Companys consolidated revenues came from these
four acquisitions and 38% of the Companys consolidated
revenues came from the two acquisitions made by the Company in
2003.


The Companys strategy through 2003 was to
add next-generation communications products to its suite of
products through strategic acquisitions and to leverage these
operations through cost reductions to enhance cash flow. With
the acquisition of substantially all of the operating assets of
Clarent Corporation, the Company enhanced its strategy to move
its growth toward international markets. International revenue
increased to 35% of the Companys consolidated revenues for
2003 versus 8% of the Companys consolidated revenues for
2002. As the acquisition of substantially all of the operating
assets of Clarent Corporation was funded primarily by short-term
seller financing, generating cash flow during 2003 was extremely
important to the Company. As such, the Company leveraged its
combined operations, reducing sales, general and administrative
costs (as compared to costs prior to the acquisition), while
preserving the research and development expenditures, which are
vital to the Companys long-term growth and viability.

Through 2003, the Companys focus has been
on completing strategic acquisitions, integrating these
acquisitions and enhancing cash flow through cost containment,
especially in the sales and marketing area. In the fourth
quarter of 2003, the Company believed that its revenues declined
largely due to the limited sales and marketing expenditures.
Going forward, the Company intends to significantly increase its
expenditures for sales and marketing and focus on growing
revenues organically. In the first quarter of 2004, the Company
completed a private placement and raised approximately
$16.3 million, net of expenses, to fund the expanded sales
and marketing programs. The Company expects that these
additional expenditures will significantly increase the
operating loss in 2004 as compared to 2003, excluding the
write-down of goodwill in 2003.

General

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 includes the Companys Clarent
softswitching division and the Companys subsidiary NACT,
and the Enterprise Solutions Group, which includes the
Companys Clarent NetPerformer division, the Companys
subsidiaries Telemate.Net and MCK and the Companys
customer response center operations. 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 hardware-based
solutions (which include software) for companies seeking to
build private, packet-based voice and data networks.
Additionally, the Enterprise Solutions Group offers
software-based solutions for Internet access and usage
management that include call accounting and usage reporting for
IP network devices. These solutions are supported by the
Companys customer response center services, which include
outsourced technical support and application installation and
training services. The Company acquired MCK in September 2003,
substantially all the business assets of Clarent in February
2003, 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 MCK, Telemate.Net, NACT and Clarent Canada Ltd.

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.

17



---



##### 



Results of Operations

Fiscal Year
2003 Compared with Fiscal Year 2002

For the year ended December 31, 2003, the
Companys net loss totaled $18.3 million, or $0.18 per
share, compared with a net loss of $2.7 million, or $0.03
per share, for the same period in 2002. The 2003 results
included $1.3 million in amortization of intangibles,
$780,000 in amortization of deferred compensation,
$10.9 million in write-down of goodwill and $425,000 in
reorganization costs. The 2002 results included $592,000 in
amortization of intangibles, $1.2 million in amortization
of deferred compensation, $324,000 in reorganization costs, a
gain on early retirement of debt totaling $350,000 and a loss
from discontinued operations of $331,000.

Total revenue was $59.5 million in the year
ended December 31, 2003, reflecting a 33% increase from
2002. Product revenue increased from $23.0 million to
$36.4 million, $2.5 million net increase from the
Carrier Group attributable to Clarent (softswitch) net of
decline in NACT sales and $10.8 million increase from the
Enterprise Group, primarily attributable to MCK and Clarent
(NetPerformer) product sales. In 2003, the Company began
redirecting its focus for NACT products sales away from its
historic market, primarily emerging domestic carriers (which
market was consolidating) towards carriers in the international
market. At the same time, the Company reduced its sales and
marketing expenditures for NACT in an across the board cost
reduction initiative required to enable the Clarent acquisition.
These events negatively impacted the revenue for NACT for 2003.
Services revenue was $23.1 million in the year ended
December 31, 2003, reflecting a 6% increase from the same
period in 2002. Gross profit increased by $6.4 million in
the year ended December 31, 2003, and was 55% of revenue in
2003, compared with 59% of revenue for 2002. The increase in
gross profit dollars resulted primarily from the increase in
revenues. The decrease in gross profit percentage is related to
lower margins on Carrier Solutions Group due to reduced margins
on NACT sales combined with the margins from the Companys
Clarent softswitching division, which has lower margins than the
Company experienced in the past.

Total operating expenses incurred in continuing
operations for the year ended December 31, 2003, were
$50.0 million, an increase of $21.3 million compared
to the same period in 2002. The increase is primarily
attributable to the following items: increases in general and
administrative expenses of $3.2 million, sales and
marketing expenses of $2.8 million, research and
development expenses of $3.8 million, depreciation expense
of $170,000, amortization of intangibles of $725,000, the
write-down of goodwill of $10.9 million and reorganization
costs of $101,000 offset by a decrease in amortization of
deferred compensation of $393,000.

The increase in general and administrative
expenses resulted from the addition of personnel and related
costs related to the acquisitions of MCK and substantially all
the business assets of Clarent totaling approximately
$2.4 million, an increase in general and administrative
expenses at NACT of $494,000 related primarily to bad debts and
an increase in corporate general and administrative expenses of
approximately $398,000. The increase in corporate general and
administrative expenses resulted primarily from increases in
personnel related costs and insurance and travel costs related
to the operations of the MCK and Clarent acquisitions during
2003.

The increase in sales and marketing expenses
resulted from the addition of personnel and related costs
related to the acquisitions of MCK and substantially all the
business assets of Clarent, totaling $4.9 million offset by
overall decreased expenses related to on-going cost reduction
initiatives of $2.1 million.

The increase in research and development is
primarily related to research and development activities at the
Companys MCK, Clarent softswitching division and Clarent
NetPerformer division of $4.6 million, net of reductions in
other product groups.

The increase in depreciation expense is primarily
related to the fixed assets recorded in connection with the
acquisition of MCK and substantially all the business assets of
Clarent of $2.0 million, as well as, the increases related
to the purchase of furniture and equipment of approximately
$1.5 million and $889,000 during 2003 and 2002,
respectively, offset by decreases related to fully-depreciated
assets. Capital expenditures are primarily depreciated on a
straight-line basis over an estimated useful life of three years.

18



---



##### 



The increase in intangible amortization is
primarily related to the amortization of other intangible assets
related to the acquisitions of MCK and substantially all the
business assets of Clarent and the amortization of the customer
relationship costs related to the 1998 acquisition of Encore
Group as recorded in the fourth quarter of 2002 as a result of
the earn-out component of that acquisition.

The write-down of goodwill relates to the
acquisition of MCK. In April 2003, the Company negotiated the
original agreement to purchase MCK in which the MCK stockholders
would be entitled to receive approximately 20.0 million
shares of the Companys Common Stock which was valued at
$13.0 million, based on the volume weighted average closing
price per share of the Companys Common Stock as reported
on the Nasdaq SmallCap Market for the 20 trading day period
beginning March 19, 2003 and ending April 15, 2003. As
part of the original agreement, the Company was to receive
$7.5 million in cash. The terms of the agreement were
amended on June 13, 2003. Under the amended terms, MCK
stockholders were entitled to receive approximately
18.3 million shares of the Companys Common Stock and
the cash MCK was required to have at the closing of the merger
was reduced from $7.5 million to approximately
$6.4 million. Although the number of shares of the
Companys Common Stock to be issued in the merger was
reduced by the amendment, the amendment changed the measurement
date for valuing such shares. As a result of the increase in the
price of the Companys Common Stock, prior to June 13,
2003, the revised valuation for the shares of the Companys
Common Stock to be issued in the merger increased to
$24.1 million. As a result of this increase in value, the
goodwill recorded in the merger was impaired upon closing the
merger. The Company completed an impairment analysis in
accordance with SFAS No. 142, Goodwill and Other
Intangible Assets (SFAS No. 142). Based
upon this analysis, the Company recorded a write-off of
approximately $10.9 million during the year ended
December 31, 2003.

In the first and third quarters of 2003, the
Company announced reorganizations to accommodate the acquisition
of the assets of Clarent and, as a part of its effort to
consolidate functions and improve operational efficiencies, the
Company eliminated 25 positions held by employees. As a result
of these actions, the Company recorded reorganization costs of
$425,000 during the year ended December 31, 2003. The
reorganization costs consist of severance costs and non-cash
stock compensation expense related primarily to the acceleration
of vesting of options. Annualized savings are expected to be
approximately $1.9 million.

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.

The $393,000 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 acquisitions 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.

As a percent of revenue, operating expenses from
continuing operations were 84% during the year ended
December 31, 2003, up from 64% for the same period in 2002.

Other income was $338,000 during the year ended
December 31, 2003, compared with $881,000 for the same
period in 2002. Included in other income during the year ended
December 31, 2003 was $323,000 of non-recurring
transactions related to the sale of non-operating assets.
Included in other income during the year ended December 31,
2002 was a gain of $350,000 on early retirement of debt and
$254,000 of non-recurring transactions related to health
insurance proceeds and sale of non-operating assets.

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 Company paid
$1.4 million plus accrued interest and recognized a gain on
early retirement of debt of $350,000.

Equity in income of BeTrue was $73,000 during the
year ended December 31, 2003, compared to equity in loss of
investment of $5,000 in 2002. This amount represents the
Companys portion of BeTrues income or

19



---



##### 



losses since the Companys acquisition of a
51% interest in BeTrue on October 1, 2002. Due to the
shared decision making between the Company and its equity
partner, the results of BeTrue are treated as an equity
investment rather than being consolidated.


Net interest expense was $1.5 million during
the year ended December 31, 2003, an increase of $367,000
compared to the same period in 2002. The increase was
attributable to increased borrowings on the Companys line
of credit and notes payable for the acquisition of assets from
Clarent, net of reductions related to the interest on the
deferred payment due for the purchase of NACT and interest
income on notes receivable from shareholders.

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.

Business Unit
Performance

|                                                          |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |         |         |   |        |        |        |  
|--------------------------------------------------------- | ------------------------------- | ------------------------------- | ------ | -------------------- |  | ------------ | ------ | ---- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | ------- | ------- | - | ------ | ------ | ------ | -
|                                                          |                                 |                                 |        |                      |  |              |        |     
|                                                          |                                 | Carrier Solutions               |        | Enterprise Solutions |  |             
|                                                          |                                 | Group                           |        | Group                |  | Consolidated
|                                                          |                                 |                                 |        |                      |  |             
|                                                          |                                 |                                
|                                                          |                                 | For the Year Ended December 31,
|                                                          |                                 |                                
|                                                          |                                 | 2003                            |        | 2002                 |  | 2003         |        | 2002 |  | 2003 |        | 2002
|                                                          |                                 |                                 |        |                      |  |              |        |      |  |      |        |     
|                                                          |                                 |                                
|                                                          |                                 | (Dollars in thousands)         
|Revenue                                                   |                                 | $                               | 29,744 |                      |  | $            | 26,319 |      |  | $    | 29,754 |      |  | $ | 18,479 |   |  | $ | 59,498 |         |         | $ | 44,798 |       
|Gross profit                                              |                                 |                                 | 16,042 |                      |  |              | 16,378 |      |  |      | 16,732 |      |  |   | 9,971  |   |  |   | 32,774 |         |         |   | 26,349 |       
|Gross margin                                              |                                 |                                 | 54     | %                    |  |              | 62     | %    |  |      | 56     | %    |  |   | 54     | % |  |   | 55     | %       |         |   | 59     | %     
|General and administrative                                |                                 |                                 | 5,238  |                      |  |              | 3,901  |      |  |      | 2,135  |      |  |   | 1,154  |   |  |   | 7,373  |         |         |   | 5,055  |       
|Sales and marketing                                       |                                 |                                 | 4,243  |                      |  |              | 3,573  |      |  |      | 4,366  |      |  |   | 2,190  |   |  |   | 8,609  |         |         |   | 5,763  |       
|Research and development                                  |                                 |                                 | 6,756  |                      |  |              | 5,417  |      |  |      | 2,874  |      |  |   | 457    |   |  |   | 9,630  |         |         |   | 5,874  |       
|                                                          |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |         |         |   |        |       
|Contribution (loss) before unallocated items              |                                 | $                               | (195   | )                    |  | $            | 3,487  |      |  | $    | 7,357  |      |  | $ | 6,170  |   |  |   | 7,162  |         |         |   | 9,657  |       
|                                                          |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |         |         |   |        |       
|Unallocated items                                         |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |         |         |   |        |       
|Corporate, sales, general and administrative
    expenses |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | 8,000  |         |         |   | 7,168  |       
|                                                          | Depreciation                    |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 2,900   |         |   |        | 2,730  |       
|                                                          | Amortization of intangibles     |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 1,317   |         |   |        | 592    |       
|                                                          | Deferred compensation           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 780     |         |   |        | 1,173  |       
|                                                          | Write-down of goodwill          |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 10,930  |         |   |        |       |       
|                                                          | Reorganization costs            |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 425     |         |   |        | 324    |       
|                                                          |                                 | Operating loss                  |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |         | (17,190 | ) |        |        | (2,330 | )
|                                                          |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |         |         |   |        |       
|Other income                                              |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | 338    |         |         |   | 881    |       
|Equity in income (loss) of investment                     |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | 73     |         |         |   | (5     | )     
|Interest expense, net                                     |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | (1,508 | )       |         |   | (1,141 | )     
|Income tax benefit                                        |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |       |         |         |   | 200    |       
|                                                          |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |         |         |   |        |       
|                                                          | Loss from continuing operations |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | $      | (18,287 | )       |   | $      | (2,395 | )     
|                                                          |                                 |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |         |         |   |        |       

Carrier
Solutions Group

Total revenue from the Companys Carrier
Solutions Group was $29.7 million in the year ended
December 31, 2003, a 13% increase from the same period in
2002. The net increase in revenue is attributable to Clarent
product sales offset by a decrease in NACT product sales. In
2003, the Company began redirecting its focus for NACT products
sales away from its historic market, primarily emerging domestic
carriers (which

20



---



##### 



market was consolidating) towards carriers in the
international market. At the same time, the Company reduced its
sales and marketing expenditures for NACT in an across the board
cost reduction initiative required to enable the Clarent
acquisition.


Gross profit decreased by $336,000 in the year
ended December 31, 2003, and was 54% of revenue, a decrease
from 62% of revenue in the same period in 2002. The decrease in
gross profit dollars and gross margin reflects the reduced
margin on NACT sales combined with the margins from the
Companys Clarent softswitching division, which has lower
margins than the Company experienced in the past.

Allocated operating expenses incurred in the
Carrier Solutions Group for the year ended December 31,
2003, were $16.2 million, an increase of $3.3 million
compared to the same period in 2002. The increase in general and
administrative expenses reflects the Companys acquisition
of Clarents business assets in February 2003 and
additional bad debt expense at NACT. The increase in sales and
marketing expenses and research and development expenses reflect
increases related to the Companys acquisition of
Clarents business assets in February 2003 offset by cost
savings in the operations of NACT. As a percent of revenue,
operating expenses for the Carrier Solutions Group were 55%
during the year ended December 31, 2003 up from 49% during
the same period in 2002.

Enterprise
Solutions Group

Total revenue for the Companys Enterprise
Solutions Group was $29.8 million in the year ended
December 31, 2003, a 61% increase from 2002. The increase
in revenue is primarily related to the Companys
acquisitions: MCK in September 2003 and Clarents
Netperformer division in February 2003.

Gross profit increased by $6.8 million in
the year ended December 31, 2003 and was 56% of revenue
compared with 54% for 2002. The Companys addition of MCK
in September 2003 and Clarents Netperformer division in
February 2003 were the primary cause of the increase in gross
profit dollars and percentage.

Allocated operating expenses incurred in
Enterprise Solutions Group for the year ended December 31,
2003, were $9.4 million, an increase of $5.6 million
compared to the same period in 2002. The increases in general
and administrative expenses, sales and marketing expenses and
research and development expenses relates to the addition of MCK
in September 2003 and Clarents Netperformer division in
February 2003. As a percent of revenue, allocated operating
expenses for Enterprise Solutions Group were 32% during the year
ended December 31, 2003, up from 21% during the same period
in 2002. The increase is primarily attributable to the increase
in research and development expenses as a percentage of revenue
related to the operations of the Companys MCK and Clarent
Netperformer divisions.

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 its legacy
VAR business. Accordingly, the Company elected to report its
legacy VAR business as discontinued operations by early adoption
of SFAS No. 144. The consolidated financial statements have
been reclassified to segregate the net assets and operating
results of this business segment.

There were no results of discontinued operations
for the year ended December 31, 2003. Summary operating
results of the discontinued operations for the year ended
December 31, 2002 (in thousands) were as follows:

|                                  |  |   |      |  
|--------------------------------- |  | - | ---- | -
|Revenue                           |  | $ | 223  |  
|                                  |  |   |      |  
|Gross loss                        |  | $ | (331 | )
|                                  |  |   |      |  
|Operating loss                    |  | $ | (331 | )
|                                  |  |   |      |  
|Loss from discontinued operations |  | $ | (331 | )
|                                  |  |   |      |  

21



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##### 



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 a $350,000 gain on early retirement of debt. 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 a $1.6 million loss from debt
conversion.

Continuing Operations

For the year ended December 31, 2002, the
Companys net loss from continuing operations totaled
$2.4 million, or $0.03 per share, compared with a net loss
of $11.5 million, or $0.21 per share, for 2001. The 2002
results included $592,000 in amortization of intangibles,
$1.2 million in amortization of deferred compensation,
$324,000 in reorganization costs and a $350,000 gain on early
retirement of debt. The 2001 results included $1.5 million
in amortization of intangibles, $1.8 million in
amortization of deferred compensation and a $1.6 million
loss on debt conversion.

Total revenue was $44.8 million in the year
ended December 31, 2002, reflecting a 50% increase from
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 attributable
to the following items: increases in sales and marketing
expenses of $3.5 million, research and development of
$3.1 million, depreciation expense of $570,000 and
reorganization costs of $324,000 offset by decreases in general
and administrative expenses of $1.1 million, intangible
amortization of $919,000 and amortization of deferred
compensation of $593,000.

The increase in sales and marketing expenses
resulted from the addition of personnel and related costs
related to the acquisitions of NACT in July 2001 of
approximately $2.3 million and Telemate.Net in November
2001 of approximately $1.3 million.

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.

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.

The decrease in general and administrative
expenses resulted from on-going cost reduction initiatives
resulting in reduced personnel, telecom and other general and
administrative expenses in the corporate and customer response
center operations of approximately $2.8 million offset by
the addition of personnel and

22



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##### 



related costs related to acquisitions of NACT in
July 2001 of approximately $1.6 million and Telemate.Net in
November 2001 of approximately $114,000.


The $919,000 decrease in intangible amortization
is primarily related to the adoption of 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.

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 $881,000 during the year ended
December 31, 2002, compared with expense of
$1.4 million for the same period in 2001. Included in other
income during the year ended December 31, 2002 was a
$350,000 gain on early retirement of debt and $254,000 of
non-recurring transactions related to health insurance proceeds
and sale of non-operating assets. The Company incurred a loss of
$1.6 million in 2001 on debt conversion, as more fully
described below.

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 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 945,378 shares of Common Stock at an
exercise price of $1.64 per share. The cost of this conversion
and early retirement of debt totaled $1.6 million.

Equity in loss of investment 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
Valley Bank, the Companys primary lender, in connection
with the Companys credit facility with Silicon Valley Bank.

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.

23



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##### 



Business Unit
Performance

|                                      |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |         |        |  
|------------------------------------- | --------------------------------------------------------- | ------------------------------- | ------ | -------------------- |  | ------------ | ------ | ---- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | ------ | ------ | - | ------ | ------- | ------ | -
|                                      |                                                           |                                 |        |                      |  |              |        |     
|                                      |                                                           | 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     | %      
|General and administrative            |                                                           |                                 | 3,901  |                      |  |              | 2,278  |      |  |      | 1,154  |      |  |   | 2,160  |   |  |   | 5,055  |        |        |   | 4,438  |        
|Sales and marketing                   |                                                           |                                 | 3,573  |                      |  |              | 1,321  |      |  |      | 2,190  |      |  |   | 1,127  |   |  |   | 5,763  |        |        |   | 2,448  |        
|Research and development              |                                                           |                                 | 5,417  |                      |  |              | 1,938  |      |  |      | 457    |      |  |   | 817    |   |  |   | 5,874  |        |        |   | 2,755  |        
|                                      |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        
|Contribution before unallocated items |                                                           | $                               | 3,487  |                      |  | $            | 3,569  |      |  | $    | 6,170  |      |  | $ | 1,877  |   |  |   | 9,657  |        |        |   | 5,446  |        
|                                      |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        
|Unallocated items                     |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        
|                                      | Corporate, sales, general and administrative
    expenses |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        | 7,168  |        |   |        | 8,628   |       
|                                      | 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                          |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | 881    |        |        |   | (1,437 | )      
|Equity in loss of investment          |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | (5     | )      |        |   |       |        
|Interest expense, net                 |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | (1,141 | )      |        |   | (1,361 | )      
|Income taxes                          |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | 200    |        |        |   | (100   | )      
|                                      |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        
|                                      | Loss from continuing operations                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   | $      | (2,395 | )      |   | $      | (11,517 | )     
|                                      |                                                           |                                 |        |                      |  |              |        |      |  |      |        |      |  |   |        |   |  |   |        |        |        |   |        |        

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, 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 general
and administrative, sales and marketing 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

24



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##### 



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 $3.8 million, a decrease of $303,000 compared to
the same period in 2001. General and administrative expenses
decreased by $1.0 million related to lower expenses related
to MessageClick, the activities of which were substantially
eliminated in the second quarter of 2001, of approximately
$409,000 and lower expenses in the Companys customer
response center of approximately $711,000 offset by the increase
related to a full year of expenses for Telemate.Net, which was
acquired in November 2001. Sales and marketing expenses
increased by $1.1 million primarily related to a full year
of expenses for Telemate.Net, which was acquired in November
2001. 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 21% during the year ended December 31,
2002, down from 29% 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.

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.

25



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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 | 
|                               |  |      |       | 

Critical Accounting Policies

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

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

Allowance for
Doubtful Accounts

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

Inventory
Obsolescence

The Company is required to state its inventories
at the lower of cost or market. In assessing the ultimate
realization of inventories, the Company makes judgments as to
future demand requirements and compares that with the current
and committed inventory levels. The Company has recorded changes
in net realizable values in recent periods due to impact of
current and future technology trends and changes in strategic
direction, such as discontinuances of product lines, as well as,
changes in market conditions due to changes in demand
requirements. Estimates of the future demand for the inventory
are based on sales projections for different products, as well
as estimates of inventory required to fulfill maintenance
requirements for products previously sold. It is possible that
changes in the net realizable value of inventory may continue to
occur in the future due to the current market conditions.

Restructuring
Accruals

Discontinued Operations

During 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 $2.4 million assumes that the

26



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##### 



building will be sub-leased for 44% of the total
lease liability over the term of the lease. As of
December 31, 2003, the Company had a remaining reserve
balance of approximately $1.5 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,
however, changes in these estimates could occur based on changes
in the financial condition of the sublessees.


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 estimates 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 assesses 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.

Goodwill,
Intangible Assets and Long-Lived Assets

Goodwill represents the excess of costs over fair
value of assets of businesses acquired. Goodwill and intangible
assets acquired in a purchase business combination and
determined to have an indefinite useful life are not amortized,
but instead are tested for impairment at least annually in
accordance with the provisions of SFAS No. 142. Significant
estimates are made with respect to the impairment testing. SFAS
No. 142 also requires that intangible assets with estimable
useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for
impairment in accordance with SFAS No. 144.

In accordance with SFAS No. 144, long-lived
assets, such as property, plant and equipment and purchased
assets subject to amortization, are reviewed for impairment
whenever events or changes in circumstances indicate that the
carrying amount of the asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated
undiscounted future cash flows expected to be generated by the
asset. If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized by the
amount by which the carrying amount of the asset exceeds the
fair value of the asset. Significant estimates are made with
respect to recoverability and fair value assessments.

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, purchases of
the other businesses and the sale of discontinued businesses and
acquisitions.

At December 31, 2003, the Company had a
positive working capital position (excess of current assets over
current liabilities) of $12.7 million compared to a
positive working capital position of $1.8 million at

27



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##### 



December 31, 2002. The Companys cash
and cash equivalents totaled $7.7 million at
December 31, 2003, and $1.3 million at
December 31, 2002. Total long-term debt, net of discount,
was $6.6 million at December 31, 2003 and
$3.7 million at December 31, 2002. At
December 31, 2003, the Company had no borrowings under its
$10.0 million Amended Credit Agreement with Silicon Valley
Bank; at December 31, 2002 there was $800,000 outstanding.
The Companys borrowing availability under the Amended
Credit Agreement at December 31, 2003 was
$7.8 million. (This amount does not include the effect of
MCK on the Companys borrowing ability because Silicon
Valley Bank has not yet conducted an audit that would determine
the amount of MCK receivables to be included in the borrowing
base. In addition, the Company was not borrowing and did not
need the additional borrowing availability. The Company
estimates that including the MCK receivables would increase
availability by approximately $1.5 million). The Company
has an outstanding stand-by letter of credit in the amount of
$200,000 at December 31, 2003 which would reduce borrowing
capacity under the Amended Credit Agreement.


On February 12, 2003, in connection with the
Companys acquisition of the assets of Clarent, the Company
amended its existing original Credit Agreement with Silicon
Valley Bank, and in connection therewith, the Company and
Silicon Valley Bank entered into certain amendments to the
existing credit facility and certain additional credit
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
facility that provides for working capital based on the
Companys international accounts receivable and inventories
related to export sales primarily associated with Clarents
assets. The amendments and additional agreements also extended
the term of the original Credit Agreement for 18 months
(through August 13, 2004). The Company and Silicon Valley
Bank further amended the credit facility in connection with the
acquisition of MCK.

On February 12, 2003, the Company acquired
substantially all the business assets and assumed certain
related liabilities of Clarent for $9.8 million in notes.
At the closing of the acquisition, 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, which was paid off at December 31, 2003; a
$1.8 million non-interest bearing unsecured note due
February 13, 2004, discounted at 6.25% per annum, of which
$1.5 million was paid through December 31, 2003 and
the balance of $350,000 was paid in February 2004; and a
$3.0 million secured note due February 12, 2008, which
bears interest at 5% per annum, discounted at 7.5% 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, 2003 totaled
approximately $536,000 compared with cash used in continuing
operations of $3.5 million for 2002. The Companys use
of cash in continuing operations during 2003 resulted primarily
from cash used for changes in current operating assets and
liabilities of approximately $1.1 million and was offset by
cash provided from continuing operations of $556,000 (net loss
from continuing operations of $18.3 million reduced by
non-cash charges totaling $19.0 million, including
depreciation and amortization of $5.6 million, provision for
doubtful accounts of $2.5 million and a write-down of
goodwill of $10.9 million). 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 a
gain on early retirement of debt of $350,000).

Cash used in the Companys discontinued
operations in the year ended December 31, 2003, totaled
$922,000 compared with cash used in discontinued operations of
$1.1 million for 2002.

The Company received cash from investing
activities in the year ended December 31, 2003 of
approximately $6.5 million, compared to cash used in
investing activities of $1.8 million in the same period of
2002. In the year ended December 31, 2003, the Company
received $9.3 million in cash, related to the acquisition
of MCK, and used $906,000 in cash, net of cash acquired, related
to the acquisition of the assets of

28



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Clarent. The Company spent $1.5 million and
$889,000 on capital expenditures in the year ended
December 31, 2003 and 2002, respectively. In 2002, the
Company paid $605,000 toward its investment in Shanghai BeTrue.
The Company also invested $533,000 and $348,000 on purchased
software development costs in the year ended December 31,
2003 and 2002, respectively. During 2003, restricted cash
decreased by $88,000.


Cash provided by financing activities totaled
approximately $1.3 million in the year ended
December 31, 2003, compared to $317,000 for 2002. The
Company received $1.8 million in payments of notes
receivable from shareholders, received proceeds from the
issuance of the Companys Common Stock related to the
exercise of stock options of $2.0 million and proceeds from
the issuance of the Companys Common Stock related to the
exercise of warrants of $4.8 million and paid $800,000 on
the Companys credit line and $6.5 million on the
notes payable for the purchase of the assets of Clarent in 2003.
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.

Contractual Obligations and Commercial
Commitments

The following summarizes the Companys
future contractual obligations at December 31, 2003 (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                                              |                         |                        |       |           |  |           |      |           |  |         |       |       |  |   |      |       |  |   |      |      
|Additional payments for the acquisition of Encore
    Group |                         |                        | 1,074  |           |  |           | 555   |           |  |         | 469    |       |  |   | 50    |       |  |   |      |      
|Notes payable                                               |                         |                        | 3,350  |           |  |           | 350   |           |  |         | 3,000  |       |  |   |       |       |  |   |       |      
|Convertible subordinated debentures                         |                         |                        | 4,500  |           |  |           |      |           |  |         | 4,500  |       |  |   |      |       |  |   |      |      
|Accrued costs of MCK acquisition                            |                         |                        | 7,372  |           |  |           | 4,324 |           |  |         | 2,609  |       |  |   | 439   |       |  |   |       |      
|Operating Leases:                                           |                         |                        |        |           |  |           |       |           |  |         |        |       |  |   |       |       |  |   |       |      
|                                                            | Continuing operations   |                        |        | 14,392    |  |           |       | 2,974     |  |         |        | 5,189 |  |   |       | 4,164 |  |   |       | 2,065 | 
|                                                            | Discontinued operations |                        |        | 2,894     |  |           |       | 988       |  |         |        | 748   |  |   |       | 764   |  |   |       | 394   | 
|                                                            |                         |                        |        |           |  |           |       |           |  |         |        |       |  |   |       |       |  |   |       |      
|Total contractual cash obligations                          |                         | $                      | 33,582 |           |  | $         | 9,191 |           |  | $       | 13,515 |       |  | $ | 8,417 |       |  | $ | 2,459 |      
|                                                            |                         |                        |        |           |  |           |       |           |  |         |        |       |  |   |       |       |  |   |       |      

Note, this table excludes interest expense and
sublease rentals and assumes that leases are not renewed.

The Company has an outstanding stand-by letter of
credit in the amount of $200,000 at December 31, 2003.
Silicon Valley Bank issued an additional stand-by letter of
credit on behalf of the Company in the amount of
$1.6 million in January 2004.

Sources of Cash

For 2004, the Company expects that its primary
sources of cash will be from issuances of equity or debt
securities, cash on hand, borrowings under its Amended Credit
Agreement with Silicon Valley Bank and other sources. In
February 2004, the Company issued, in a private placement,
9.8 million shares of its Common Stock and warrants to
purchase 2.5 million shares of its Common Stock for an
aggregate purchase price of $17.7 million, or $1.80 per
share. The Company received approximately $16.25 million,
net of expenses. The Company expects that its current operations
will not generate positive income from continuing operations
before interest, taxes, depreciation, amortization of
intangibles and amortization of deferred compensation
(EBITDA) for next year as the Company is investing
in additional sales and marketing and research and development
costs. However, the Company believes that it will have
sufficient liquidity from its cash on hand,

29



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the cash raised in the private placement and its
unused credit facility to meet its current financial obligations
during 2004.


The Amended Credit Agreement with Silicon Valley
Bank, however, is subject to certain financial covenants
(including a minimum EBITDA covenant) and limitations on the
Companys ability to access funds under the Amended Credit
Agreement. The Company was not in compliance with the EBITDA
covenant as of December 31, 2003 and received a waiver. In
February 2004, the Company and Silicon Valley Bank further
amended the credit facility to replace the EBITDA covenant, with
an adjusted minimum cash on hand requirement and a tangible net
worth covenant. If the Company is in violation of the Amended
Credit Agreement, or does not have sufficient eligible accounts
receivable and inventory to support the level of borrowings it
may need, then the Company may be unable to draw on the Amended
Credit Agreement to the extent necessary. To the extent the
Company does not have borrowing availability under the Amended
Credit Agreement, the Company may be required to obtain
additional sources of capital, sell assets, obtain an amendment
to the Amended Credit Agreement or otherwise restructure its
outstanding indebtedness. Additional borrowings other than
pursuant to the Amended Credit Agreement must be approved by
Silicon Valley Bank. If the Company is unable to obtain
additional capital, sell assets, obtain an amendment to the
Amended Credit Agreement or otherwise restructure its
outstanding indebtedness, then the Company may not be able to
meet its obligations. The Amended Credit Agreement if not
extended or replaced expires August 12, 2004.

The Companys short-term cash needs are for
working capital, including cash operating losses, capital
expenditures, remaining unpaid transaction costs related to the
acquisition of MCK, severance and retention bonus payments
related to the acquisition of MCK totaling approximately
$3.0 million, payments on the unsecured note made by the
Company in connection with the acquisition of Clarents
assets, totaling approximately $350,000 plus interest due
February 13, 2004 and payments related to discontinued
operations. At December 31, 2003, accrued costs of MCK
acquisition and other long-term liabilities include
$1.7 million in lease payments related to lease obligations
for excess space at the date of acquisition. The Company expects
to pay out approximately $611,000 related to these obligations
in the next twelve months. At December 31, 2003,
liabilities of discontinued operations included
$1.5 million in lease payments related to discontinued
operations. The Company expects to pay out approximately
$367,000 related to discontinued operations in the next twelve
months.

The Companys long-term cash needs are
related to the costs of growing its current business as well as
prospective businesses to be acquired, including capital
expenditures and working capital. The Company expects to meet
these cash needs through cash from operations, if any, cash on
hand, borrowings under the Amended 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 Amended
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.

Accounting Pronouncements Issued, Not
Adopted

In February 2003, the Financial Accounting
Standards Board (FASB) issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and
Equity (SFAS No. 150). The
provisions of SFAS No. 150 (see below for additional
information) are effective for financial instruments entered
into or modified after May 31, 2003, and otherwise are
effective at the beginning of the first interim period beginning
after June 15, 2003, except for mandatorily redeemable
financial instruments of nonpublic entities.
SFAS No. 150 is to be implemented by reporting the
cumulative effect of a change in an accounting principle for
financial instruments created before May 31, 2003 and still
existing at the beginning of the interim period of adoption.

FASB Staff Position FAS 150-3,
Effective Date, Disclosures, and Transition for
Mandatorily Redeemable Financial Instruments of Certain
Nonpublic Entities and Certain Mandatorily Redeemable
Noncontrolling Interests under FASB Statement No. 150,
Accounting for Certain Financial Instruments with

30



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Characteristics of Both Liabilities and
Equity (FSP FAS 150-3), defers the
effective date for certain mandatorily redeemable financial
instruments issued by a non-SEC registrant and defers the
effective date of SFAS No. 150 for certain mandatorily
redeemable noncontrolling interests of all entities. The
adoption of SFAS No. 150 did not have a material
effect on the Companys financial position or results of
operations. Additionally, based on the nature of the
Companys current instruments and interests, the Company
does not believe there will be a material effect on the
Companys financial position or results of operations
resulting from the adoption of the remaining components of FSP
FAS 150-3.


In December 2003, the FASB issued FASB
Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities
(FIN No. 46R), which addresses how a business
enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. FIN
No. 46R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which
was issued in January 2003. Companies are required to apply FIN
No. 46R to variable interests in variable interest entities
(VIEs) created after December 31, 2003. For
variable interests in VIEs created before January 1, 2004,
the Interpretation is applied beginning on January 1, 2005.
For any VIEs that must be consolidated under FIN No. 46R
that were created before January 1, 2004, the assets,
liabilities and noncontrolling interests of the VIE initially
are measured at their carrying amounts with any difference
between the net amount added to the balance sheet and any
previously recognized interest being recognized as the
cumulative effect of an accounting change. If determining the
carrying amounts is not practicable, fair value at the date FIN
No. 46R first applies may be used to measure the assets,
liabilities and noncontrolling interest of the VIE. The Company
is evaluating the impact of applying FIN No. 46R and has
not yet completed its analysis.

Risk Factors

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
February 29, 2004, the per share closing price of the
Common Stock on the Nasdaq SmallCap Market fluctuated from a
high of $5.07 to a low of $0.26. The Company believes that the
volatility of the price of the Common Stock does not solely
relate to the Companys performance and is broadly
consistent with volatility experienced in the Companys
industry. Fluctuations may result from, among other reasons,
responses to operating results, announcements by competitors,
regulatory changes, economic changes, market valuation of
technology firms and general market conditions.

In addition, in order to respond to competitive
developments, the Company may from time to time make pricing,
service or marketing decisions that could harm its business.
Also, the Companys operating results in one or more future
quarters may fall below the expectations of securities analysts
and investors. In either case, the trading price of the Common
Stock would likely 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 Company
may be unable to fund future growth.

The Companys business strategy calls for
growth internally as well as through acquisitions. To this end,
the Company has determined to invest substantial funds to
increase its sales and marketing resources in order to grow
revenues. This strategy to increase sales and marketing
resources as well as other strategies for growth internally
which the Company may implement now or in the future 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

31



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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 ownership of
the Companys 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. Moreover, if the Companys strategy to increase
its sales and marketing resources in order to grow revenues does
not produce the desired result, then the Company will have
incurred significant expenses for which it may or may not have
obtained adequate funding to cover.


The Company
has a history of losses and may not be profitable in the
future.

The Company has a history of net losses,
including net losses of $18.3 million for the 2003 fiscal year,
$2.7 million for the 2002 fiscal year and
$147.6 million for the 2001 fiscal year. As of
December 31, 2003, the Company had an accumulated deficit
of $273.1 million. Further, developing the Companys
business strategy and expanding the Companys services will
require significant additional capital and other expenditures.
Accordingly, if the Company is not able to increase its revenue,
then it may never generate sufficient revenues to achieve or
sustain profitability.



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

The Common Stock is currently listed 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 listed on the Nasdaq National Market. On June 6,
2002, Nasdaq 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 unable to regain compliance with the minimum bid price
requirement of the Nasdaq National Market, and on
September 13, 2002, the Company transferred the Common
Stock to the Nasdaq SmallCap Market. In June 2003, the Company
regained compliance with the $1.00 minimum bid price requirement
of the Nasdaq SmallCap Market.

If the bid price of the Common Stock were to
remain below $1.00 per share for 30 consecutive trading days, or
if the Company was unable to continue to meet the Nasdaq Small
Cap Markets other listing standards, then Nasdaq would
notify the Company that the Common Stock could 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, which is viewed by most
investors as a less desirable and less liquid market place.
Delisting from the Nasdaq SmallCap Market could make trading the
Common Stock more difficult for the Companys investors,
leading to 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
credit facility with Silicon Valley Bank, its outstanding
convertible debentures and, through certain cross default
provisions, the Loan and Security Agreement the Company entered
into with Clarent Corporation in connection with the
Companys acquisition of substantially all of the business
assets, and certain related liabilities, of Clarent Corporation
on February 12, 2003.



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

The Company announced plans in February 2004 to
significantly and quickly increase sales and marketing personnel
in order to grow revenue. The Company believes that its success
depends largely on its

32



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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 an
understanding of the markets which the Company serves. Workforce
reductions by the Company during 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 its business strategy and
harm its business.




| |                                                                                      
| | -------------------------------------------------------------------------------------
| | 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 the prolonged slowdown in the
telecommunications industry continues, then the Company may
experience adverse operating results.



| |                                                                                                             
| | ------------------------------------------------------------------------------------------------------------
| | The Companys need to invest in
    research and development could harm the Companys operating
    results.

The Companys industry is characterized by
the need for continued investment in research and development.
If the Company fails to invest sufficiently in research and
development, then the Companys products could become less
attractive to potential customers, which could have a material
adverse effect on the Companys results of operations and
financial condition. As a result of the Companys need to
maintain or increase its spending levels in this area, the
Companys operating results could be materially harmed if
the Companys net sales fall below expectations. In
addition, as a result of the need for research and development
and technological innovation, the Companys operating costs
may increase in the future.



| |                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The market for converged communications
    solutions is still in its infancy and rapidly evolving. If this
    market does not develop and grow as expected, then it could have
    a material adverse effect on the Companys
    business.

While the Company believes there is a significant
growth opportunity in providing converged communications
solutions to its customers, 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 expected, then the Company may not be able to sell
its products in significant volume, or at all. Due to the
intense competition in this market and the recent introduction
of this technology, there can be no assurance that the Company
will succeed in this evolving marketplace.



| |                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 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 its 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 results of operations and
financial condition. If successful, a claim of product
infringement could deprive the Company of the technology it
needs altogether.

33



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| |                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------
| | 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 you that
these efforts will be adequate. Despite the Companys
efforts to protect the Companys proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain
rights to use the Companys products or technology.

The Company has pending several patent
applications related to its VoIP products, system architecture
for Internet telephone, interaction of VoIP calls and cellular
networks, real time addition of devices to 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 to the intellectual property covered by these patents.

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 also not be successful.
Additionally, even if the Companys domestic and
international efforts 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 product 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 or legal claims by customers against
the Company.

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 its customers,
and in connection with such sale or lease, 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 its business, results of operations and
financial condition.



| |                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------
| | The new softswitch and VoIP routers which
    the Company intends to offer may not achieve acceptance in the
    marketplace.

As a result of the Companys acquisition of
substantially all of the operating assets of Clarent Corporation
in February 2003, the Company now offers products which it could
not offer previously, including Class 5 softswitch products
and Enterprise VoIP routers. The markets for these products are
relatively new,

34



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##### 



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.




| |                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Sales to customers based outside the United
    States have recently accounted for a significant portion of the
    Companys revenues, which exposes the Company to risks
    inherent in international operations.

International sales represented 35% of the
Companys revenues for the year ended December 31,
2003. Furthermore, the Company expects sales to international
markets to increase as a percentage of revenues in the future.
International sales are subject to a number of risks, including
changes in foreign government regulations, laws, and
communications standards; export license requirements; currency
fluctuations, tariffs and taxes; other trade barriers;
difficulty in collecting accounts receivable; longer accounts
receivable collection cycles; difficulty in managing across
disparate geographic areas; difficulties in hiring qualified
local personnel; difficulties associated with enforcing
agreements and collecting receivables through foreign legal
systems; expenses associated with localizing products for
foreign markets; and political and economic instability,
including disruptions of cash flow and normal business
operations that may result from terrorist attacks or armed
conflict.

If the relative value of the U.S. dollar in
comparison to the currency of the Companys foreign
customers should increase, then the resulting effective price
increase of the Companys products to these foreign
customers could result in decreased sales. In addition, to the
extent that general economic downturns impact the Companys
customers, the ability of these customers to purchase the
Companys products could be adversely affected. Payment
cycles for international customers are typically longer than
those for customers in the United States. The foreign markets
for the Companys products may develop more slowly than
currently anticipated. Also, the Companys ability to
expand the sale of certain of its products internationally is
limited by the necessity of obtaining regulatory approval in new
countries. The Company anticipates that its non-Canadian,
foreign sales will generally be invoiced in U.S. dollars, and
does not currently plan to engage in foreign currency hedging
transactions. As the Company expands its international
operations, however, it may allow payment in foreign currencies,
and exposure to losses in foreign currency transactions may
increase. The Company may choose to limit any currency exposure
through the purchase of forward foreign exchange contracts or
other hedging strategies. The Companys future currency
hedging strategies may not be successful.



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

In February 2003, the Company purchased from
Clarent Corporation certain assets and technology, including a
certain product, a component of which has been the subject of
patent infringement claims made against Clarent Corporation. 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 increased product costs, service
delays or both. If successful, a claim of product infringement
could deprive the Company of the assets and technology related
to this product.



| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | The Companys dependence on contract
    manufacturers and suppliers could result in product delivery
    delays.

The Company currently uses contract manufacturers
to manufacture a significant portion of its products. The
Companys reliance on contract manufacturers involves a
number of risks, including the absence of adequate capacity, the
unavailability of, or interruptions in access to necessary
manufacturing processes and reduced control over delivery
schedules. If the Companys manufacturers are unable or
unwilling to continue manufacturing the Companys products
and components in required volumes, then the Company will have
to identify one or more acceptable alternative manufacturers.
Furthermore, the use of new manufacturers may cause significant
interruptions in supply if the new manufacturers have difficulty
manufacturing products to the Companys specifications.
Further, the introduction of new manufacturers may increase the
variance in the quality of the Companys products. In
addition, the Company relies upon third-party suppliers of
specialty

35



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##### 



components and intellectual property used in its
products. It is possible that a component needed to complete the
manufacture of the Companys products may not be available
at acceptable prices or on a timely basis, if at all. Inadequate
supplies of components, or the loss of intellectual property
rights, could affect the Companys ability to deliver
products to its customers. Any significant interruption in the
supply of the Companys products would result in the
reduction of product sales to customers, which in turn could
permanently harm the Companys reputation in the industry.




| |                                              
| | ---------------------------------------------
| | 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 the Common Stock or other securities. Any such
claims against the Company may affect its business, results of
operations and financial conditions. Such claims, including
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.



| |                                                                                                       
| | ------------------------------------------------------------------------------------------------------
| | The Company may be unable to successfully
    integrate its operations with the operations of
    MCK.

The Companys acquisition of MCK in
September 2003 by means of a merger involves the integration of
two companies that have previously operated independently. The
challenges of combining the companies operations include
integrating personnel with diverse business backgrounds,
combining different corporate cultures and managing a
geographically dispersed organization. The process of
integrating operations could cause an interruption of, or loss
of momentum in, the activities of one or more of the combined
companys businesses and the loss of key personnel. The
diversion of managements attention and any delays or
difficulties encountered in connection with the merger and the
integration of the two companies operations could have an
adverse effect on the business, results of operations and
financial condition of the combined company.



| |                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company derives a substantial amount of
    its revenues from channel distribution partners and such
    revenues may decline significantly if any major partner cancels
    or delays a purchase of its products.

The Company uses an indirect sales model to
derive a substantial portion of its revenue. Failure to generate
revenue as expected from this channel could have a material
adverse effect on the Companys results of operations and
financial condition.

No channel partner or distributor is obligated to
purchase additional products or services from the Company.
Accordingly, present and future partners may terminate their
purchasing arrangements with the Company or significantly reduce
or delay their orders. Any termination, change, reduction or
delay in orders could have a material adverse effect on the
Companys results of operations and financial condition. In
addition, the Company currently has varying distribution,
marketing and development arrangements with its partners. There
is no assurance that the Company will continue to enjoy the
support and cooperation that it has historically experienced
from these parties or their associated distribution channels.
Also, there is no certainty that these parties will continue to
offer the Companys products in their sales portfolio. It
is possible that these vendors may seek to offer broader product
lines and solutions that are competitive with the Companys
products. In addition, they may change their distribution models
which could negatively impact revenues of the Company.
Furthermore, the Company must correctly anticipate the price,
performance and functionality requirements of these partners and
must successfully develop products that meet end user
requirements and make these products available on a timely basis
and in sufficient quantities in order to sustain and grow its
business.

36



---



##### 



The Companys inability to develop and
maintain relationships with key technology suppliers could harm
its ability to sustain and grow its business.

The success of the Company depends to a
significant degree upon its continued relationships with leading
technology suppliers. The standards for telephony equipment and
data networks are evolving, and the Companys products may
not be compatible with new technology standards that may emerge.
If the Company is unable to provide its customers with
interoperable solutions, then they may make purchases from
vendors who provide the requisite product interoperability. This
could have a material adverse effect on the Companys
results of operations and financial condition.



|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

Market Risk

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

Interest Rate Risks

The Companys notes payable and convertible
subordinated debentures at December 31, 2003, carry
interest rates which are fixed. The Companys line of
credit with Silicon Valley Bank carries interest rates which
vary with the prime rate. Accordingly, if the Company has any
indebtedness outstanding under its line of credit with Silicon
Valley Bank, then any increases in Silicon Valley Banks
prime rate will reduce the Companys earnings. At
December 31, 2003, the Company did not have any
indebtedness outstanding under its line of credit with Silicon
Valley Bank.

Foreign Currency Risks

Products sold outside of the United States of
America are transacted in U.S. dollars and, therefore, the
Company is not exposed to foreign currency exchange risk.
Transactions with Clarent Canada present foreign currency
exchange risk. The principal transactions are personnel and
related costs. The intercompany balance is denominated in U.S.
dollars and changes in foreign currency rates would result in
foreign currency gains and losses. Using the intercompany
balance at December 31, 2003, a 10% strengthening of the
U.S. dollar against the Canadian dollar would result in a
foreign currency transaction loss of approximately $3,000. To
date, foreign exchange gains and losses have not been
significant.



|        |                                                
|------- | -----------------------------------------------
|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

37



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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  |      |           
|     |                                                        | Quarter                                  |                           | Quarter |        | Quarter(1) |   | Quarter |      | Total Year
|     |                                                        |                                          |                           |         |        |            |   |         |      |           
|     |                                                        |                                         
|     |                                                        | (In thousands, except per share amounts)
|2003 |                                                        |                                          |                           |         |        |            |   |         |      |            |   |         |         |        |   |        |        |    |   |        
|     | Revenue                                                |                                          | $                         | 12,997  |        |            | $ | 15,858  |      |            | $ | 15,315  |         |        | $ | 15,328 |        |    | $ | 59,498  |        
|     | Gross profit                                           |                                          |                           | 7,572   |        |            |   | 9,534   |      |            |   | 8,956   |         |        |   | 6,712  |        |    |   | 32,774  |        
|     | Sales, general and administrative                      |                                          |                           | 5,212   |        |            |   | 6,128   |      |            |   | 5,299   |         |        |   | 7,343  |        |    |   | 23,982  |        
|     | Research and development                               |                                          |                           | 1,896   |        |            |   | 2,383   |      |            |   | 2,382   |         |        |   | 2,969  |        |    |   | 9,630   |        
|     | Operating income (loss) from continuing
    operations |                                          |                           | (794    | )      |            |   | 73      |      |            |   | (11,209 | )       |        |   | (5,260 | )      |    |   | (17,190 | )      
|     | Loss from continuing operations                        |                                          |                           | (1,125  | )      |            |   | (391    | )    |            |   | (11,606 | )       |        |   | (5,165 | )      |    |   | (18,287 | )      
|     |                                                        | Net loss                                 |                           | $       | (1,125 | )          |   | $       | (391 | )          |   | $       | (11,606 | )      |   | $      | (5,165 | )  |   | $       | (18,287 | )     
|     |                                                        |                                          |                           |         |        |            |   |         |      |            |   |         |         |        |   |        |        |    |   |        
|     | Net loss per common share  basic and
    diluted:(2)  |                                          |                           |         |        |            |   |         |      |            |   |         |         |        |   |        |        |    |   |         |        
|     | Loss from continuing operations                        |                                          | $                         | (0.01   | )      |            | $ |        |      |            | $ | (0.12   | )       |        | $ | (0.04  | )      |    | $ | (0.18   | )      
|     | Loss from discontinued operations                      |                                          |                           |         |        |            |   |         |      |            |   |        |         |        |   |       |        |    |   |        |        
|     |                                                        |                                          |                           |         |        |            |   |         |      |            |   |         |         |        |   |        |        |    |   |        
|     |                                                        | Net loss per common share                |                           | $       | (0.01  | )          |   | $       |     |            |   | $       | (0.12   | )      |   | $      | (0.04  | )  |   | $       | (0.18   | )     
|     |                                                        |                                          |                           |         |        |            |   |         |      |            |   |         |         |        |   |        |        |    |   |        
|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 income (loss) from continuing
    operations |                                          |                           | (735    | )      |            |   | (635    | )    |            |   | (719    | )       |        |   | (241   | )      |    |   | (2,330  | )      
|     | Income (loss) from continuing operations               |                                          |                           | (859    | )      |            |   | (599    | )    |            |   | (1,019  | )       |        |   | 82     |        |    |   | (2,395  | )      
|     |                                                        |                                          | Net loss                  |         | $      | (1,190     | ) |         | $    | (599       | ) |         | $       | (1,019 | ) |        | $      | 82 |   |         | $       | (2,726 | )
|     |                                                        |                                          |                           |         |        |            |   |         |      |            |   |         |         |        |   |        |        |    |   |        
|     | Net loss per common share  basic and
    diluted:     |                                          |                           |         |        |            |   |         |      |            |   |         |         |        |   |        |        |    |   |         |        
|     | Loss from continuing operations                        |                                          | $                         | (0.01   | )      |            | $ | (0.01   | )    |            | $ | (0.01   | )       |        | $ |       |        |    | $ | (0.03   | )      
|     | Loss from discontinued operations                      |                                          |                           | (0.01   | )      |            |   |         |      |            |   |        |         |        |   |       |        |    |   |        |        
|     |                                                        |                                          | Net loss per common share |         | $      | (0.02      | ) |         | $    | (0.01      | ) |         | $       | (0.01  | ) |        | $      |   |   |         | $       | (0.03  | )
|     |                                                        |                                          |                           |         |        |            |   |         |      |            |   |         |         |        |   |        |        |    |   |        



---



|    |                                                                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Third quarter 2003 net loss includes a write-down
    of goodwill totaling $10.9 million                                                                                                                                                                      
|   
|(2) | 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.



|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

The Companys Chief Executive Officer and
Chief Financial Officer have evaluated the Companys
disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) or 15d-15(e) of the Exchange Act), as of
the end of the period covered by this Annual Report, as required
by paragraph (b) of Rules 13a-15

38



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##### 



or 15d-15 of the Exchange Act. Based on such
evaluation, such officers have concluded that, as of the end of
the period covered by this Annual Report, the Companys
disclosure controls and procedures are effective in alerting
them on a timely basis to material information relating to the
Company and its consolidated subsidiaries required to be
included in the Companys periodic filings under the
Exchange Act.


PART III



|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive officers of the
    Registrant

Board of Directors

Set forth below is certain information, as of
March 8, 2004, 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
|                      |  |     |    |         
|Paul R. Garcia        |  |     | 51 |          |  | Director                                                                     
|Gary H. Heck          |  |     | 59 |          |  | Director, President and Chief Operating Officer                              
|Amy L. Newmark        |  |     | 46 |          |  | Director                                                                     
|Steven A. Odom        |  |     | 50 |          |  | Director, Chairman of the Board and Chief
    Executive Officer              
|Stephen E. Raville    |  |     | 56 |          |  | Director                                                                     
|Juliet M. Reising     |  |     | 53 |          |  | Director, Executive Vice President, Chief
    Financial Officer and Secretary
|Joseph R. Wright, Jr. |  |     | 65 |          |  | Director                                                                     

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

Paul R. Garcia,age
51, has served as a director of the Company since April 2003.
Mr. Garcia also currently serves as a member of the
Companys audit committee (the Audit
Committee). Mr. Garcia has served as a director,
President and Chief Executive Officer of Global Payments Inc.
since February 2001. Mr. Garcia also currently serves as
Chairman of the Board of Global Payments Inc. From June 1999 to
January 2001, he served as Chief Executive Officer of NDC
eCommerce. From March 1997 to September 1998, he served as
President and Chief Executive Officer of Productivity Point
International. From 1995 to 1997, he served as Group President
of First Data Card Services.

Amy L. Newmark,age
46, has served as a director of the Company since September
2000. Ms. Newmark also currently serves as a member of the
Compensation Committee. 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.

Stephen E. Raville,age 56, has served as a director of the Company since October
1997. Mr. Raville also currently serves as the Chairman of
the Audit Committee. Since 1996, Mr. Raville has served as
Chief 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 Telecom-

39



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##### 



munications into MCI WorldCom, Inc. in late 1992.
Mr. Raville also currently serves as a director of the
Cleveland Group, Inc.


Joseph R. Wright,
Jr., age 65, has served as a
director of the Company since September 2000. Mr. Wright
also currently serves as a member of the 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 of the Board and a 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 Directors of Terremark Worldwide, Inc.,
Titan Corporation, Jefferson Consulting Group, AT&T
Government Markets, Proxim Corp. and Barington Capital.

The biographical information for
Messrs. Heck and Odom 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. Pursuant to the
terms of the Telemate.Net acquisition, until the 2004 annual
meeting of the Companys shareholders, any vacancy on the
Board arising from the resignation, removal or death of Messrs.
Anantharaman or Mauro is to be filled, and any nominee selected
to fill a director position occupied by
Messrs. Anantharaman or Mauro is to be nominated, by the
remaining Telemate.Net representative on the Board and approved
by the Board. Messrs. Mauro and Anantharaman resigned as
directors of the Company effective February 19, 2002, and
March 27, 2003, respectively. After the resignation of
Mr. Mauro, Mr. Anantharaman did not nominate any
individual to fill the vacancy on the Board created by such
resignation. Additionally, effective February 23, 2004,
Mr. Logsdon resigned from the Board. The Board has not
nominated any individual to fill the vacancy created by
Mr. Logsdons resignation.

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.

40



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##### 



Audit Committee and Audit Committee Financial
Expert

The Company has a separately designated standing
audit committee established in accordance with
Section 3(a)(58)(A) of the Exchange Act. The members of the
Audit Committee are Messrs. Garcia, Raville and Wright.

The Board has determined that the Audit
Committees chairperson, Mr. Raville, is an
audit committee financial expert as such term is
defined in Item 401(h) of Regulation S-K.
Mr. Raville meets the independence requirements of
Rule 4200(a)(15) of the National Association of Securities
Dealers listing standards.

Pursuant to the regulations of the SEC, a person
who is determined to be an audit committee financial expert will
not be deemed an expert for any purpose, including,
without limitation, for purposes of Section 11 of the
Securities Act, as a result of being designated or identified as
an audit committee financial expert pursuant to Item 401 of
Regulation S-K. Furthermore, the designation or
identification of a person as an audit committee financial
expert pursuant to Item 401 of Regulation S-K does not
impose on such person any duties, obligations or liability that
are greater than the duties, obligations and liability imposed
on such person as a member of the Audit Committee or the Board
in the absence of such designation or identification. Moreover,
the designation or identification of a person as an audit
committee financial expert pursuant to Item 401 of
Regulation S-K does not affect the duties, obligations or
liability of any other member of the Audit Committee or Board.

Code of Ethics

The Board has adopted a Code of Ethics and
Conduct that applies to all of the Companys employees,
including the Companys Chief Executive Officer, Chief
Operating Officer, Chief Financial Officer and Corporate
Controller. The Company shall provide to any person without
charge, upon request, a copy of the Companys Code of
Ethics and Conduct. Such requests should be directed to the
Secretary of Verso Technologies, Inc. at 400 Galleria
Parkway, Suite 300, Atlanta, Georgia 30339.

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, 2003, 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.

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.

Executive Compensation

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, 2003, as well as for other executive officers
of the Company and its subsidiaries

41



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##### 



whose salary and bonus exceeded $100,000 during
the year ended December 31, 2003 (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              |                              |      | 2003 |                     |  |            | 435,000 |                        |  |                 |        |         |     |  | 500,000 | (2)     |  |  |  |  
|                            | Chief Executive Officer      |      |      | 2002                |  |            |         | 443,180                |  |                 |         |        |     |  |         |        |  |  |   |  | 
|                            |                              |      | 2001 |                     |  |            | 431,250 |                        |  |                 | 168,750 | (2)     |     |  |        |         |  |  |  |  
|James M. Logsdon            |                              |      | 2003 |                     |  |            | 261,000 |                        |  |                 |        |         |     |  | 304,621 | (3)     |  |  |   |  
|                            | President and Chief          |      |      | 2002                |  |            |         | 266,180                |  |                 |         |        |     |  |         |        |  |  |   |  | 
|                            | Operating Officer            |      |      | 2001                |  |            |         | 270,000                |  |                 |         | 63,750  | (3) |  |         |        |  |  |   |  | 
|Juliet M. Reising           |                              |      | 2003 |                     |  |            | 261,000 |                        |  |                 |        |         |     |  | 238,728 | (4)     |  |  |   |  
|                            | Executive Vice President and |      |      | 2002                |  |            |         | 258,680                |  |                 |         |        |     |  |         | 437,500 |  |  |   |  | 
|                            | Chief Financial Officer      |      |      | 2001                |  |            |         | 225,000                |  |                 |         | 112,500 |     |  |         |        |  |  |   |  | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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) | The amount of 2001 bonus earned by Mr. Odom
    was previously reported by the Company as $225,000. Of such
    amount, only $168,750 was paid to Mr. Odom in cash and the
    remainder was paid to Mr. Odom in the form of a stock
    option to purchase 248,773 shares of Common Stock at an exercise
    price of $0.46 per share granted to Mr. Odom on
    January 3, 2003 and exercisable in its entirety on the date
    thereof. On February 12, 2003, the Company also granted to
    Mr. Odom an option to purchase 251,227 shares of
    Common Stock at an exercise price of $0.42 per share,
    exercisable in its entirety on the date of grant.                                                                                                                                                                                                                                             
|   
|(3) | The amount of 2001 bonus earned by
    Mr. Logsdon was previously reported by the Company as
    $85,000. Of such amount, only $63,750 was paid to
    Mr. Logsdon in cash and the remainder was paid to
    Mr. Logsdon in the form of a stock option to purchase
    104,621 shares of Common Stock at an exercise price of
    $0.46 per share granted to Mr. Logsdon on January 3,
    2003 and exercisable in its entirety on the date thereof. The
    Company also granted to Mr. Logsdon an option to purchase
    200,000 shares of Common Stock at an exercise price of $0.42 per
    share, exercisable with respect to fifty percent (50%) of the
    underlying shares on the date of grant and all of the underlying
    shares as of February 12, 2004. Mr. Logsdon ceased
    serving as the President, Chief Operation Officer and a director
    of the Company effective February 23, 2004.
|   
|(4) | On January 3, 2003, the Company granted to
    Ms. Reising a stock option to purchase 38,728 shares of
    Common Stock at an exercise price of $0.46 per share,
    exercisable in its entirety on the date of grant. The Company
    granted this option to Ms. Reising in lieu of payments of
    cash salary and bonus earned by Ms. Reising in the years
    ended 2002 and 2001, respectively. On February 12, 2003,
    the Company also granted to Ms. Reising a stock option to
    purchase 200,000 shares of Common Stock at an exercise price of
    $0.42 per share, exercisable in its entirety on the date of
    grant.                                                                                                                                                                                                                                                                       

42



---



##### 



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, 2003.

|                  |  |                   |         |                      |  |                |   |                        |  |    |      |     |  |  |          |  |  |   |        |  |  |   |         | 
|----------------- |  | ----------------- | ------- | -------------------- |  | -------------- | - | ---------------------- |  | -- | ---- | --- |  |  | -------- |  |  | - | ------ |  |  | - | ------- | 
|                  |  |                   |         |                      |  |               
|                  |  | Individual Grants |         |                      |  |               
|                  |  |                   |         |                     
|                  |  |                   |         | Potential Realizable
|                  |  |                   |         | Percent of           |  |                |   | Value at Assumed      
|                  |  | Number of         |         | Total                |  |                |   | Annual Rates of Stock 
|                  |  | Securities        |         | Options              |  |                |   | Price Appreciation for
|                  |  | Underlying        |         | Granted to           |  |                |   | Option Term(1)        
|                  |  | Options           |         | Employees            |  | Exercise Price |   | Expiration             |  |   
|Name              |  | Granted           |         | in 2003              |  | (per share)    |   | Date                   |  | 5% |      | 10%
|                  |  |                   |         |                      |  |                |   |                        |  |    |      |    
|Steven A. Odom    |  |                   | 248,773 |                      |  |                | 5 | %                      |  | $  | 0.46 |     |  |  | 01/03/08 |  |  | $ | 32,341 |  |  | $ | 69,656  | 
|                  |  |                   | 251,227 |                      |  |                | 5 |                        |  |    | 0.42 |     |  |  | 02/11/13 |  |  |   | 65,319 |  |  |   | 168,322 | 
|James M. Logsdon  |  |                   | 104,621 |                      |  |                | 2 |                        |  |    | 0.46 |     |  |  | 01/03/08 |  |  |   | 13,601 |  |  |   | 29,294  | 
|                  |  |                   | 200,000 |                      |  |                | 4 |                        |  |    | 0.42 |     |  |  | 02/11/13 |  |  |   | 52,000 |  |  |   | 134,000 | 
|Juliet M. Reising |  |                   | 38,728  |                      |  |                | 1 |                        |  |    | 0.46 |     |  |  | 01/03/08 |  |  |   | 5,035  |  |  |   | 10,844  | 
|                  |  |                   | 200,000 |                      |  |                | 4 |                        |  |    | 0.42 |     |  |  | 02/11/13 |  |  |   | 52,000 |  |  |   | 134,000 | 



---



|    |                                                                                                                                                                                                                                                                                                                                  
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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.

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, 2003, 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, 2003. No Named Executive Officer
exercised any options during the year ended December 31,
2003.

|                     |  |                            |           |                               |  |             |         |               |  |   |           |  |  |   |         | 
|-------------------- |  | -------------------------- | --------- | ----------------------------- |  | ----------- | ------- | ------------- |  | - | --------- |  |  | - | ------- | 
|                     |  |                            |           |                              
|                     |  | Number of Securities       |           | Value of Unexercised In-The- 
|                     |  | Underlying Unexercised     |           | Money Options at Fiscal Year-
|                     |  | Options at Fiscal Year-End |           | End(1)                       
|                     |  |                            |           |                              
|Name                 |  | Exercisable                |           | Unexercisable                 |  | Exercisable |         | Unexercisable
|                     |  |                            |           |                               |  |             |         |              
|Steven A. Odom(2)    |  |                            | 2,820,821 |                               |  |             | 750,000 |               |  | $ | 2,590,049 |  |  | $ | 420,000 | 
|James M. Logsdon(3)  |  |                            | 1,139,724 |                               |  |             | 318,750 |               |  |   | 1,216,199 |  |  |   | 436,000 | 
|Juliet M. Reising(4) |  |                            | 1,194,456 |                               |  |             | 153,125 |               |  |   | 1,448,842 |  |  |   | 105,000 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Value of the Companys unexercised,
    in-the-money options based on the average of the high and low
    price of a share of the Common Stock as of December 31,
    2003, which was $3.10.                                                                                                                                                                                                                                                                                                
|   
|(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
    2,345,821 shares of Common Stock, of which options or
    warrants to acquire an aggregate of 1,777,071 shares of
    Common Stock were exercisable at December 31, 2003, and
    options or warrants to acquire an aggregate of
    568,750 shares of Common Stock were unexercisable at
    December 31, 2003.
|   
|(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
    1,058,853 shares of Common Stock, of which options or
    warrants to acquire an aggregate of 840,103 shares of
    Common Stock were exercisable at December 31, 2003, and
    options or warrants to acquire an aggregate of
    218,750 shares of Common Stock were unexercisable at
    December 31, 2003.  
|   
|(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
    621,353 shares of Common Stock, of which options or
    warrants to acquire an aggregate of 468,228 shares of
    Common Stock were exercisable at                                                                                                                                                              

43



---



##### 



| |                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------
| | December 31, 2003, and options or warrants
    to acquire an aggregate of 153,125 shares of Common Stock
    were unexercisable at December 31, 2003.

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 1, 2002,
Mr. Odoms base salary under the agreement was reduced
to $405,000 until May 1, 2003, when his base salary under
the agreement returned to $450,000.

On September 29, 2000, the Company entered
into an Executive Employment Agreement with Mr. Logsdon,
pursuant to which Mr. Logsdon 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 1, 2002, Mr. Logsdons base salary under
the agreement was reduced to $243,000 until May 1, 2003,
when his base salary under the agreement returned to $270,000.
Effective as of February 23, 2004, Mr. Logsdon ceased
serving as President, Chief Operating Officer and a director of
the Company. Consequently, Mr. Logsdon is entitled to
receive certain payments and benefits in accordance with
section 10.1(ii) of his Executive Employment Agreement with
the Company.

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 1, 2002, Ms. Reisings base salary under
the agreement was reduced to $243,000 until May 1, 2003,
when her base salary under the agreement returned to $270,000.

Compensation Committee Interlocks And Insider
Participation

From January 1, 2003 through
December 31, 2003, the Compensation Committee of the Board
was comprised of non-employee directors Ms. Newmark and
Mr. Heck. There were no Compensation Committee Interlocks.

44



---



##### 



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 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.

Mr. Heck ceased serving on the Compensation
Committee effective February 23, 2004, when he became the
President and Chief Operating Officer of the Company.



|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|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, 2003.

|                                                                |  |                            |            |                   |  |                      |      |        |  |  |           | 
|--------------------------------------------------------------- |  | -------------------------- | ---------- | ----------------- |  | -------------------- | ---- | ------ |  |  | --------- | 
|                                                                |  |                            |            | 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)  |  |                            | 10,727,970 |                   |  | $                    | 1.81 |        |  |  | 1,958,752 | 
|Equity compensation plans not approved by
    security holders: |  |                            | 442,172    | (2)(3)            |  | $                    | 4.27 | (2)(3) |  |  | 0         | 
|                                                                |  |                            |            |                   |  |                      |      |        |  |  |           | 
|Total                                                           |  |                            | 11,170,142 |                   |  | $                    | 1.91 |        |  |  | 1,958,752 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Represents options granted pursuant to the
    Companys 1999 Stock Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|(2) | Does not include (i) options to purchase
    757,265 shares of Common Stock with a weighted average
    exercise price of $1.56 per share, 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 5,080,244 shares
    of Common Stock with a weighted average exercise price of $2.52
    per share, 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 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 thereof are subject to
    adjustment as set forth in the warrant.
|
| |  | (b) On September 1, 2000, the Company
    issued a warrant to purchase 12,532 shares of Common Stock to
    PNC in consideration of PNC consenting to certain transactions
    engaged in by the Company. The warrant is exercisable until
    September 1, 2005, at an exercise price of $0.01 per share.
    The number                                                                                                                                                                                                                     

45



---



##### 



| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | of shares of Common Stock underlying the warrant
    and the exercise price thereof are subject to adjustment as set
    forth in the warrant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | (c) On October 16, 2001, the Company
    issued a warrant to purchase 25,000 shares of Common Stock to
    PNC in consideration of PNC consenting to certain transactions
    engaged in by the Company. The warrant is exercisable until
    October 16, 2006, at an exercise price of $0.01 per share.
    The number of shares of Common Stock underlying the warrant and
    the exercise price thereof are subject to adjustment as set
    forth in the warrant.                                                                                                                                                                                                                                                                                              
|
| |  | (d) On February 8, 2000, the Company
    issued warrants to purchase an aggregate of 37,364 shares
    of Common Stock to Burnham Securities, Inc. and three of its
    affiliates as compensation for services rendered by Burnham
    Securities, Inc. in connection with a private placement of
    securities conducted by the Company in February 2000. The
    warrants are exercisable until February 8, 2005, with an
    exercise price of $3.09 with respect to 5,336 shares
    underlying such warrants and $5.62 with respect to the remaining
    32,028 shares underlying such warrants. The number of shares of
    Common Stock underlying the warrants and the exercise prices
    thereof are subject to adjustment as set forth in the warrants.
|
| |  | (e) On February 18, 2000, the Company
    issued a warrant to purchase 8,942 shares of Common Stock to a
    broker dealer as compensation for services rendered by such
    broker dealer in connection with a private placement of
    securities conducted by the Company in August 2000. The warrant
    is exercisable until August 2005, with an exercise price of
    $1.82 per share.                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | (f) On October 31, 1996, the Company
    issued warrants to purchase an aggregate of 150,000 shares of
    Common Stock to three individuals as compensation for consulting
    services rendered by such individuals to the Company. The
    warrants are exercisable until October 30, 2006, at an
    exercise price of $6.00 per share.                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  | (g) On January 21, 1997, the Company
    issued a warrant to purchase 25,000 shares of Common Stock to
    one individual as compensation for consulting services rendered
    by such individual to the Company. The warrant expired on
    January 20, 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | (h) On September 19, 1997, the Company
    issued warrants to purchase an aggregate of 100,000 shares of
    Common Stock to two individuals as compensation for consulting
    services rendered by such individuals to the Company. The
    warrants are exercisable until October 30, 2006, at an
    exercise price of $5.25 per share.                                                                                                                                                                                                                                                                                                                                                                                                                         

46



---



##### 



Beneficial Ownership

The following table sets forth information
regarding the beneficial ownership of Common Stock as of
March 8, 2004, 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. All beneficial ownership
information reported below is based upon publicly available
information and certain additional information known to the
Company.

|                                                                    |  |                       |           |             |  |  |     |  
|------------------------------------------------------------------- |  | --------------------- | --------- | ----------- |  |  | --- | -
|                                                                    |  |                      
|                                                                    |  | Common Stock         
|                                                                    |  | Beneficially Owned(1)
|                                                                    |  |                      
|                                                                    |  | Number of             |           |            
|                                                                    |  | Shares of             |           | Percentage 
|Name of Beneficial Owner                                            |  | Common Stock          |           | of Class(2)
|                                                                    |  |                       |           |            
|Steven A. Odom (3)                                                |  |                       | 3,155,921 |             |  |  | 2.3 | %
|Juliet M. Reising (4)                                             |  |                       | 1,337,538 |             |  |  | 1.0 |  
|James M. Logsdon(5)                                                 |  |                       | 1,325,888 |             |  |  | 1.0 |  
|Gary H. Heck (6)                                                  |  |                       | 626,875   |             |  |  | *   |  
|Amy L. Newmark(7)                                                  |  |                       | 615,000   |             |  |  | *   |  
|Joseph R. Wright, Jr.(8)                                           |  |                       | 562,465   |             |  |  | *   |  
|Paul R. Garcia(9)                                                  |  |                       | 372,000   |             |  |  | *   |  
|Stephen E. Raville(10)                                             |  |                       | 352,500   |             |  |  | *   |  
|All executive officers and directors as a group
    (7 persons)(11) |  |                       | 8,348,187 |             |  |  | 6.0 |  



---



|  |                        
|- | -----------------------
| | 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 8, 2004, 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 132,726,585 shares of
    Common Stock issued and outstanding as of March 8, 2004,
    plus shares of Common Stock which may be acquired within
    60 days of March 8, 2004, by each individual or group
    listed.                                                                                                                                                       
|
| | (3) | 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
    Mr. Odoms son as to which Mr. Odom may be deemed
    to share voting and investment power; and
    (iii) 2,820,821 shares of Common Stock issuable
    pursuant to options or warrants exercisable within 60 days
    of March 8, 2004.                      
|
| | (4) | Includes (i) 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 (ii) 1,194,456 shares of Common
    Stock issuable pursuant to options or warrants exercisable
    within 60 days of March 8, 2004.                                                                                                                                       
|
| | (5) | Includes 1,283,474 shares of Common Stock
    issuable pursuant to options or warrants exercisable within
    60 days of March 8, 2004.                                                                                                                                                                                                                                                                                                                             
|
| | (6) | Includes 600,000 shares of Common Stock
    issuable pursuant to options or warrants exercisable within
    60 days of March 8, 2004.                                                                                                                                                                                                                                                                                                                               
|
| | (7) | Includes 475,000 shares of Common Stock
    issuable pursuant to options or warrants exercisable within
    60 days of March 8, 2004.                                                                                                                                                                                                                                                                                                                               
|
| | (8) | Includes (i) 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                                                                                                                                                                                                                                                           

47



---



##### 



| |     |                                                                                                                                                                            
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     | sole investment and voting power; and
    (ii) 458,853 shares of Common Stock issuable pursuant to
    options or warrants exercisable within 60 days of
    March 8, 2004.
|
| | (9) | Represents 262,000 shares of Common Stock
    issuable pursuant to options exercisable within 60 days of
    March 8, 2004.                                                



|     |                                                                                                                                                                                                                                                                                                                                                                 
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Includes (i) 247,500 shares of Common Stock
    issuable pursuant to options exercisable within 60 days of
    March 8, 2004; and (ii) 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.
|    
|(11) | Includes 7,342,104 shares of Common Stock
    issuable pursuant to options or warrants exercisable within
    60 days of March 8, 2004.                                                                                                                                                                                                                         



|         |                                                   
|-------- | --------------------------------------------------
|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 Item 11 
Executive Compensation  Employment Agreements.

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.

Effective February 23, 2003, the Company
hired Mr. Heck to serve as President and Chief Operating
Officer of the Company. Mr. Hecks current annual
salary is $270,000. On March 1, 2004, in connection with
Mr. Hecks employment, the Company issued to
Mr. Heck an option to purchase 100,000 shares of Common
Stock at an exercise price of $1.82 per share. The option was
issued pursuant to the Companys 1999 Stock Incentive Plan
and vests in its entirety on September 1, 2004.

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.



|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

Audit Fees

KPMG LLP billed $284,500 and $275,660 for fiscal
years 2003 and 2002, respectively, for professional services
rendered by KPMG LLP for the audit of the Companys annual
consolidated financial statements and review of the interim
consolidated financial statements included in quarterly reports,
and services that are normally provided by KPMG LLP in
connection with statutory and regulatory filings or engagements.

Audit-Related Fees

KPMG LLP billed $122,475 and $103,178 for fiscal
years 2003 and 2002, respectively, for assurance and related
services that are reasonably related to the performance of the
audit or review of the Companys consolidated financial
statements and are not reported under Audit Fees.
These services include consultations concerning certain
financial accounting and reporting standards.

Tax Fees

KPMG LLP billed $91,381 and $107,142 for fiscal
years 2003 and 2002, respectively, for professional services
rendered by KPMG LLP for tax compliance, tax advice and tax
planning. These services include

48



---



##### 



assistance regarding federal, state and local tax
compliance, tax audit defense, custom and duties and
acquisitions and divestitures tax planning.


All Other Fees

KPMG LLP did not bill for, and did not render
professional services to the Company during, fiscal years 2003
or 2002 for any services that are not included in the above
classifications.

Policy on Audit Committee Pre-Approval of
Audit and Permissible Non-Audit Services of Independent
Auditors

The Audit Committee is required to pre-approve
the audit and non-audit services performed by the Companys
independent auditors. The Audit Committee has adopted a policy
which provides for general pre-approval of specified Audit,
Audit-Related, Tax and Other Services that do not exceed
enumerated dollar amounts. The policy also provides that, unless
a type of service to be provided by the independent auditors has
received general pre-approval, it will require specific
pre-approval by the Audit Committee.

The Audit Committee has determined the Audit,
Audit-Related, Tax and Other Services that are the basis for
general pre-approval by the Audit Committee. The enumerated
dollar amounts at which such general pre-approval will apply are
currently under consideration by the Audit Committee. Until the
Audit Committee has determined such enumerated dollar amounts,
all services performed by the Companys independent
auditors will require the specific pre-approval of the Audit
Committee.

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, 2003,
the Company filed with the SEC on November 3, 2003, a
Current Report on Form 8-K which reported under
Item 12 of such report the Companys information
regarding the Companys results, operations and financial
condition for the third quarter of 2003.

49



---



##### 



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, 2003 and 2002                                         |  |      | F-3  | 
|Consolidated Statements of Operations for the
    years ended December 31, 2003, 2002 and 2001           |  |      | F-4  | 
|Consolidated Statements of Shareholders
    Equity for the years ended December 31, 2003, 2002 and 2001 |  |      | F-5  | 
|Consolidated Statements of Cash Flows for the
    years ended December 31, 2003 2002 and 2001            |  |      | F-6  | 
|Notes to Consolidated Financial Statements                                                               |  |      | F-8  | 
|Independent Auditors Report on Financial
    Statement Schedule                                         |  |      | F-38 | 
|Schedule II  Valuation and
    Qualifying Accounts                                                      |  |      | F-39 | 

F-1



---



##### 



INDEPENDENT AUDITORS REPORT

The Board of Directors

Verso Technologies, Inc.:


We have audited the accompanying consolidated
balance sheets of Verso Technologies, Inc. and subsidiaries
as of December 31, 2003 and 2002, and the related
consolidated statements of operations, shareholders
equity, and cash flows for the each of the years in the
three-year period ended December 31, 2003. These
consolidated financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these consolidated financial statements 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,
2003 and 2002, and the results of their operations and their
cash flows for each of the years in the three-year period ended
December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America.

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 27, 2004


F-2



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)


|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |          |        |        | 
|--------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------------------------ | ------------ | ------ | ------ | ------ | -------- | ------ | ------ | 
|                                                                                                                |                                                                                                                               | December 31,               |                                            | December 31,
|                                                                                                                |                                                                                                                               | 2003                       |                                            | 2002        
|                                                                                                                |                                                                                                                               |                            |                                            |             
|ASSETS:                                                                                                        
|Current assets:                                                                                                 |                                                                                                                               |                            |                                            |              |        |        |        |         
|                                                                                                                | Cash and cash equivalents                                                                                                     |                            | $                                          | 7,654        |        |        | $      | 1,294    |       
|                                                                                                                | Restricted cash                                                                                                               |                            |                                            | 2,290        |        |        |        | 300      |       
|                                                                                                                | Accounts receivable, net of allowance for
    doubtful accounts of $1,995 and $1,853, respectively                            |                            |                                            | 13,620       |        |        |        | 10,909   |       
|                                                                                                                | Inventories                                                                                                                   |                            |                                            | 8,727        |        |        |        | 4,733    |       
|                                                                                                                | Other current assets                                                                                                          |                            |                                            | 1,003        |        |        |        | 681      |       
|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |         
|                                                                                                                |                                                                                                                               | Total current assets       |                                            |              | 33,294 |        |        |          | 17,917 |       
|Property and equipment, net of accumulated
    depreciation and amortization of $7,907 and $4,893, respectively |                                                                                                                               |                            | 5,749                                      |              |        |        | 4,962  |         
|Investment                                                                                                      |                                                                                                                               |                            | 673                                        |              |        |        | 600    |         
|Other intangibles, net of accumulated
    amortization of $2,145 and $828, respectively                         |                                                                                                                               |                            | 7,308                                      |              |        |        | 3,671  |         
|Goodwill                                                                                                        |                                                                                                                               |                            | 16,228                                     |              |        |        | 12,685 |         
|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |         
|                                                                                                                |                                                                                                                               | Total assets               |                                            | $            | 63,252 |        |        | $        | 39,835 |       
|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |         
|LIABILITIES AND SHAREHOLDERS
    EQUITY:                                                                       |                                                                                                                               |                            |                                            |             
|Current liabilities:                                                                                            |                                                                                                                               |                            |                                            |              |        |        |        |         
|                                                                                                                | Line of credit                                                                                                                |                            | $                                          |             |        |        | $      | 800      |       
|                                                                                                                | Accounts payable                                                                                                              |                            |                                            | 4,418        |        |        |        | 1,993    |       
|                                                                                                                | Accrued compensation                                                                                                          |                            |                                            | 1,564        |        |        |        | 1,586    |       
|                                                                                                                | Accrued expenses                                                                                                              |                            |                                            | 3,007        |        |        |        | 4,473    |       
|                                                                                                                | Current portion of notes payable                                                                                              |                            |                                            | 347          |        |        |        |         |       
|                                                                                                                | Current portion of accrued costs of MCK
    acquisition                                                                       |                            |                                            | 4,464        |        |        |        |         |       
|                                                                                                                | Current portion of liabilities of discontinued
    operations                                                                 |                            |                                            | 1,039        |        |        |        | 1,829    |       
|                                                                                                                | Unearned revenue and customer deposits                                                                                        |                            |                                            | 5,718        |        |        |        | 5,387    |       
|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |         
|                                                                                                                |                                                                                                                               | Total current liabilities  |                                            |              | 20,557 |        |        |          | 16,068 |       
|Liabilities of discontinued operations, net of
    current portion                                              |                                                                                                                               |                            | 834                                        |              |        |        | 1,302  |         
|Other long-term liabilities                                                                                     |                                                                                                                               |                            | 1,637                                      |              |        |        | 1,128  |         
|Notes payable, net of current portion                                                                           |                                                                                                                               |                            | 2,652                                      |              |        |        |       |         
|Convertible subordinated debentures                                                                             |                                                                                                                               |                            | 3,979                                      |              |        |        | 3,703  |         
|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |         
|                                                                                                                |                                                                                                                               | Total liabilities          |                                            |              | 29,659 |        |        |          | 22,201 |       
|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |         
|Shareholders equity:                                                                                           |                                                                                                                               |                            |                                            |              |        |        |        |         
|                                                                                                                | Preferred stock, no par value,
    1,000,000 shares authorized; 780,000 shares issued and
    none outstanding                |                            |                                            |             |        |        |        |         |       
|                                                                                                                | Common stock, $.01 par value,
    200,000,000 shares authorized; 122,781,117 and
    89,077,846 shares issued and outstanding |                            |                                            | 1,228        |        |        |        | 891      |       
|                                                                                                                | Additional paid-in capital                                                                                                    |                            |                                            | 306,293      |        |        |        | 275,040  |       
|                                                                                                                | Stock payable                                                                                                                 |                            |                                            | 130          |        |        |        |         |       
|                                                                                                                | Notes receivable from shareholders                                                                                            |                            |                                            |             |        |        |        | (1,623   | )     
|                                                                                                                | Accumulated deficit                                                                                                           |                            |                                            | (273,144     | )      |        |        | (254,857 | )     
|                                                                                                                | Deferred compensation                                                                                                         |                            |                                            | (1,012       | )      |        |        | (1,797   | )     
|                                                                                                                | Accumulated other comprehensive income
    (loss)  foreign currency translation                                              |                            |                                            | 98           |        |        |        | (20      | )     
|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |         
|                                                                                                                |                                                                                                                               | Total shareholders equity |                                            |              | 33,593 |        |        |          | 17,634 |       
|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |         
|Commitments and contingencies (Notes 6, 7,
    10, 14, 16 and 17)                                               |                                                                                                                               |                            |                                            |              |        |        |        |         
|                                                                                                                |                                                                                                                               |                            | Total liabilities and shareholders equity |              | $      | 63,252 |        |          | $      | 39,835 | 
|                                                                                                                |                                                                                                                               |                            |                                            |              |        |        |        |         

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

F-3



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except share data)


|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |          |          |  
|----------------------------------------------------------- | -------------------------------------------------------------------------------------- | ----------------------------------------- | ---------- | ------- | ------- | ---- | ---------- | ------ | ------ | - | ---------- | -------- | -------- | -
|                                                            |                                                                                        |                                          
|                                                            |                                                                                        | For the Years Ended December 31,         
|                                                            |                                                                                        |                                          
|                                                            |                                                                                        | 2003                                      |            | 2002    |         | 2001
|                                                            |                                                                                        |                                           |            |         |         |     
|Revenue:                                                    |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | Products                                                                               |                                           | $          | 36,359  |         |      | $          | 22,983 |        |   | $          | 14,367   |         
|                                                            | Services                                                                               |                                           |            | 23,139  |         |      |            | 21,815 |        |   |            | 15,532   |         
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            |                                                                                        | Total revenue                             |            |         | 59,498  |      |            |        | 44,798 |   |            |          | 29,899   |  
|Cost of revenue:                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | Products                                                                               |                                           |            | 15,588  |         |      |            | 8,141  |        |   |            | 5,762    |         
|                                                            | Services                                                                               |                                           |            | 11,136  |         |      |            | 10,308 |        |   |            | 9,050    |         
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            |                                                                                        | Total cost of revenue                     |            |         | 26,724  |      |            |        | 18,449 |   |            |          | 14,812   |  
|Gross profit:                                               |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | Products                                                                               |                                           |            | 20,771  |         |      |            | 14,842 |        |   |            | 8,605    |         
|                                                            | Services                                                                               |                                           |            | 12,003  |         |      |            | 11,507 |        |   |            | 6,482    |         
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            |                                                                                        | Total gross profit                        |            |         | 32,774  |      |            |        | 26,349 |   |            |          | 15,087   |  
|Operating expenses:                                         |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | General and administrative                                                             |                                           |            | 14,340  |         |      |            | 11,151 |        |   |            | 12,207   |         
|                                                            | Sales and marketing                                                                    |                                           |            | 9,642   |         |      |            | 6,835  |        |   |            | 3,307    |         
|                                                            | Research and development                                                               |                                           |            | 9,630   |         |      |            | 5,874  |        |   |            | 2,755    |         
|                                                            | Depreciation and amortization of property and
    equipment                            |                                           |            | 2,900   |         |      |            | 2,730  |        |   |            | 2,160    |         
|                                                            | Amortization of intangibles                                                            |                                           |            | 1,317   |         |      |            | 592    |        |   |            | 1,511    |         
|                                                            | Amortization of deferred stock compensation,
    related to general and administrative |                                           |            | 780     |         |      |            | 1,173  |        |   |            | 1,766    |         
|                                                            | Write-down of goodwill                                                                 |                                           |            | 10,930  |         |      |            |       |        |   |            |         |         
|                                                            | Reorganization costs                                                                   |                                           |            | 425     |         |      |            | 324    |        |   |            |         |         
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            |                                                                                        | Total operating expenses                  |            |         | 49,964  |      |            |        | 28,679 |   |            |          | 23,706   |  
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            |                                                                                        | Operating loss from continuing operations |            |         | (17,190 | )    |            |        | (2,330 | ) |            |          | (8,619   | )
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|Other income (expense), net:                                |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | Other income (expense)                                                                 |                                           |            | 338     |         |      |            | 881    |        |   |            | (1,437   | )       
|                                                            | Equity in income (loss) of investment                                                  |                                           |            | 73      |         |      |            | (5     | )      |   |            |         |         
|                                                            | Interest expense, net                                                                  |                                           |            | (1,508  | )       |      |            | (1,141 | )      |   |            | (1,361   | )       
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|Other income (expense), net                                 |                                                                                        |                                           | (1,097     | )       |         |      | (265       | )      |        |   | (2,798     | )       
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | Loss from continuing operations before income
    taxes                                |                                           |            | (18,287 | )       |      |            | (2,595 | )      |   |            | (11,417  | )       
|Income tax benefit (expense)                                |                                                                                        |                                           |           |         |         |      | 200        |        |        |   | (100       | )       
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | Loss from continuing operations                                                        |                                           |            | (18,287 | )       |      |            | (2,395 | )      |   |            | (11,517  | )       
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|Discontinued operations:                                    |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | Loss from discontinued operations                                                      |                                           |            |        |         |      |            | (331   | )      |   |            | (135,598 | )       
|                                                            | Loss on disposal of discontinued operations                                            |                                           |            |        |         |      |            |       |        |   |            | (500     | )       
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            |                                                                                        | Total loss from discontinued operations   |            |         |        |      |            |        | (331   | ) |            |          | (136,098 | )
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | Net loss                                                                               |                                           | $          | (18,287 | )       |      | $          | (2,726 | )      |   | $          | (147,615 | )       
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|Net loss per common share  basic and
    diluted:          |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|                                                            | Loss from continuing operations                                                        |                                           | $          | (0.18   | )       |      | $          | (0.03  | )      |   | $          | (0.21    | )       
|                                                            | Loss from discontinued operations                                                      |                                           |            |        |         |      |            |       |        |   |            | (2.49    | )       
|                                                            | Loss on disposal of discontinued operations                                            |                                           |            |        |         |      |            |       |        |   |            | (0.01    | )       
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|Net loss per common share  basic and
    diluted           |                                                                                        | $                                         | (0.18      | )       |         | $    | (0.03      | )      |        | $ | (2.71      | )       
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         
|Weighted average shares outstanding 
    basic and diluted |                                                                                        |                                           | 99,134,790 |         |         |      | 80,533,324 |        |        |   | 54,431,651 |         
|                                                            |                                                                                        |                                           |            |         |         |      |            |        |        |   |            |         

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

F-4



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2003,
2002 AND 2001


(In thousands, except share data)


|                                                                                                                           |                                         |              |             |            |  |         |       |            |  |              |         |          |  |              |     |             |  |       |        |   |  |   |          |          |   |   |        |   |  |   |     |     |   |   |          |          |  
|-------------------------------------------------------------------------------------------------------------------------- | --------------------------------------- | ------------ | ----------- | ---------- |  | ------- | ----- | ---------- |  | ------------ | ------- | -------- |  | ------------ | --- | ----------- |  | ----- | ------ | - |  | - | -------- | -------- | - | - | ------ | - |  | - | --- | --- | - | - | -------- | -------- | -
|                                                                                                                           |                                         |              |             |            |  |         |       | Notes      |  |              |         |          |  |              |     |            
|                                                                                                                           |                                         | Common Stock |             | Additional |  |         |       | Receivable |  |              |         |          |  | Foreign      |     |            
|                                                                                                                           |                                         |              |             | Paid-in    |  | Stock   |       | from       |  | Accumulated  |         | Deferred |  | Currency     |     |            
|                                                                                                                           |                                         | Shares       |             | Amount     |  | Capital |       | Payable    |  | Shareholders |         | Deficit  |  | Compensation |     | Translation |  | Total
|                                                                                                                           |                                         |              |             |            |  |         |       |            |  |              |         |          |  |              |     |             |  |      
|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   |         
|Comprehensive loss:                                                                                                        |                                         |              |             |            |  |         |       |            |  |              |         |          |  |              |     |             |  |       |        |   |  |   |          |          |   |   |        |   |  |   |     |     |   |   |          |         
|                                                                                                                           | Net loss                                |              |             |           |  |         |       |           |  |              |         |         |  |              |     |            |  |       |        |  |  |   |          | (18,287  | ) |   |        |  |  |   |     |    |   |   |          | (18,287  | )
|                                                                                                                           | Foreign currency translation adjustment |              |             |           |  |         |       |           |  |              |         |         |  |              |     |            |  |       |        |  |  |   |          |         |   |   |        |  |  |   |     | 118 |   |   |          | 118      |  
|                                                                                                                           |                                         |              |             |            |  |         |       |            |  |              |         |          |  |              |     |             |  |       |        |   |  |   |          |          |   |   |        |   |  |   |     |     |   |   |          |         
|                                                                                                                           | Comprehensive loss                      |              |             |            |  |         |       |            |  |              |         |          |  |              |     |             |  |       |        |   |  |   |          |          |   |   |        |   |  |   |     |     |   |   |          | (18,169  | )
|Amortization of deferred compensation                                                                                      |                                         |              |            |            |  |         |      |            |  |              |        |          |  |              |    |             |  |       |       |   |  |   |         |          |   |   | 780    |   |  |   |    |     |   |   | 780      |         
|Exercise of stock options and warrants                                                                                     |                                         |              | 14,708,688  |            |  |         | 147   |            |  |              | 6,439   |          |  |              |    |             |  |       |       |   |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 6,586    |         
|Reduction of deferred compensation due to
    forfeitures                                                                  |                                         |              |            |            |  |         |      |            |  |              | (5      | )        |  |              |    |             |  |       |       |   |  |   |         |          |   |   | 5      |   |  |   |    |     |   |   |         |         
|Issuance of common stock in MCK
    Communications, Inc. acquisition                                                       |                                         |              | 18,278,423  |            |  |         | 183   |            |  |              | 23,947  |          |  |              |     |             |  |       |        |   |  |   |          |          |   |   |        |   |  |   |     |     |   |   | 24,130   |         
|Acceleration of compensatory options in
    reorganization                                                                 |                                         |              |            |            |  |         |      |            |  |              | 219     |          |  |              |    |             |  |       | 45     |   |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 264      |         
|Shares issued in employee stock purchase plan                                                                              |                                         |              | 166,160     |            |  |         | 2     |            |  |              | 166     |          |  |              |    |             |  |       |       |   |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 168      |         
|Shares issued in litigation settlement                                                                                     |                                         |              | 550,000     |            |  |         | 5     |            |  |              | 259     |          |  |              |    |             |  |       |       |   |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 264      |         
|Warrants issued in connection with credit facility                                                                         |                                         |              |            |            |  |         |      |            |  |              | 119     |          |  |              |    |             |  |       |       |   |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 119      |         
|Stock payable for consulting services                                                                                      |                                         |              |             |            |  |         |       |            |  |              |         |          |  |              | 130 |             |  |       |        |   |  |   |          |          |   |   |        |   |  |   |     |     |   |   | 130      |         
|Accrued interest on notes receivable from
    shareholders                                                                 |                                         |              |            |            |  |         |      |            |  |              |        |          |  |              |    |             |  |       | (84    | ) |  |   |         |          |   |   |       |   |  |   |    |     |   |   | (84      | )       
|Payment received on notes receivable from
    shareholders                                                                 |                                         |              |            |            |  |         |      |            |  |              | 109     |          |  |              |    |             |  |       | 1,662  |   |  |   |         |          |   |   |       |   |  |   |    |     |   |   | 1,771    |         
|                                                                                                                           |                                         |              |             |            |  |         |       |            |  |              |         |          |  |              |     |             |  |       |        |   |  |   |          |          |   |   |        |   |  |   |     |     |   |   |          |         
|BALANCES, December 31, 2003                                                                                                |                                         |              | 122,781,117 |            |  | $       | 1,228 |            |  | $            | 306,293 |          |  | $            | 130 |             |  | $     |       |   |  | $ | (273,144 | )        |   | $ | (1,012 | ) |  | $ | 98  |     |   | $ | 33,593   |         
|                                                                                                                           |                                         |              |             |            |  |         |       |            |  |              |         |          |  |              |     |             |  |       |        |   |  |   |          |          |   |   |        |   |  |   |     |     |   |   |          |         

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

F-5



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands, except share data)


|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |       |          |         |         |  
|--------------------- | ------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------- | ------- | ------ | ------ | - | ------ | ------ | ------ | ----- | -------- | ------- | ------- | -
|                      |                                                                                 |                                                                                                                      
|                      |                                                                                 | For the Years Ended December 31,                                                                                     
|                      |                                                                                 |                                                                                                                      
|                      |                                                                                 | 2003                                                                                                                  |                                                                                          | 2002                                                                              |         | 2001  
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |       
|Operating Activities: |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      | Continuing operations:                                                          |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |       |         
|                      |                                                                                 | Net loss from continuing operations                                                                                   |                                                                                          | $                                                                                 | (18,287 | )      |        | $ | (2,395 | )      |        | $     | (11,517  | )      
|                      |                                                                                 | Adjustments to reconcile net loss from continuing
    operations to net cash used in continuing operating activities: |                                                                                          |                                                                                   |         |        |        |   |        |        |        |       |          |        
|                      |                                                                                 |                                                                                                                       | Gain on early retirement of debt                                                         |                                                                                   |         |       |        |   |        | (350   | )      |       |          |        |        
|                      |                                                                                 |                                                                                                                       | Loss on debt conversion                                                                  |                                                                                   |         |       |        |   |        |       |        |       |          | 1,640   |        
|                      |                                                                                 |                                                                                                                       | Equity in (income) loss of investment                                                    |                                                                                   |         | (73    | )      |   |        | 5      |        |       |          |        |        
|                      |                                                                                 |                                                                                                                       | Writedown of goodwill                                                                    |                                                                                   |         | 10,930 |        |   |        |       |        |       |          |        |        
|                      |                                                                                 |                                                                                                                       | Depreciation and amortization of property and
    equipment                              |                                                                                   |         | 2,900  |        |   |        | 2,730  |        |       |          | 2,160   |        
|                      |                                                                                 |                                                                                                                       | Amortization of intangibles                                                              |                                                                                   |         | 1,317  |        |   |        | 592    |        |       |          | 1,511   |        
|                      |                                                                                 |                                                                                                                       | Amortization of deferred compensation                                                    |                                                                                   |         | 780    |        |   |        | 1,173  |        |       |          | 1,766   |        
|                      |                                                                                 |                                                                                                                       | Provision for doubtful accounts                                                          |                                                                                   |         | 2,505  |        |   |        | 1,760  |        |       |          | 1,516   |        
|                      |                                                                                 |                                                                                                                       | Amortization of loan fees and discount on
    convertible subordinated debentures        |                                                                                   |         | 561    |        |   |        | 601    |        |       |          | 606     |        
|                      |                                                                                 |                                                                                                                       | Other                                                                                    |                                                                                   |         | (77    | )      |   |        | 73     |        |       |          | (22     | )      
|                      |                                                                                 |                                                                                                                       | Changes in current operating assets and
    liabilities, net of effects of acquisitions: |                                                                                   |         |        |        |   |        |        |        |       |          |         |        
|                      |                                                                                 |                                                                                                                       |                                                                                          | Accounts receivable                                                               |         |        | (1,454 | ) |        |        | (3,403 | )     |          |         | (3,676  | )
|                      |                                                                                 |                                                                                                                       |                                                                                          | Inventories                                                                       |         |        | 1,894  |   |        |        | (913   | )     |          |         | 1,238   |  
|                      |                                                                                 |                                                                                                                       |                                                                                          | Other current assets                                                              |         |        | 548    |   |        |        | 308    |       |          |         | 1,060   |  
|                      |                                                                                 |                                                                                                                       |                                                                                          | Accounts payable                                                                  |         |        | 1,814  |   |        |        | 369    |       |          |         | (1,178  | )
|                      |                                                                                 |                                                                                                                       |                                                                                          | Accrued compensation                                                              |         |        | (149   | ) |        |        | (1,492 | )     |          |         | 794     |  
|                      |                                                                                 |                                                                                                                       |                                                                                          | Accrued expenses                                                                  |         |        | (3,072 | ) |        |        | (2,187 | )     |          |         | (821    | )
|                      |                                                                                 |                                                                                                                       |                                                                                          | Unearned revenue and customer deposits                                            |         |        | (673   | ) |        |        | (396   | )     |          |         | (1,838  | )
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      |                                                                                 |                                                                                                                       | Net cash used in continuing operating activities                                         |                                                                                   |         | (536   | )      |   |        | (3,525 | )      |       |          | (6,761  | )      
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      | Discontinued operations:                                                        |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |       |         
|                      |                                                                                 | Loss from discontinued operations                                                                                     |                                                                                          |                                                                                   |        |        |        |   | (331   | )      |        |       | (136,098 | )      
|                      |                                                                                 | Estimated loss on disposal of discontinued
    operations                                                             |                                                                                          |                                                                                   |        |        |        |   |       |        |        |       | 500      |        
|                      |                                                                                 | Adjustment to reconcile loss from discontinued
    operations to net cash used in discontinued operating activities   |                                                                                          |                                                                                   | (922    | )      |        |   | (775   | )      |        |       | 129,797  |        
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      |                                                                                 |                                                                                                                       | Net cash used in discontinued operating activities                                       |                                                                                   |         | (922   | )      |   |        | (1,106 | )      |       |          | (5,801  | )      
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      |                                                                                 |                                                                                                                       | Net cash used in operating activities                                                    |                                                                                   |         | (1,458 | )      |   |        | (4,631 | )      |       |          | (12,562 | )      
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|Investing Activities: |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      | Continuing operations:                                                          |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |       |         
|                      |                                                                                 | Net cash provided by (used in) investing
    activities for continuing operations                                    |                                                                                          |                                                                                   |         |        |        |   |        |        |        |       |          |        
|                      |                                                                                 |                                                                                                                       | Purchases of property and equipment                                                      |                                                                                   |         | (1,481 | )      |   |        | (889   | )      |       |          | (1,429  | )      
|                      |                                                                                 |                                                                                                                       | Purchased software development                                                           |                                                                                   |         | (533   | )      |   |        | (348   | )      |       |          | (48     | )      
|                      |                                                                                 |                                                                                                                       | Decrease in restricted cash                                                              |                                                                                   |         | 88     |        |   |        |       |        |       |          |        |        
|                      |                                                                                 |                                                                                                                       | Investment in Shanghai BeTrue Infotech Co.
    Ltd.                                      |                                                                                   |         |       |        |   |        | (605   | )      |       |          |         |        
|                      |                                                                                 |                                                                                                                       | Acquisition of MCK Communications, Inc., net
    of cash acquired                        |                                                                                   |         | 9,345  |        |   |        |       |        |       |          |        |        
|                      |                                                                                 |                                                                                                                       | Acquisition of certain assets of Clarent
    Corporation, net of cash acquired           |                                                                                   |         | (906   | )      |   |        |       |        |       |          |        |        
|                      |                                                                                 |                                                                                                                       | Acquisition of NACT
    Telecommunications, Inc., net of cash acquired                   |                                                                                   |         |       |        |   |        |       |        |       |          | (12,074 | )      
|                      |                                                                                 |                                                                                                                       | Acquisition of Telemate.Net Software, Inc.,
    net of cash acquired                     |                                                                                   |         |       |        |   |        |       |        |       |          | 3,327   |        
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      |                                                                                 |                                                                                                                       |                                                                                          | Net cash provided by (used in) investing
    activities for continuing operations |         |        | 6,513  |   |        |        | (1,842 | )     |          |         | (10,224 | )
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      | Discontinued operations  net proceeds
    from sale of discontinued operations |                                                                                                                       |                                                                                          |                                                                                  |         |        |        |  |        |        |        | 8,122 |         
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      |                                                                                 |                                                                                                                       | Net cash provided by (used in) investing
    activities                                  |                                                                                   |         | 6,513  |        |   |        | (1,842 | )      |       |          | (2,102  | )      
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      
|                      |                                                                                 |                                                                                                                       | Net cash provided by (used in) operating and
    investing activities, carried forward   |                                                                                   |         | 5,055  |        |   |        | (6,473 | )      |       |          | (14,664 | )      
|                      |                                                                                 |                                                                                                                       |                                                                                          |                                                                                   |         |        |        |   |        |        |        |      

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

F-6



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH
FLOWS  (Continued)

(In thousands, except share data)


|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |   |        |        |  
|-------------------------------------------------------------------------------------- | ----------------------------------------------- | -------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------- | ---- | ------ | ------ | ------ | --- | ------ | ------ | ------- | - | ------ | ------ | -
|                                                                                       |                                                 |                                                                                                         
|                                                                                       |                                                 | For the Years Ended December 31,                                                                        
|                                                                                       |                                                 |                                                                                                         
|                                                                                       |                                                 | 2003                                                                                                     |                                                                                                               | 2002 |        | 2001  
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |       
|Net cash provided by (used in) operating and
    investing activities, carried forward |                                                 |                                                                                                          | 5,055                                                                                                         |      |        |        | (6,473 | )   |        |        | (14,664 | )
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|Financing Activities:                                                                  |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|                                                                                       | Net borrowings (payments) on line of credit     |                                                                                                          |                                                                                                               | (800 | )      |        |        | 800 |        |        |         |  |       
|                                                                                       |                                                 | Payments of notes payable                                                                                |                                                                                                               |      | (6,450 | )      |        |     |       |        |         |   |       |       
|                                                                                       |                                                 | Payments on long-term debt                                                                               |                                                                                                               |      |       |        |        |     | (3,900 | )      |         |   |       |       
|                                                                                       |                                                 | Payments on convertible subordinated debentures                                                          |                                                                                                               |      |       |        |        |     |       |        |         |   | (4,500 | )     
|                                                                                       |                                                 | Proceeds from private placement, net                                                                     |                                                                                                               |      |       |        |        |     | 2,985  |        |         |   |       |       
|                                                                                       |                                                 | Proceeds from issuances of common stock in
    connection with the exercise of options and warrants, net |                                                                                                               |      | 6,754  |        |        |     | 408    |        |         |   | 755    |       
|                                                                                       |                                                 | Proceeds from issuance of redeemable preferred
    stock                                                 |                                                                                                               |      |       |        |        |     |       |        |         |   | 15,000 |       
|                                                                                       |                                                 | Proceeds from repayments of notes receivable by
    shareholders                                         |                                                                                                               |      | 1,771  |        |        |     | 24     |        |         |   |       |       
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|                                                                                       |                                                 |                                                                                                          | Net cash provided by financing activities                                                                     |      |        | 1,275  |        |     |        | 317    |         |   |        | 11,255 |  
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|Effect of exchange rate changes on
    cash                                            |                                                 |                                                                                                          | 30                                                                                                            |      |        |        | 5      |     |        |        | (1      | )
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|                                                                                       |                                                 |                                                                                                          | Increase (decrease) in cash and cash equivalents                                                              |      |        | 6,360  |        |     |        | (6,151 | )       |   |        | (3,410 | )
|Cash and cash equivalents at beginning of
    year                                     |                                                 |                                                                                                          | 1,294                                                                                                         |      |        |        | 7,445  |     |        |        | 10,855  |  
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|Cash and cash equivalents at end of
    year                                           |                                                 | $                                                                                                        | 7,654                                                                                                         |      |        | $      | 1,294  |     |        | $      | 7,445   |  
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|Supplemental disclosure of cash flow
    information:                                  |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|                                                                                       | Cash payments during the years for:             |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |   |       
|                                                                                       |                                                 | Interest                                                                                                 |                                                                                                               | $    | 814    |        |        | $   | 395    |        |         | $ | 170    |       
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|                                                                                       |                                                 | Income taxes                                                                                             |                                                                                                               | $    | 16     |        |        | $   | 47     |        |         | $ | 101    |       
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  
|                                                                                       | Non-cash investing and financing
    activities |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |   |       
|                                                                                       |                                                 | Common stock consideration for acquisitions:                                                             |                                                                                                               |      |        |        |        |     |        |        |         |   |        |       
|                                                                                       |                                                 |                                                                                                          | MCK Communications, Inc. 
    issuance of 18,278,423 shares of common stock                                  |      | $      | 24,130 |        |     | $      |       |         |   | $      |       |  
|                                                                                       |                                                 |                                                                                                          | 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    |  
|                                                                                       |                                                 | Additional payments accrued for the acquisition
    of Encore Group                                      |                                                                                                               |      |       |        |        |     | 2,403  |        |         |   |       |       
|                                                                                       |                                                 | Common stock and compensatory options issued in
    reorganization                                       |                                                                                                               |      | 264    |        |        |     | 88     |        |         |   | 150    |       
|                                                                                       |                                                 | 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                                                       |                                                                                                               |      | 264    |        |        |     | 437    |        |         |   |       |       
|                                                                                       |                                                 | Issuance of warrants in exchange for services                                                            |                                                                                                               |      | 119    |        |        |     | 211    |        |         |   | 219    |       
|                                                                                       |                                                 | Issuance of common stock in exchange for services                                                        |                                                                                                               |      |       |        |        |     | 28     |        |         |   | 19     |       
|                                                                                       |                                                 | Assets acquired and liabilities assumed in
    conjunction with business acquisitions:                   |                                                                                                               |      |        |        |        |     |        |        |         |   |        |       
|                                                                                       |                                                 |                                                                                                          | Fair value of assets acquired, excluding cash and
    restricted cash                                         |      |        | 20,695 |        |     |        |       |         |   |        | 27,909 |  
|                                                                                       |                                                 |                                                                                                          | Liabilities assumed                                                                                           |      |        | 8,931  |        |     |        |       |         |   |        | 10,705 |  
|                                                                                       |                                                 |                                                                                                          | Notes payable for acquisition of certain assets
    of Clarent Corporation                                    |      | $      | 9,339  |        |     | $      |       |         |   | $      |       |  
|                                                                                       |                                                 |                                                                                                          |                                                                                                               |      |        |        |        |     |        |        |         |  

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

F-7



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

1.     Business 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 includes the Companys Clarent
softswitching division and the Companys subsidiary NACT
Telecommunications, Inc. (NACT), and the
Enterprise Solutions Group, which includes the Companys
Clarent Netperformer division, the Companys subsidiaries
Telemate.Net Software, Inc. (Telemate.Net) and
MCK Communications, Inc. (MCK) and the
Companys customer response center operations. 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
hardware-based solutions (which include software) for companies
seeking to build private, packet-based voice and data networks.
Additionally, the Enterprise Solutions Group offers
software-based solutions for Internet access and usage
management that include call accounting and usage reporting for
Internet protocol network devices. These solutions are supported
by the Companys customer response center services, which
include outsourced technical support and application
installation and training services. The Company acquired MCK in
September 2003, substantially all the business assets of Clarent
Corporation (Clarent) in February 2003, 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 (HSG), all of which were
inactive by the end of the first quarter of 2002.

The consolidated financial statements include the
accounts of Verso Technologies, Inc. and its wholly-owned
subsidiaries, including MCK, Telemate.Net, NACT, Clarent Canada
Ltd, MessageClick, Inc. (MessageClick) and
Cereus Technology Partners, Inc. and subsidiaries
(Cereus). These acquisitions were all 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. Most notably, the extraordinary items
of gain on early retirement of debt of $350,000 in 2002 and loss
from debt conversion of $1.6 million in 2001 have been
reclassified as other income (expense) in 2002 and 2001,
respectively, in accordance with Statement of Financial
Accounting Standards (SFAS) No. 145,
Rescission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement 13, and Technical
Corrections, which eliminated the requirement to report
gains and losses related to extinguishment of debt as
extraordinary items. The reclassifications had no effect on
previously reported net loss.

2.     Summary of
Significant Accounting Policies and Practices



| |                            
| | ---------------------------
| | 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
consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual
results could differ from those estimates.

F-8



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies and Practices 
(Continued)




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

The Company recognizes revenue when persuasive
evidence of an agreement exists, delivery has occurred, the fee
is fixed and determinable, and collection of the resulting
receivable is reasonably assured. The determination of whether
the collectibility is reasonably assured is based upon an
assessment of the creditworthiness of the customers. In
instances where the collection of a receivable is not reasonably
assured, the revenue and related costs are deferred.

Deferred revenue generally represents amounts
collected for which revenue has not yet been recognized. It is
principally comprised of deferred maintenance revenue.

The Company recognizes revenue in accordance with
Staff Accounting Bulletin (SAB) No. 101,
Revenue Recognition in Financial Statements
(SAB No. 101) as updated by Staff Accounting
Bulletin No. 104 and in accordance with Emerging Issues
Task Force (EITF) 00-21, Revenue
Arrangements with Multiple Deliverables, 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).

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
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 allocated to the delivered
element and recognized as revenue.

Certain distribution partners have the right to
return a contractual percentage of sales. For sales to these
partners, the Company defers revenue subject to return until
such rights have expired. Certain of MCKs contractual
arrangements contain price protection provisions whereby the
Company is obligated to provide refunds or credits for any
decrease in unit prices of product in MCKs customers
inventory. The Company routinely analyzes and establishes, as
necessary, reserves at the time of shipment for product returns
and allowances and warranty costs.



| |                 
| | ----------------
| | 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, 2003 and 2002
of approximately $6.5 million and $575,000, respectively,
consist primarily of money market investments, which are
recorded at cost, which approximates market.

The Company has $2.3 million and $300,000 of
restricted cash at December 31, 2003 and 2002,
respectively. At December 31, 2003, the restricted cash is
comprised of an investment pledged as security for a letter of
credit related to a property lease and a foreign cash account.
The restriction related to the letter of credit was removed in
January 2004, when the letter of credit was included under the
Companys current credit facility and, at that time,
restricted cash was reduced by $2.1 million. At
December 31, 2002, the restricted cash is comprised of a
foreign cash account.

F-9



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies and Practices 
(Continued)




| |                                   
| | ----------------------------------
| | 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,
2003, the Companys Carrier Solutions Group had one
customer that accounted for 10% of the Companys gross
accounts receivable and another customer that accounted for 20%
of the Companys gross accounts receivable. During the year
ended December 31, 2003, one customer from the
Companys Enterprise Solutions Group accounted for 11% of
the Companys total revenue.

As of December 31, 2002, one customer of the
Companys Carrier Solutions Group accounted for 27% of the
Companys gross accounts receivable. During the year ended
December 31, 2002, one customer from the Companys
Carrier Solutions Group accounted for 12% of the Companys
total revenue and one customer from the Companys
Enterprise Solutions Group accounted for 15% of the
Companys total revenue.

As of December 31, 2001, the Companys
Carrier Solutions Group had one customer that accounted for 12%
of the Companys gross accounts receivable and another
customer that accounted for 15% of the Companys gross
accounts receivable. During the year ended December 31,
2001, one customer from the Companys Enterprise Solutions
Group accounted for 24% of the Companys total revenue.



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

Inventories consist primarily of purchased
electronic components, 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, 2003 and
2002, are comprised of the following (in thousands):

|                |                   |              |       |       |  |   |       |       | 
|--------------- | ----------------- | ------------ | ----- | ----- |  | - | ----- | ----- | 
|                |                   |             
|                |                   | December 31,
|                |                   |             
|                |                   | 2003         |       | 2002 
|                |                   |              |       |      
|Raw materials   |                   | $            | 5,610 |       |  | $ | 1,566 |      
|Work in process |                   |              | 1,028 |       |  |   | 2,380 |      
|Finished goods  |                   |              | 2,089 |       |  |   | 787   |      
|                |                   |              |       |       |  |   |       |      
|                | Total inventories |              | $     | 8,727 |  |   | $     | 4,733 | 
|                |                   |              |       |       |  |   |       |      



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

Property and equipment, consisting principally of
computer equipment, are stated at cost or if acquired through a
business acquisition then at fair value. 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

F-10



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies and Practices 
(Continued)


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):

|                                               |                            |              |        |       |  |   |        |       | 
|---------------------------------------------- | -------------------------- | ------------ | ------ | ----- |  | - | ------ | ----- | 
|                                               |                            |             
|                                               |                            | December 31,
|                                               |                            |             
|                                               |                            | 2003         |        | 2002 
|                                               |                            |              |        |      
|Computers and equipment                        |                            | $            | 8,141  |       |  | $ | 5,205  |      
|Purchased software                             |                            |              | 1,728  |       |  |   | 1,252  |      
|Furniture and fixtures                         |                            |              | 1,182  |       |  |   | 1,082  |      
|Leasehold improvements                         |                            |              | 2,605  |       |  |   | 2,316  |      
|                                               |                            |              |        |       |  |   |        |      
|                                               |                            |              | 13,656 |       |  |   | 9,855  |      
|Less accumulated depreciation and amortization |                            |              | (7,907 | )     |  |   | (4,893 | )    
|                                               |                            |              |        |       |  |   |        |      
|                                               | Net property and equipment |              | $      | 5,749 |  |   | $      | 4,962 | 
|                                               |                            |              |        |       |  |   |        |      

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
$470,000, $433,000 and $193,000 in 2003, 2002 and 2001,
respectively. Accumulated amortization related to purchased
software totaled approximately $1.2 million and $708,000 at
December 31, 2003 and 2002, 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.



| |                                   
| | ----------------------------------
| | Goodwill and Other
    Intangibles

Intangible assets represent the excess of cost
over the fair value of net tangible assets acquired and
identified other intangible assets which consist of purchased
software development, channels of distribution, strategic
licenses, current technology and a customer relationship.
Purchased software development is amortized on a straight-line
basis over an estimated useful life of three years once the
projects are placed in service. The channels of distribution,
strategic licenses and current technology are amortized on a
straight-line basis over their estimated useful life of three
years. The customer relationship is amortized on a straight-line
basis over its estimated useful life of ten years. Goodwill
associated with acquisitions is not being amortized in
accordance with SFAS No. 142, Goodwill and Other
Intangible Assets (SFAS No. 142).

F-11



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies and Practices 
(Continued)


Goodwill and other intangible assets consist of
the following (in thousands):

|                                     |                                |                                         |                                |              |  |           |        |       |       |        |        |       |       |       |  
|------------------------------------ | ------------------------------ | --------------------------------------- | ------------------------------ | ------------ |  | --------- | ------ | ----- | ----- | ------ | ------ | ----- | ----- | ----- | -
|                                     |                                |                                         |                                |             
|                                     |                                |                                         |                                | December 31,
|                                     |                                | Amortization                            |                                |             
|                                     |                                | Period in months                        |                                | 2003         |  | 2002     
|                                     |                                |                                         |                                |              |  |          
|Intangibles subject to amortization: |                                |                                         |                                |              |  |           |        |       |       |        |        |      
|                                     | Purchased software development |                                         |                                | 36 months    |  |           | $      | 2,629 |       |        | $      | 2,096 |      
|                                     | Channels of distribution       |                                         |                                | 36 months    |  |           |        | 900   |       |        |        |      |      
|                                     | Strategic licenses             |                                         |                                | 36 months    |  |           |        | 1,800 |       |        |        |      |      
|                                     | Current technology             |                                         |                                | 36 months    |  |           |        | 1,721 |       |        |        |      |      
|                                     | Customer relationship          |                                         |                                | 120 months   |  |           |        | 2,403 |       |        |        | 2,403 |      
|                                     |                                |                                         |                                |              |  |           |        |       |       |        |        |      
|                                     |                                |                                         | Weighted
    average months    |              |  | 57 months |        |       |       | 9,453  |        |       |       | 4,499 |  
|                                     |                                |                                         |                                |              |  |           |        |       |       |        |        |      
|                                     | Accumulated amortization:      |                                         |                                |              |  |           |        |       |       |        |        |       |      
|                                     |                                |                                         | Purchased software development |              |  |           |        |       |       | (1,438 | )      |       |       | (828  | )
|                                     |                                |                                         | Channels of distribution       |              |  |           |        |       |       | (75    | )      |       |       |      |  
|                                     |                                |                                         | Strategic licenses             |              |  |           |        |       |       | (150   | )      |       |       |      |  
|                                     |                                |                                         | Current technology             |              |  |           |        |       |       | (242   | )      |       |       |      |  
|                                     |                                |                                         | Customer relationship          |              |  |           |        |       |       | (240   | )      |       |       |      |  
|                                     |                                |                                         |                                |              |  |           |        |       |       |        |        |      
|                                     |                                | Net intangibles subject to amortization |                                |              |  |           |        |       | 7,308 |        |        |       | 3,671 |      
|Goodwill                             |                                |                                         |                                |              |  |           | 16,228 |       |       |        | 12,685 |      
|                                     |                                |                                         |                                |              |  |           |        |       |       |        |        |      
|Total goodwill and other intangibles |                                |                                         |                                |              |  | $         | 23,536 |       |       | $      | 16,356 |      
|                                     |                                |                                         |                                |              |  |           |        |       |       |        |        |      

Goodwill activity is as follows (in thousands):

|                              |  |   |         |  
|----------------------------- |  | - | ------- | -
|Balance December 31, 2001     |  | $ | 12,685  |  
|No activity                   |  |   |        |  
|                              |  |   |         |  
|Balance December 31, 2002     |  |   | 12,685  |  
|Goodwill from MCK acquisition |  |   | 14,473  |  
|Write-down of MCK goodwill    |  |   | (10,930 | )
|                              |  |   |         |  
|Balance December 31, 2003     |  | $ | 16,228  |  
|                              |  |   |         |  

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

|           |  |              |       | 
|---------- |  | ------------ | ----- | 
|           |  | Annual      
|           |  | Amortization
|           |  |             
|2004       |  | $            | 2,088 | 
|2005       |  |              | 1,998 | 
|2006       |  |              | 1,513 | 
|2007       |  |              | 507   | 
|2008       |  |              | 240   | 
|Thereafter |  |              | 962   | 
|           |  |              |       | 
|           |  | $            | 7,308 | 
|           |  |              |       | 

F-12



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies and Practices 
(Continued)


The Company fully adopted SFAS No. 142
in 2002. Under the provisions of SFAS No. 142,
goodwill is no longer subject to amortization effective
January 1, 2002. Goodwill amortization expense totaled
approximately $1.3 million in 2001. 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, 2001 
|                                  |                            |                   
|Reported net loss                 |                            | $                  | (147,615 | )    
|                                  | Add: Goodwill amortization |                    |          | 1,275 |  
|                                  |                            |                    |          |      
|Adjusted net loss                 |                            | $                  | (146,340 | )    
|                                  |                            |                    |          |      
|Basic and diluted loss per share: |                            |                    |          |      
|                                  | Reported net loss          |                    | $        | (2.71 | )
|                                  | Goodwill amortization      |                    |          | 0.02  |  
|                                  |                            |                    |          |      
|Adjusted net loss                 |                            | $                  | (2.69    | )    
|                                  |                            |                    |          |      



| |                                    
| | -----------------------------------
| | 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 early-adopted SFAS No. 144
effective January 1, 2001.

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.

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.

In April 2003, the Company negotiated the
original agreement to purchase MCK in which the MCK stockholders
would be entitled to receive approximately 20.0 million
shares of the Companys common stock which was valued at
$13.0 million, based on the volume weighted average closing
price per share of the Companys common stock as reported
on the Nasdaq SmallCap Market for the 20 trading day period
beginning March 19, 2003 and ending April 15, 2003. As
part of the original agreement, the Company was to receive
$7.5 million in cash. The terms of the agreement were
amended on June 13, 2003. Under the amended terms, MCK
stockholders were entitled to receive approximately
18.3 million shares of the Companys common stock and
the cash MCK was required to have at the closing of the merger
was reduced from $7.5 million to approximately
$6.4 million. Although the number of shares of the
Companys common stock to be issued in the merger was
reduced by the amendment, the amendment changed the measurement
date for valuing such shares. As a result of the increase in the
price of the Companys common stock prior to June 13,
2003, the revised valuation for the shares of the Companys
common stock to be issued in the merger increased to
$24.1 million. As a result of this increase in value, the
goodwill recorded in the merger was

F-13



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies and Practices 
(Continued)


impaired upon closing the merger. The Company
completed an impairment analysis in accordance with
SFAS No. 142. The impairment analysis was performed by
using the average of the discounted cash flow methodology and
guideline market multiples methodology. Based upon this
analysis, the Company recorded a write-off of approximately
$10.9 million during the year ended December 31, 2003.



| |           
| | ----------
| | Warranties

The Company provides a basic limited warranty for
its products for one year with optional pre-paid factory support
renewals. The Company estimates the costs that may be incurred
under its basic limited warranty and records a liability in the
amount of such costs at the time product revenue is recognized.
Factors that affect the Companys warranty liability
include the number of installed units, historical and
anticipated rates of warranty claims and cost per claim. The
Company periodically assesses the adequacy of its recorded
warranty liabilities and adjusts the amounts as necessary.

Warranty liability activity for the year ended
December 31, 2003 is as follows (in thousands):

|                                     |  |   |      |  
|------------------------------------ |  | - | ---- | -
|Balance December 31, 2002            |  | $ |     |  
|Warranty liability from acquisitions |  |   | 341  |  
|Provision for warranty costs         |  |   | 186  |  
|Warranty expenditures                |  |   | (205 | )
|                                     |  |   |      |  
|Balance December 31, 2003            |  | $ | 322  |  
|                                     |  |   |      |  



| |                                        
| | ---------------------------------------
| | 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 the
    Companys notes payable has been discounted to approximate
    its fair value in connection with the accounting for the Clarent
    acquisition. The carrying amount of convertible subordinated
    debentures under fixed rate debt approximates its fair value
    because it approximates the Companys estimated long-term
    borrowing rate.

At December 31, 2003 and 2002, the carrying
amounts of all financial instruments approximate their fair
values.



| |                              
| | -----------------------------
| | 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),

F-14



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies and Practices 
(Continued)


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 accounted for under the asset
and liability method. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases
and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled.



| |                   
| | ------------------
| | 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, 2003, 2002 and 2001 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:

|                                                                  |  |      |            |      |  |      |           |  |  |  |         | 
|----------------------------------------------------------------- |  | ---- | ---------- | ---- |  | ---- | --------- |  |  |  | ------- | 
|                                                                  |  | 2003 |            | 2002 |  | 2001
|                                                                  |  |      |            |      |  |     
|Shares issuable under stock options                               |  |      | 5,232,642  |      |  |      | 2,376,136 |  |  |  | 717,302 | 
|Shares issuable pursuant to warrants to purchase
    common stock |  |      | 7,056,306  |      |  |      | 1,641,781 |  |  |  | 39,323  | 
|                                                                  |  |      |            |      |  |      |           |  |  |  |         | 
|                                                                  |  |      | 12,288,948 |      |  |      | 4,017,917 |  |  |  | 756,625 | 
|                                                                  |  |      |            |      |  |      |           |  |  |  |         | 

See Footnotes 9 and 10 for disclosure of all
warrants to purchase common stock and shares issuable under
stock options.



| |                            
| | ---------------------------
| | 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, 2003.



| |                                       
| | --------------------------------------
| | 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 two
reportable operating segments, the Carrier Solutions Group and
the Enterprise Solutions Group. Following the acquisition of
substantially all the business assets of Clarent in February
2003, the Company began conducting research and development in
Canada. International sales of the Companys products and
services continue to originate only from the United States.

F-15



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



2.     Summary of
Significant Accounting Policies and Practices 
(Continued)




| |                                                  
| | -------------------------------------------------
| | Accounting Pronouncements Issued, Not
    Adopted

In February 2003, the Financial Accounting
Standards Board (FASB) issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and
Equity (SFAS No. 150). The
provisions of SFAS No. 150 (see below for additional
information) are effective for financial instruments entered
into or modified after May 31, 2003, and otherwise are
effective at the beginning of the first interim period beginning
after June 15, 2003, except for mandatorily redeemable
financial instruments of nonpublic entities.
SFAS No. 150 is to be implemented by reporting the
cumulative effect of a change in an accounting principle for
financial instruments created before May 31, 2003 and still
existing at the beginning of the interim period of adoption.

FASB Staff Position FAS 150-3,
Effective Date, Disclosures, and Transition for
Mandatorily Redeemable Financial Instruments of Certain
Nonpublic Entities and Certain Mandatorily Redeemable
Noncontrolling Interests under FASB Statement No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity (FSP
FAS 150-3), defers the effective date for certain
mandatorily redeemable financial instruments issued by a non-SEC
registrant and defers the effective date of
SFAS No. 150 for certain mandatorily redeemable
noncontrolling interests of all entities. The adoption of
SFAS No. 150 did not have a material effect on the
Companys financial position or results of operations.
Additionally, based on the nature of the Companys current
instruments and interests, the Company does not believe there
will be a material effect on the Companys financial
position or results of operations resulting from the adoption of
the remaining components of FSP FAS 150-3.

In December 2003, the FASB issued FASB
Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities
(FIN No. 46R), which addresses how a business
enterprise should evaluate whether it has a controlling
financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. FIN
No. 46R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which
was issued in January 2003. Companies are required to apply FIN
No. 46R to variable interests in variable interest entities
(VIEs) created after December 31, 2003. For
variable interests in VIEs created before January 1, 2004,
the Interpretation is applied beginning on January 1, 2005.
For any VIEs that must be consolidated under FIN No. 46R
that were created before January 1, 2004, the assets,
liabilities and noncontrolling interests of the VIE initially
are measured at their carrying amounts with any difference
between the net amount added to the balance sheet and any
previously recognized interest being recognized as the
cumulative effect of an accounting change. If determining the
carrying amounts is not practicable, fair value at the date FIN
No. 46R first applies may be used to measure the assets,
liabilities and noncontrolling interest of the VIE. The Company
is evaluating the impact of applying FIN No. 46R and has
not yet completed its analysis.

3.     Mergers and
Acquisitions



| |                         
| | ------------------------
| | MCK Communications, Inc.

On September 26, 2003, to increase capital
and to enhance the Companys ability to provide technology
that allows enterprises the ability to migrate to
next-generation environments, the Company acquired all of the
outstanding capital stock of MCK by means of a subsidiary
merger. The fair value of the acquisition cost was approximately
$25.1 million, consisting of 18,278,423 shares of the
Companys common stock with a fair value of
$24.1 million and acquisition costs of approximately
$1.0 million.

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.

F-16



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



3.     Mergers and
Acquisitions  (Continued)


The Company has prepared an allocation of the
purchase price based on the estimated fair values of acquired
assets and liabilities. The Company anticipates the fair value
assessments and allocation of the purchase price to be finalized
in 2004. Intangible assets relating to channels of distribution,
strategic licenses and current technology and total
$3.6 million and are being amortized over three years.

In April 2003, the Company negotiated the
original agreement to purchase MCK in which the MCK stockholders
would be entitled to receive approximately 20.0 million
shares of the Companys common stock which was valued at
$13.0 million, based on the volume weighted average closing
price per share of the Companys common stock as reported
on the Nasdaq SmallCap Market for the twenty trading day period
beginning March 19, 2003 and ending April 15, 2003. As
part of the original agreement, the Company was to receive
$7.5 million in cash. The terms of the agreement were
amended on June 13, 2003. Under the amended terms, MCK
stockholders were entitled to receive approximately
18.3 million shares of the Companys common stock and
the cash MCK was required to have at the closing of the merger
was reduced from $7.5 million to approximately
$6.4 million. Although the number of shares of the
Companys common stock to be issued in the merger was
reduced by the amendment, the amendment changed the measurement
date for valuing such shares. As a result of the increase in the
price of the Companys common stock prior to June 13,
2003, the revised valuation for the shares of the Companys
common stock to be issued in the merger increased to
$24.1 million. As a result of this increase in value, the
goodwill recorded in the merger was impaired upon closing the
merger. The Company completed an impairment analysis in
accordance with SFAS No. 142. Based upon this
analysis, the Company recorded a write-off of goodwill of
approximately $10.9 million during the quarter ended
September 30, 2003.



| |                    
| | -------------------
| | Clarent Corporation

On February 12, 2003, to enhance the
Companys position in the next-generation networking and
technology market, the Company acquired substantially all the
business assets and certain related liabilities of Clarent. The
purchase consideration was approximately $10.8 million,
consisting of $9.3 million in discounted seller notes
issued by the Company and acquisition costs of approximately
$1.5 million. At the closing of the acquisition, 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, which was paid in full at
December 31, 2003; a $1.8 million non-interest bearing
unsecured note due February 13, 2004, discounted at
6.25% per annum, of which $1.5 million was paid
through December 31, 2003 and the $350,000 balance is due
February 12, 2004; and a $3.0 million secured note due
February 12, 2008, which bears interest at 5% per
annum, discounted at 7.5% per annum. The unamortized
discount totaled approximately $350,000 at December 31,
2003. The assets the Company purchased from Clarent secure the
secured notes.

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. Intangible assets acquired totaling $821,000
primarily consist of current technology and are being amortized
over three years.



| |                            
| | ---------------------------
| | 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 

F-17



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



3.     Mergers and
Acquisitions  (Continued)


3.3%; and expected dividend yield 
0%), deferred compensation of $131,000 (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.

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.

F-18



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



3.     Mergers and
Acquisitions  (Continued)


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.



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

|                                                 |  |     |        |         |  |              |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------ |  | --- | ------ | ------- |  | ------------ | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                 |  | MCK |        | Clarent |  | Telemate.Net |        | NACT
|                                                 |  |     |        |         |  |              |        |     
|Cash                                             |  | $   | 10,575 |         |  | $            | 571    |      |  | $ | 4,810  |   |  | $ | 2,538  |  
|Restricted cash                                  |  |     | 2,015  |         |  |              | 115    |      |  |   |       |   |  |   |       |  
|Accounts receivable                              |  |     | 1,045  |         |  |              | 2,717  |      |  |   | 618    |   |  |   | 5,233  |  
|Inventories                                      |  |     | 423    |         |  |              | 5,465  |      |  |   |       |   |  |   | 4,559  |  
|Other current assets                             |  |     | 453    |         |  |              | 613    |      |  |   | 743    |   |  |   | 755    |  
|Property and equipment                           |  |     | 365    |         |  |              | 1,650  |      |  |   | 563    |   |  |   | 2,505  |  
|Other intangibles                                |  |     | 3,600  |         |  |              | 821    |      |  |   |       |   |  |   | 1,700  |  
|Goodwill(1)                                      |  |     | 14,473 |         |  |              |       |      |  |   | 1,062  |   |  |   | 10,171 |  
|Accounts payable                                 |  |     | (508   | )       |  |              | (103   | )    |  |   | (217   | ) |  |   | (726   | )
|Accrued compensation                             |  |     | (195   | )       |  |              | (198   | )    |  |   | (427   | ) |  |   | (769   | )
|Current portion of accrued costs of MCK purchase |  |     | (5,810 | )       |  |              |       |      |  |   |       |   |  |   |        |  
|Accrued expenses                                 |  |     | (782   | )       |  |              | (331   | )    |  |   | (1,350 | ) |  |   | (49    | )
|Deferred revenue                                 |  |     | (524   | )       |  |              | (480   | )    |  |   | (1,827 | ) |  |   |       |  
|Deferred payment on purchase of NACT             |  |     |       |         |  |              |       |      |  |   |       |   |  |   | (5,340 | )
|Deferred compensation                            |  |     |       |         |  |              |       |      |  |   | 131    |   |  |   |       |  
|                                                 |  |     |        |         |  |              |        |      |  |   |        |   |  |   |        |  
|Cost of acquisition                              |  | $   | 25,130 |         |  | $            | 10,840 |      |  | $ | 4,106  |   |  | $ | 20,577 |  
|                                                 |  |     |        |         |  |              |        |      |  |   |        |   |  |   |        |  



---



|    |                                                      
|--- | -----------------------------------------------------
|(1) | Prior to MCK goodwill write-down of
    $10.9 million



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

The following unaudited pro forma information
presents the results of continuing operations of the Company as
if the acquisitions of MCK and Clarent had taken place on
January 1, 2002 and the acquisitions of Telemate.Net and
NACT had taken place on January 1, 2001 (in thousands,
except per share amounts):

|                                                                         |  |         |         |         |  |      |        |   |  |   |          |  
|------------------------------------------------------------------------ |  | ------- | ------- | ------- |  | ---- | ------ | - |  | - | -------- | -
|                                                                         |  | 2003(1) |         | 2002(1) |  | 2001
|                                                                         |  |         |         |         |  |     
|Revenues                                                                 |  | $       | 70,325  |         |  | $    | 92,039 |   |  | $ | 47,567   |  
|Loss from continuing operations                                          |  | $       | (16,740 | )       |  | $    | (8,838 | ) |  | $ | (17,623  | )
|Net loss                                                                 |  | $       | (16,740 | )       |  | $    | (9,169 | ) |  | $ | (155,362 | )
|Loss from continuing operations per common share
    - basic and diluted |  | $       | (0.15   | )       |  | $    | (0.09  | ) |  | $ | (0.25    | )
|Net loss per common share  basic and
    diluted                        |  |         | (0.15   | )       |  |      | (0.09  | ) |  |   | (2.04    | )
|Weighted average shares
    outstanding  basic and diluted              |  |         | 112,556 |         |  |      | 98,812 |   |  |   | 76,137   |  



---



|    |                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------
|(1) | The write-down of goodwill in 2003 for MCK of
    $10.9 million is excluded from the amounts for 2003 and
    2002.

F-19



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


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. The Company also
contributed to the joint venture certain next-generation
communication equipment and software valued at approximately
$236,000 and $100,000 cash.

Summarized financial information reported by this
affiliate for the year ended December 31, 2003 and for the
period subsequent to the Companys investment for the
fourth quarter ended December 31, 2002 (in thousands) are
as follows:

|                   |                         |              |   |              |  |  |   |     |  
|------------------ | ----------------------- | ------------ | - | ------------ |  |  | - | --- | -
|                   |                         |              |   | Quarter     
|                   |                         | Year Ended   |   | Ended       
|                   |                         | December 31, |   | December 31,
|                   |                         | 2003         |   | 2002        
|                   |                         |              |   |             
|Operating results: |                         |              |   |              |  |  |   |    
|                   | Revenues                |              | $ | 3,324        |  |  | $ | 725 |  
|                   |                         |              |   |              |  |  |   |    
|                   | Operating income (loss) |              | $ | 128          |  |  | $ | (5  | )
|                   |                         |              |   |              |  |  |   |    
|                   | Net income (loss)       |              | $ | 141          |  |  | $ | (9  | )
|                   |                         |              |   |              |  |  |   |    

The Company had approximately $60,000 in sales to
BeTrue during the year ended December 31, 2003 and none in
2002.

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 beginning in 2000) 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.

F-20



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



5.     Discontinued
Operations  (Continued)


There were no results of discontinued operations
for the year ended December 31, 2003. Summary operating
results of the discontinued operations (in thousands) are as
follows:

|                                  |  |                    |      |      |  |   |          |  
|--------------------------------- |  | ------------------ | ---- | ---- |  | - | -------- | -
|                                  |  |                   
|                                  |  | For the Year 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 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 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 | 
|                               |  |      |       | 

Liabilities of discontinued operations (in
thousands) are as follows:

|                            |                                        |              |       |       |  |   |       |       | 
|--------------------------- | -------------------------------------- | ------------ | ----- | ----- |  | - | ----- | ----- | 
|                            |                                        |             
|                            |                                        | December 31,
|                            |                                        |             
|                            |                                        | 2003         |       | 2002 
|                            |                                        |              |       |      
|Accrued restructuring costs |                                        | $            | 1,472 |       |  | $ | 2,010 |      
|Other current liabilities   |                                        |              | 401   |       |  |   | 1,121 |      
|                            |                                        |              |       |       |  |   |       |      
|                            | Liabilities of discontinued operations |              | $     | 1,873 |  |   | $     | 3,131 | 
|                            |                                        |              |       |       |  |   |       |      

Accrued restructuring 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 estimated amounts
to be paid by any sublessors. The accrual for one of the leases
with total payments remaining through January 31, 2010 of
$2.4 million assumes that the building will be sub-leased
for approximately 44% of the total lease liability over the
remaining term of the lease.

The 2003 activity in the liabilities of
discontinued operations (in thousands) was as follows:

|                                         |  |   |       |  
|---------------------------------------- |  | - | ----- | -
|Balance December 31, 2002                |  | $ | 3,131 |  
|Lease payments, net of sublease receipts |  |   | (739  | )
|Other payments                           |  |   | (720  | )
|Additional lease accrual                 |  |   | 201   |  
|                                         |  |   |       |  
|Balance December 31, 2003                |  | $ | 1,873 |  
|                                         |  |   |       |  

F-21



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

6.     Financing
Arrangements

In February 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
export-import (EX-IM) facility that will provide for
working capital based on the Companys international
accounts receivable and inventories related to export sales. The
Company and Silicon further amended the credit facility in
connection with the acquisition of MCK and the acquisition of
substantially all of the business assets along with related
liabilities of Clarent (as amended, the Amended Credit
Agreement). The Companys borrowings under the
Amended Credit Agreement are secured by substantially all of the
assets of the Company. Interest on borrowings under the Amended
Credit Agreement at 2.0% above Silicons Base Rate, with a
minimum Base Rate of 4.25% (6.25% at December 31, 2003).
The Amended Credit Agreement provides for up to
$2.5 million in letters of credit. Advances are limited by
a formula based on eligible receivables, inventories, certain
cash balances, outstanding letters of credit and certain
subjective limitations. Interest payments are due monthly, and
the Amended Credit Agreement expires in August 2004. The Amended
Credit Agreement includes a loan fee of $170,000 and
..375% per annum on unused available borrowings. Under the
terms of the Amended Credit Agreement, the Company must maintain
a minimum EBITDA (earnings before interest, taxes, depreciation
and amortization), computed monthly, and may not declare
dividends or incur any additional indebtedness without the
consent of Silicon, and must comply with other financial
covenants, as defined in the Amended Credit Agreement. The
Company was not in compliance with the EBITDA covenant as of
December 31, 2003 and received a waiver. In February 2004,
the Company and Silicon further amended the credit facility to
replace the EBITDA covenant, with an adjusted minimum cash on
hand requirement and a tangible net worth covenant.

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 warrants issued
totaled approximately $119,000, using the Black-Scholes option
pricing method based on the following weighted-average
assumptions: expected volatility  104%; expected
life  five years; risk-free interest
rate  3.0%; and expected dividend
yield  0%. The loan fees and fair value of the
warrants issued are being amortized to interest expense over the
term of the Amended Credit Agreement.

The Company had no borrowings under the Amended
Credit Agreement as of December 31, 2003. The availability
under the Amended Credit Agreement at December 31, 2003 was
$7.8 million. (This amount does not include the effect of
MCK on the Companys borrowing ability because Silicon has
not yet conducted an audit that would determine the amount of
MCK receivables to be included in the borrowing base. In
addition, the Company was not borrowing and did not need the
additional borrowing availability. The Company estimates that
including the MCK receivables would increase availability by
approximately $1.5 million). The Company has an outstanding
stand-by letter of credit in the amount of $200,000 at
December 31, 2003, which would reduce borrowing capacity
under the Amended Credit Agreement.

In addition, the Companys subsidiary MCK
has an outstanding stand-by letter of credit, of which their
landlord is the named beneficiary, in the amount of
$1.5 million that is secured by restricted cash in the
amount of $2.1 million at December 31, 2003. This
letter of credit was cancelled and replaced in January 2004 with
a letter of credit under the Companys Amended Credit
Agreement.

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
1,000,000 shares of the Companys common stock at an
exercise price of $7.50 per share. The

F-22



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



7.     Convertible
Subordinated Debentures  (Continued)


debentures are convertible into the
Companys common stock at a conversion price of $3.57. 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 $521,000 at December 31, 2003. 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 is approximately
$4.0 million at December 31, 2003.

The Company issued $7.0 million of its
5% convertible subordinated debentures, along with warrants
to purchase 364,584 shares of the Companys common
stock at an exercise price of $5.03 per share, during the
year ended December 31, 2000. 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
$1.64 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 other
expense 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 first and third quarters of 2003, the
Company initiated reorganizations to accommodate the acquisition
of the assets of Clarent and as a part of its effort to
consolidate functions and improve operational efficiencies, the
Company eliminated 25 positions held by employees. As a result
of these actions, the Company recorded reorganization costs of
$425,000 during the year ended December 31, 2003. The
reorganization costs consist of severance costs and non-cash
stock compensation expense related primarily to the acceleration
of vesting of options.

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.

F-23



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

9.     Shareholders
Equity



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

The Company originally authorized
1,000,000 shares of preferred stock, 30,000 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.

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, 2003 and
2002. 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. In 2003, the Company exercised the
call feature in these warrants resulting in aggregate proceeds
of $3.0 million.



| |               
| | --------------
| | 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 2003, the Company issued 350,000 warrants
in connection with the Companys Original Credit Agreement
(see Note 6). The warrants were exercised in 2003 resulting
in aggregate proceeds of $154,000.

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). The
Company exercised the call feature for the warrants related to
the private placement. These warrants were exercised in 2003
resulting in aggregate proceeds of $3.2 million.

During 2001, the Company issued 945,378 warrants
in connection with the modification of the terms of its
5% convertible subordinated debt agreement.

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.

F-24



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



9.     Shareholders
Equity  (Continued)


A summary of warrants outstanding at
December 31, 2003, is as follows:

|               |  |             |           |          |  |                 |      |  |  |  |                                | 
|-------------- |  | ----------- | --------- | -------- |  | --------------- | ---- |  |  |  | ------------------------------ | 
|               |  |             |           | Weighted |  |                
|               |  | Number of   |           | Average  |  |                
|               |  | Outstanding |           | Exercise |  |                
|Exercise Price |  | Warrants    |           | Price    |  | Expiration Date
|               |  |             |           |          |  |                
|$0.01          |  |             | 37,532    |          |  | $               | 0.01 |  |  |  | September 2005  October 2006  | 
|$1.50-$1.82    |  |             | 1,244,106 |          |  | $               | 1.63 |  |  |  | August 2005  January 2006     | 
|$3.09-$5.25    |  |             | 767,749   |          |  | $               | 4.21 |  |  |  | January 2004  October 2006    | 
|$5.62-$5.65    |  |             | 4,534,839 |          |  | $               | 5.65 |  |  |  | February 2005  September 2005 | 
|$5.88          |  |             | 1,275,970 |          |  | $               | 5.88 |  |  |  | November 2005                  | 
|$6.00          |  |             | 150,000   |          |  | $               | 6.00 |  |  |  | October 2006                   | 
|               |  |             |           |          |  |                 |      |  |  |  |                                | 
|Total          |  |             | 8,010,196 |          |  | $               | 4.90 |  |  |  |                                | 
|               |  |             |           |          |  |                 |      |  |  |  |                                | 

As of December 31, 2003, all of the warrants
are vested.

The exercise price and number of outstanding
warrants for certain warrants previously issued have been
adjusted according to their antidilution provisions.

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 have been granted under the 1999 Plan for the
year ended December 31, 2002. None were awarded for 2003
and 2001. Total options remaining available for grant under the
1999 Plan as of December 31, 2003 were 1,958,752.

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%, and was included in the cost of the
acquisition. The Company does not plan to issue any additional
shares under the Telemate.Net Plans.

F-25



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



10.     Stock Option
Plan  (Continued)


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 $29,000, $48,000 and $8,000
of the deferred compensation related to these option grants for
the years ended December 31, 2003, 2002 and 2001,
respectively. The Company reduced deferred compensation due to
forfeitures relating to these options totaling approximately
$5,000 and $41,000 during the years ended December 31, 2003
and 2002, respectively.

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 $750,000, $1.1 million and $1.8 million
of the deferred compensation related to these option grants for
the years ended December 31, 2003, 2002 and 2001,
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 Companys 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.

The Company accelerated vesting and extended
exercise dates on options for certain terminated individuals in
connection with reorganizations during 2003 and 2002 (see
Note 8). As a result, the Company recorded a non-cash
charges of approximately $219,000 and $23,000 for the years
ended December 31, 2003 and 2002, respectively,
representing the value of the accelerated vesting and extended
exercise dates for certain terminated employees. The expense is
included in reorganization costs.

F-26



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



10.     Stock Option
Plan  (Continued)


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, 2003, December 31, 2002, and
December 31, 2001 and the changes during the years ended on
these dates is presented below:

|                                                                       |  |            |            |          |  |            |      |          |  |            |            |          |  |   |      |  |  |  |            |  |  |   |      | 
|---------------------------------------------------------------------- |  | ---------- | ---------- | -------- |  | ---------- | ---- | -------- |  | ---------- | ---------- | -------- |  | - | ---- |  |  |  | ---------- |  |  | - | ---- | 
|                                                                       |  |            |            |          |  |           
|                                                                       |  | 2003       |            | 2002     |  | 2001      
|                                                                       |  |            |            |          |  |           
|                                                                       |  | 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                                   |  |            | 15,798,288 |          |  | $          | 2.13 |          |  |            | 18,029,478 |          |  | $ | 2.57 |  |  |  | 14,599,370 |  |  | $ | 4.19 | 
|Granted                                                                |  |            | 4,863,197  |          |  |            | 1.07 |          |  |            | 1,366,300  |          |  |   | 1.46 |  |  |  | 9,547,453  |  |  |   | 0.90 | 
|Exercised                                                              |  |            | 3,702,017  |          |  |            | 0.55 |          |  |            | 847,082    |          |  |   | 0.34 |  |  |  | 1,090,702  |  |  |   | 0.60 | 
|Forfeited                                                              |  |            | 2,231,704  |          |  |            | 2.52 |          |  |            | 2,750,408  |          |  |   | 5.10 |  |  |  | 5,026,643  |  |  |   | 4.53 | 
|Expired                                                                |  |            |           |          |  |            |     |          |  |            |           |          |  |   |     |  |  |  |           |  |  |   |     | 
|                                                                       |  |            |            |          |  |            |      |          |  |            |            |          |  |   |      |  |  |  |            |  |  |   |      | 
|Outstanding at end of year                                             |  |            | 14,727,764 |          |  |            | 2.13 |          |  |            | 15,798,288 |          |  |   | 2.13 |  |  |  | 18,029,478 |  |  |   | 2.57 | 
|                                                                       |  |            |            |          |  |            |      |          |  |            |            |          |  |   |      |  |  |  |            |  |  |   |      | 
|Exercisable at end of year                                             |  |            | 10,143,506 |          |  |            | 2.29 |          |  |            | 9,901,956  |          |  |   | 2.16 |  |  |  | 8,210,833  |  |  |   | 2.49 | 
|                                                                       |  |            |            |          |  |            |      |          |  |            |            |          |  |   |      |  |  |  |            |  |  |   |      | 
|Weighted-average fair value of all options granted                     |  |            |            |          |  |            | 0.85 |          |  |            |            |          |  |   | 0.70 |  |  |  |            |  |  |   | 0.75 | 
|Weighted-average remaining contractual life of
    outstanding options |  |            |            |          |  |            | 6.99 |          |  |            |            |          |  |   | 6.46 |  |  |  |            |  |  |   | 7.69 | 

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              |  | 2003 |        | 2002 |  | 2001
|                        |  |      |        |      |  |     
|Expected Term           |  |      | 4.00   |      |  |      | 4.00   |   |  |  | 4.00   |  
|Expected Volatility     |  |      | 115.00 | %    |  |      | 110.00 | % |  |  | 130.00 | %
|Expected Dividend Yield |  |      | 0.00   | %    |  |      | 0.00   | % |  |  | 0.00   | %
|Risk-Free Interest Rate |  |      | 3.00   | %    |  |      | 3.00   | % |  |  | 3.32   | %

F-27



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


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, 2003:

|                         |  |                      |            |                      |  |             |      |                |  |  |            |  |  |   |      | 
|------------------------ |  | -------------------- | ---------- | -------------------- |  | ----------- | ---- | -------------- |  |  | ---------- |  |  | - | ---- | 
|                         |  |                      |            |                     
|                         |  | Options and Warrants |            | Options and Warrants
|                         |  | Outstanding          |            | Exercisable         
|                         |  |                      |            |                     
|                         |  | Number               |            |                      |  | Number      |      |               
|                         |  | Outstanding          |            | Wgtd. Avg.           |  | Exercisable |      | Wgtd. Avg.    
|Range of Exercise Prices |  | at 12/31/03          |            | Exercise Price       |  | at 12/31/03 |      | Exercise Price
|                         |  |                      |            |                      |  |             |      |               
|$0.19 to $0.50           |  |                      | 3,713,881  |                      |  | $           | 0.42 |                |  |  | 2,240,131  |  |  | $ | 0.40 | 
|$0.51 to $1.19           |  |                      | 1,802,330  |                      |  |             | 0.94 |                |  |  | 870,717    |  |  |   | 0.86 | 
|$1.20 to $1.50           |  |                      | 468,000    |                      |  |             | 1.44 |                |  |  | 414,750    |  |  |   | 1.46 | 
|$1.51 to $2.14           |  |                      | 4,592,619  |                      |  |             | 2.14 |                |  |  | 3,661,369  |  |  |   | 2.14 | 
|$2.15 to $3.05           |  |                      | 290,690    |                      |  |             | 2.75 |                |  |  | 282,226    |  |  |   | 2.75 | 
|$3.06 to $4.00           |  |                      | 1,795,734  |                      |  |             | 3.50 |                |  |  | 920,859    |  |  |   | 3.44 | 
|$4.01 to $5.00           |  |                      | 1,381,435  |                      |  |             | 4.23 |                |  |  | 1,074,535  |  |  |   | 4.25 | 
|$5.01 to $18.00          |  |                      | 683,075    |                      |  |             | 6.77 |                |  |  | 678,919    |  |  |   | 6.77 | 
|                         |  |                      |            |                      |  |             |      |                |  |  |            |  |  |   |      | 
|$0.19 to $18.00          |  |                      | 14,727,764 |                      |  | $           | 2.13 |                |  |  | 10,143,506 |  |  | $ | 2.29 | 
|                         |  |                      |            |                      |  |             |      |                |  |  |            |  |  |   |      | 

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):

|                                                                                                                          |           |      |         |       |   |      |        |       |   |   |          |       |  
|------------------------------------------------------------------------------------------------------------------------- | --------- | ---- | ------- | ----- | - | ---- | ------ | ----- | - | - | -------- | ----- | -
|                                                                                                                          |           | 2003 |         | 2002  |   | 2001
|                                                                                                                          |           |      |         |       |   |     
|Net loss, as reported                                                                                                     |           | $    | (18,287 | )     |   | $    | (2,726 | )     |   | $ | (147,615 | )    
|Add: Stock-based compensation expense included in
    net loss                                                            |           |      | 780     |       |   |      | 1,173  |       |   |   | 1,766    |      
|Less: Total stock-based employee
    compensation expense
    determined under fair value based method for
    all awards |           |      | (3,146  | )     |   |      | (3,296 | )     |   |   | (4,114   | )    
|                                                                                                                          |           |      |         |       |   |      |        |       |   |   |          |      
|Pro forma net loss                                                                                                        |           | $    | (20,653 | )     |   | $    | (4,849 | )     |   | $ | (149,963 | )    
|                                                                                                                          |           |      |         |       |   |      |        |       |   |   |          |      
|Net loss per common share As reported                                                                                     |           | $    | (0.18   | )     |   | $    | (0.03  | )     |   | $ | (2.71    | )    
|                                                                                                                          | Pro forma |      |         | (0.21 | ) |      |        | (0.06 | ) |   |          | (2.76 | )

11.     Income
Taxes

The components of loss from continuing
operations, before income taxes were (in thousands):

|         |  |                          |         |      |  |      |        |   |  |   |         |  
|-------- |  | ------------------------ | ------- | ---- |  | ---- | ------ | - |  | - | ------- | -
|         |  |                         
|         |  | Years Ended December 31,
|         |  |                         
|         |  | 2003                     |         | 2002 |  | 2001
|         |  |                          |         |      |  |     
|Domestic |  | $                        | (17,421 | )    |  | $    | (2,595 | ) |  | $ | (11,417 | )
|Foreign  |  |                          | (866    | )    |  |      |       |   |  |   |        |  
|         |  |                          |         |      |  |      |        |   |  |   |         |  
|         |  | $                        | (18,287 | )    |  | $    | (2,595 | ) |  | $ | (11,417 | )
|         |  |                          |         |      |  |      |        |   |  |   |         |  

F-28



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

11.     Income
Taxes  (Continued)

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

|              |                    |                          |                              |      |   |      |      |   |      |      |     |   |     |     | 
|------------- | ------------------ | ------------------------ | ---------------------------- | ---- | - | ---- | ---- | - | ---- | ---- | --- | - | --- | --- | 
|              |                    |                         
|              |                    | Years Ended December 31,
|              |                    |                         
|              |                    | 2003                     |                              | 2002 |   | 2001
|              |                    |                          |                              |      |   |     
|Income Taxes: |                    |                          |                              |      |   |      |      |   |      |      |     |  
|              | Currently Payable: |                          |                              |      |   |      |      |   |      |      |     |   |    
|              |                    | Domestic                 |                              | $    |  |      |      | $ | (200 | )    |     | $ | 100 |    
|              |                    | Foreign                  |                              |      |  |      |      |   |     |      |     |   |    |    
|              |                    |                          |                              |      |   |      |      |   |      |      |     |  
|              |                    |                          |                             |      |   |      | (200 | ) |      |      | 100 |  
|              | Deferred           |                          |                              |      |   |      |      |   |      |      |     |   |    
|              |                    | Domestic                 |                              |      |  |      |      |   |     |      |     |   |    |    
|              |                    | Foreign                  |                              |      |  |      |      |   |     |      |     |   |    |    
|              |                    |                          |                              |      |   |      |      |   |      |      |     |  
|              |                    |                          |                             |      |   |      |     |   |      |      |    |  
|              |                    |                          |                              |      |   |      |      |   |      |      |     |  
|              |                    |                          | Income Tax (Benefit) Expense |      | $ |     |      |   | $    | (200 | )   |   | $   | 100 | 
|              |                    |                          |                              |      |   |      |      |   |      |      |     |  

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

|                                                 |  |                          |       |      |  |      |       |    |  |  |       |   
|------------------------------------------------ |  | ------------------------ | ----- | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                                                 |  |                         
|                                                 |  | Years Ended December 31,
|                                                 |  |                         
|                                                 |  | 2003                     |       | 2002 |  | 2001
|                                                 |  |                          |       |      |  |     
|Statutory U.S. rate                              |  |                          | (34.0 | )%   |  |      | (34.0 | )% |  |  | (34.0 | )%
|State income taxes, net of federal benefit       |  |                          | (4.0  | )    |  |      | (4.0  | )  |  |  | (4.0  | ) 
|Non-deductible charges for intangibles           |  |                          | 23.3  |      |  |      | 7.5   |    |  |  | 29.3  |   
|Effect of acquisitions                           |  |                          |      |      |  |      |      |    |  |  | (8.4  | ) 
|Effect of valuation allowance                    |  |                          | 17.2  |      |  |      | 1.2   |    |  |  | 8.3   |   
|Other permanent differences                      |  |                          | (8.4  | )    |  |      | 15.2  |    |  |  | 8.9   |   
|Non-deductible compensation                      |  |                          | 0.0   |      |  |      | 0.9   |    |  |  |      |   
|Effect of expiring net operating loss            |  |                          | 5.9   |      |  |      | 13.2  |    |  |  |      |   
|Reversal of accrued exposure no longer necessary |  |                          |      |      |  |      | (6.8  | )  |  |  |      |   
|                                                 |  |                          |       |      |  |      |       |    |  |  |       |   
|Total income tax expense (benefit)               |  |                          | 0.0   | %    |  |      | (6.8  | )% |  |  | 0.1   | % 
|                                                 |  |                          |       |      |  |      |       |    |  |  |       |   

F-29



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



11.     Income
Taxes  (Continued)


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,          
|                     |                                           |                       
|                     |                                           | 2003                   |   | 2002   
|                     |                                           |                        |   |        
|Deferred tax assets: |                                           |                        |   |         |   |  |   |        
|                     | Net operating loss carryforwards          |                        | $ | 63,133  |   |  | $ | 48,161  |  
|                     | Capital loss carryforwards                |                        |   | 269     |   |  |   | 269     |  
|                     | Research and development credits          |                        |   | 1,248   |   |  |   | 1,248   |  
|                     | Foreign research and development expenses |                        |   | 1,502   |   |  |   |        |  
|                     | Foreign investment tax credits            |                        |   | 1,246   |   |  |   |        |  
|                     | Unearned revenue                          |                        |   | 1,906   |   |  |   | 2,044   |  
|                     | Reserves                                  |                        |   | 3,875   |   |  |   | 1,929   |  
|                     | Compensation accruals                     |                        |   | 423     |   |  |   | 1,843   |  
|                     | Intangible assets                         |                        |   | 705     |   |  |   | 2,099   |  
|                     | Depreciable assets                        |                        |   | 2,791   |   |  |   | 1,182   |  
|                     | Other                                     |                        |   | 235     |   |  |   |        |  
|                     | Valuation allowance                       |                        |   | (77,333 | ) |  |   | (58,775 | )
|                     |                                           |                        |   |         |   |  |   |        
|                     |                                           | Net deferred tax asset |   | $       |  |  |   | $       |  | 
|                     |                                           |                        |   |         |   |  |   |        

The valuation allowance for deferred tax assets
as of December 31, 2003, was approximately
$77.3 million. The increase of $18.5 million in the
total valuation allowance for 2003 is due partly to the
establishment of valuation reserves on acquired deferred tax
assets ($15.4 million) and partly to increases in above
described temporary differences on which a valuation allowance
was provided.

Substantially all of the companies deferred tax
assets are attributable to acquisitions accounted for as
purchase transactions. The valuation allowances associated with
these deferred assets will be credited to goodwill if and when
realized. 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, 2003 and
2002.

At December 31, 2003, the Company had net
operating loss (NOL) carry-forwards of approximately
$162.1 million and other business tax credits of
approximately $1.2 million, a substantial portion of which
are subject to certain limitations under the Internal Revenue
Code Section 382. If not utilized, the NOLs will begin
expiring in years 2004 through 2023. In addition the Company had
foreign investment tax credits totaling approximately
$1.2 million which begin expiring in years 2009 through
2013.

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 $266,000, $209,000 and $132,000 for the years
ended December 31, 2003, 2002 and 2001, respectively.

F-30



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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
166,160, 290,171 and 211,965 for the years ended
December 31, 2003, 2002 and 2001, respectively.

14.     Other
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
$3.1 million, $2.3 million and $1.9 million for
the years ended December 31, 2003, 2002 and 2001,
respectively.

As of December 31, 2003, approximate future
commitments under operating leases and future minimum rentals to
be received under noncancelable subleases in excess of one year
are as follows (in thousands):

|           |  |            |        |                         |  |                  |       |        |  |           |        |   |  |   |       |  |  |   |        |  
|---------- |  | ---------- | ------ | ----------------------- |  | ---------------- | ----- | ------ |  | --------- | ------ | - |  | - | ----- |  |  | - | ------ | -
|           |  |            |        |                         |  |                  |       |       
|           |  |            |        |                         |  | Accrued Costs of
|           |  |            |        | Discontinued Operations |  | MCK Acquisition 
|           |  |            |        | (See Note 5)            |  | (See Note 3)    
|           |  | Continuing |        |                         |  |                 
|           |  | Operations |        | Leases                  |  | Subleases        |       | Leases |  | Subleases
|           |  |            |        |                         |  |                  |       |        |  |          
|2004       |  | $          | 2,974  |                         |  | $                | 988   |        |  | $         | (706   | ) |  | $ | 1,345 |  |  | $ | (686   | )
|2005       |  |            | 2,826  |                         |  |                  | 378   |        |  |           | (230   | ) |  |   | 1,295 |  |  |   | (686   | )
|2006       |  |            | 2,363  |                         |  |                  | 370   |        |  |           | (214   | ) |  |   | 1,314 |  |  |   | (686   | )
|2007       |  |            | 2,088  |                         |  |                  | 378   |        |  |           | (156   | ) |  |   | 439   |  |  |   | (229   | )
|2008       |  |            | 2,076  |                         |  |                  | 386   |        |  |           | (160   | ) |  |   |      |  |  |   |       |  
|Thereafter |  |            | 2,065  |                         |  |                  | 394   |        |  |           | (164   | ) |  |   |      |  |  |   |       |  
|           |  |            |        |                         |  |                  |       |        |  |           |        |   |  |   |       |  |  |   |        |  
|Total      |  | $          | 14,392 |                         |  | $                | 2,894 |        |  | $         | (1,630 | ) |  | $ | 4,393 |  |  | $ | (2,287 | )
|           |  |            |        |                         |  |                  |       |        |  |           |        |   |  |   |       |  |  |   |        |  

15.     Segment
Information

The Company reports information for two segments,
the Carrier Solutions Group and the Enterprise Solutions Group.



|                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|------------------------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Carrier Solutions Group: |  | The Companys Carrier Solutions Group
    consists of the operations of the Companys Clarent
    softswitching division and the Companys switching
    subsidiary, NACT. The Companys Carrier Solutions Group
    includes hardware and software, integration, applications and
    technical training and support. Management evaluates the
    business segment performance based on contributions before
    unallocated items. Inter-segment sales and transfers are not
    significant.

F-31



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



15.     Segment
Information  (Continued)




|                            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Enterprise Solutions Group: |  | The Companys Enterprise Solutions Group
    consists of the operations of the Companys Clarent
    Netperformer division, the Companys subsidiaries
    Telemate.Net and MCK and the Companys customer response
    center services. The Enterprise Solutions Group offers
    hardware-based solutions (which include software) for companies
    seeking to build private, packet-based voice and data networks.
    Additionally, the Enterprise Group offers software-based
    solutions for Internet access and usage management that include
    call accounting and usage reporting for Internet protocol
    network devices. These solutions are supported by the
    Companys customer response center services, which include
    outsourced technical support and application installation and
    training services. Management evaluates the business segment
    performance based on contributions before unallocated items.
    Inter- segment sales and transfers are not significant.

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

|                                     |                                              |           |   |            |   |       |   |        |  |  |   |        |  | 
|------------------------------------ | -------------------------------------------- | --------- | - | ---------- | - | ----- | - | ------ |  |  | - | ------ |  | 
|                                     |                                              | Carrier   |   | Enterprise |   |      
|                                     |                                              | Solutions |   | Solutions  |   |      
|                                     |                                              | Group     |   | Group      |   | Total
|                                     |                                              |           |   |            |   |      
|For the Years Ended
    December 31, |                                              |           |   |            |   |       |   |        |  |  |   |       
|                                     |                                              | 2003      |   |            |   |       |   |        |  |  |   |        |  | 
|                                     | Revenue                                      |           | $ | 29,744     |   |       | $ | 29,754 |  |  | $ | 59,498 | 
|                                     | Contribution (loss) before unallocated items |           |   | (195       | ) |       |   | 7,357  |  |  |   | 7,162  | 
|                                     | Goodwill                                     |           |   | 10,170     |   |       |   | 6,058  |  |  |   | 16,228 | 
|                                     | Total assets                                 |           |   | 28,279     |   |       |   | 20,927 |  |  |   | 49,206 | 
|                                    
|                                     |                                              | 2002      |   |            |   |       |   |        |  |  |   |        |  | 
|                                     | Revenue                                      |           | $ | 26,319     |   |       | $ | 18,479 |  |  | $ | 44,798 | 
|                                     | Contribution before unallocated items        |           |   | 3,487      |   |       |   | 6,170  |  |  |   | 9,657  | 
|                                     | Goodwill                                     |           |   | 10,170     |   |       |   | 2,515  |  |  |   | 12,685 | 
|                                     | Total assets                                 |           |   | 28,045     |   |       |   | 6,218  |  |  |   | 34,263 | 
|                                    
|                                     |                                              | 2001      |   |            |   |       |   |        |  |  |   |        |  | 
|                                     | Revenue                                      |           | $ | 15,773     |   |       | $ | 14,126 |  |  | $ | 29,899 | 
|                                     | Contribution before unallocated items        |           |   | 3,569      |   |       |   | 1,877  |  |  |   | 5,446  | 
|                                     | Goodwill                                     |           |   | 10,170     |   |       |   | 2,515  |  |  |   | 12,685 | 
|                                     | Total assets                                 |           |   | 26,205     |   |       |   | 5,458  |  |  |   | 31,663 | 

F-32



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



15.     Segment
Information  (Continued)


The following table reconciles the total
contribution before unallocated items to the loss from
continuing operations (in thousands):

|                                                 |  |                          |         |      |  |      |        |   |  |   |         |  
|------------------------------------------------ |  | ------------------------ | ------- | ---- |  | ---- | ------ | - |  | - | ------- | -
|                                                 |  |                         
|                                                 |  | Years Ended December 31,
|                                                 |  |                         
|                                                 |  | 2003                     |         | 2002 |  | 2001
|                                                 |  |                          |         |      |  |     
|Contribution before unallocated items, per above |  | $                        | 7,162   |      |  | $    | 9,657  |   |  | $ | 5,446   |  
|Corporate and administrative expenses            |  |                          | (8,000  | )    |  |      | (7,168 | ) |  |   | (8,628  | )
|Depreciation                                     |  |                          | (2,900  | )    |  |      | (2,730 | ) |  |   | (2,160  | )
|Amortization of intangibles                      |  |                          | (1,317  | )    |  |      | (592   | ) |  |   | (1,511  | )
|Deferred compensation                            |  |                          | (780    | )    |  |      | (1,173 | ) |  |   | (1,766  | )
|Write-down of goodwill                           |  |                          | (10,930 | )    |  |      |       |   |  |   |        |  
|Reorganization costs                             |  |                          | (425    | )    |  |      | (324   | ) |  |   |        |  
|Other income                                     |  |                          | 338     |      |  |      | 881    |   |  |   | (1,437  | )
|Equity in income (loss) of investment            |  |                          | 73      |      |  |      | (5     | ) |  |   |        |  
|Interest expense, net                            |  |                          | (1,508  | )    |  |      | (1,141 | ) |  |   | (1,361  | )
|Income taxes                                     |  |                          |        |      |  |      | 200    |   |  |   | (100    | )
|                                                 |  |                          |         |      |  |      |        |   |  |   |         |  
|Loss from continuing operations                  |  | $                        | (18,287 | )    |  | $    | (2,395 | ) |  | $ | (11,517 | )
|                                                 |  |                          |         |      |  |      |        |   |  |   |         |  

The following table reconciles the segment total
assets to the Companys total assets:

|                                                 |  |              |        |      |  |   |        | 
|------------------------------------------------ |  | ------------ | ------ | ---- |  | - | ------ | 
|                                                 |  |             
|                                                 |  | Years Ended 
|                                                 |  | December 31,
|                                                 |  |             
|                                                 |  | 2003         |        | 2002
|                                                 |  |              |        |     
|Total assets before unallocated items, per above |  | $            | 49,206 |      |  | $ | 34,263 | 
|Corporate assets:                                |  |              |        |      |  |   |        | 
|Cash and cash equivalents                        |  |              | 7,654  |      |  |   | 692    | 
|Restricted cash                                  |  |              | 2,290  |      |  |   | 300    | 
|Other current assets                             |  |              | 144    |      |  |   | 592    | 
|Property and equipment, net                      |  |              | 3,285  |      |  |   | 3,388  | 
|Investment                                       |  |              | 673    |      |  |   | 600    | 
|                                                 |  |              |        |      |  |   |        | 
|                                                 |  | $            | 63,252 |      |  | $ | 39,835 | 
|                                                 |  |              |        |      |  |   |        | 

Following the acquisition of substantially all
the business assets along with certain liabilities of Clarent in
February 2003, the Company began conducting research and
development in Canada. International sales of the Companys
products and services continue to originate only from the United
States. The geographic distribution of the Companys
revenue and contribution before unallocated items (in thousands)
are as follows:

|                                |                                       |        |   |               |   |       |   |        |  |  |   |        |  | 
|------------------------------- | ------------------------------------- | ------ | - | ------------- | - | ----- | - | ------ |  |  | - | ------ |  | 
|                                |                                       | Canada |   | United States |   | Total
|                                |                                       |        |   |               |   |      
|For the Year Ended December 31, |                                       |        |   |               |   |       |   |        |  |  |   |       
|                                |                                       | 2003   |   |               |   |       |   |        |  |  |   |        |  | 
|                                | Revenue                               |        | $ |              |   |       | $ | 59,498 |  |  | $ | 59,498 | 
|                                | Contribution before unallocated items |        |   | (3,670        | ) |       |   | 10,832 |  |  |   | 7,162  | 
|                                | Total Assets                          |        |   | 1,514         |   |       |   | 61,738 |  |  |   | 63,252 | 

F-33



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


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 and 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. These
obligations have been accrued for in the prior year.



| |                                     
| | ------------------------------------
| | 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

F-34



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



16.     Other
Events  (Continued)


award. On March 14, 2003, the AAA arbitrator
awarded $250,000 and $240,000 to Mr. OReilly and
Mr. Lewis, respectively. These items were accrued in 2002.

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.

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
cost 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. The outstanding liability
at December 31, 2003 is $1.1 million, including
$519,000 in other long-term liabilities.

17.     Litigation

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 are not
expected to have a material adverse impact on the Companys
results of operations or financial condition. In addition, the
Company or its subsidiaries are a party to the proceedings
discussed below.

F-35



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



17.     Litigation  (Continued)


In December 2001, a complaint was filed in the
Southern District of New York seeking an unspecified amount
of damages on behalf of an alleged class of persons who
purchased shares of the MCKs common stock between the date
of MCKs initial public offering and December 6, 2000.
The complaint named as defendants MCK and certain of its former
officers and other parties as underwriters of its initial public
offering (the MCK defendants). The plaintiffs
allege, among other things, that MCKs prospectus,
contained in the Registration Statement on Form S-1 filed
with the SEC, was materially false and misleading because it
failed to disclose that the investment banks which underwrote
MCKs initial public offering of securities and others
received undisclosed and excessive brokerage commissions, and
required investors to agree to buy shares of securities after
the initial public offering was completed at predetermined
prices as a precondition to obtaining initial public offering
allocations. The plaintiffs further allege that these actions
artificially inflated the price of MCKs common stock after
the initial public offering. This case is one of many with
substantially similar allegations known as the Laddering
Cases filed before the Southern District of New York
against a variety of unrelated issuers (the
Issuers), directors and officers (the
Laddering Directors and Officers) and underwriters
(the Underwriters), and have been consolidated for
pre-trial purposes before one judge to assist with
administration. A motion to dismiss addressing issues common to
the companies and individuals who have been sued in these
actions was filed in July 2002. After a hearing on the motion to
dismiss the Court, on February 19, 2003, denied dismissal
of the claims against MCK as well as other Issuers. Although MCK
believes that the claims asserted are meritless, MCK and other
Issuers have negotiated a tentative settlement with the
plaintiffs. The terms of the tentative settlement agreement
provide, among other things, that (i) the insurers of the
Issuers will deliver a surety undertaking in the amount of
$1 billion payable to the plaintiffs to settle the actions
against all Issuers and the Laddering Directors and Officers;
(ii) each Issuer will assign to a litigation trust, for the
benefit of the plaintiffs, any claims it may have against its
Underwriters in the initial public offering for excess
compensation in the form of fees or commissions paid to such
Underwriters by their customers for allocation of initial public
offering shares; (iii) the plaintiffs will release all
claims against the Issuers and the Laddering Directors and
Officers asserted or which could have been asserted in the
actions arising out of the factual allegations of the amended
complaints; and (iv) appropriate releases and bar orders
and, if necessary, judgment reductions, will be entered to
preclude the Underwriters and any non-settling defendants from
recovering any amounts from the settling Issuers or the
Laddering Directors and Officers by way of contribution or
indemnification. Prior to the Companys acquisition of MCK,
MCKs board of directors voted to approve the tentative
settlement. The proposed settlement is subject to acceptance by
the other Issuers and court approval. No provision was recorded
for this matter in the financial statements of MCK prepared
prior to its acquisition by the Company because MCK believed
that its portion of the proposed settlement would be paid by its
insurance carrier. The Company agrees with MCKs treatment
of this matter. While a final agreement has not been executed,
MCK expects to finalize the agreement in the next several months.

MCK has been named a defendant in a lawsuit filed
in Norfolk County, Massachusetts by Entrata
Communications, Inc. (Entrata). Entrata
Communications Inc. v. Superwire.com Inc. and
MCK, Inc. arises out of a dispute between Entrata and one
of its largest shareholders, Superwire.com, Inc.
(Superwire). Pursuant to a contract with Entrata,
MCK was obligated to pay Entrata $750,000 in early 2002. In
order to take advantage of a $100,000 discount offered for early
payment, MCK paid Entrata $650,000 in November 2001, in full
satisfaction of its contractual obligations. The funds were
placed in escrow with Superwires California law firm,
Jeffers, Shaff & Falk, LLP (JSF), which
agreed not to disburse the funds until the dispute between
Entrata and Superwire had been resolved. Nevertheless, Entrata
contends that it never received the funds from MCK and that the
funds were diverted to Superwire and JSF. Through the lawsuit,
Entrata seeks to recover from both MCK and Superwire the
$750,000 that MCK would have owed in 2002. MCK has asserted
counterclaims against Entrata, and cross-claims against
Superwire, for fraud and breach of contract. On October 11,
2002, Superwire and Entrata filed cross-motions for summary
judgment

F-36



---



##### 



VERSO TECHNOLOGIES, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



17.     Litigation  (Continued)


against each other. The court denied both motions
on March 13, 2003. Following denial of the cross-motions
for summary judgment, MCK filed a motion to add JSF and two of
its partners, Barry D. Falk and Mark R. Ziebell, as third-party
defendants. The court had given the parties until March 17,
2004 to complete discovery. Before the completion of the
discovery period, Entrata filed a Chapter 7 bankruptcy
proceeding pursuant to the United States Bankruptcy Code. MCK
has not as of yet been notified by the trustee of Entratas
estate as to whether the trustee will pursue the claims against
MCK. If such claims are pursued, then the Company intends to
defend the claims against MCK and prosecute its counterclaims
and third-party claims. No amounts, other than the original
payment, were provided for this matter in the financial
statements of MCK prepared prior to its acquisition by the
Company. The Company believes that the claim against MCK is
without merit.

18.     Subsequent
Event



| |                  
| | -----------------
| | Private Placement

On February 25, 2004, the Company issued, in
a private placement, 9.8 million shares of its common stock
and warrants to purchase 2.5 million shares of its common
stock for an aggregate purchase price of $17.7 million, or
$1.80 per share. The warrants issued in connection with the
private placement are exercisable for a period of seven years
and at an exercise price of $2.30 per share. The Company
received approximately $16.25 million, net of expenses.

F-37



---



##### 



INDEPENDENT AUDITORS REPORT

The Board of Directors

Verso Technologies, Inc.:


Under date of February 27, 2004, we reported
on the consolidated balance sheets of Verso
Technologies, Inc. and subsidiaries as of December 31,
2003 and 2002, 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,
2003. In connection with our audits of the aforementioned
consolidated financial statements, we also audited the related
financial statement schedule as listed in the accompanying
index. This financial statement schedule is the responsibility
of the Companys management. Our responsibility is to
express an opinion on this financial statement schedule based on
our audits.

In our opinion, such 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 27, 2004


F-38



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##### 



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: 
|                                  | 2003 |              | $ | (1,853,000  | ) |            | $ | (2,505,000  | ) |                | $ | (560,000   | ) |  | $ | 2,923,000 |  |  | $ | (1,995,000  | )
|                                  | 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  | )
|Deferred tax valuation allowance:
|                                  | 2003 |              | $ | (58,775,000 | ) |            | $ | (15,033,000 | ) |                | $ | (3,525,000 | ) |  | $ |          |  |  | $ | (77,333,000 | )
|                                  | 2002 |              | $ | (58,740,000 | ) |            | $ | (35,000     | ) |                | $ |           |   |  | $ |          |  |  | $ | (58,775,000 | )
|                                  | 2001 |              | $ | (46,402,000 | ) |            | $ | (12,338,000 | ) |                | $ |           |   |  | $ |          |  |  | $ | (58,740,000 | )

F-39



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##### 



SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act, 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, 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/ PAUL R. GARCIAPaul R. Garcia               |  | Director                                                                                                                                      |  | March 15, 2004
|                                              
|/s/ GARY H. HECKGary H. Heck                   |  | President, Chief Operating Officer
    and Director                                                                                           |  | March 15, 2004
|                                              
|/s/ AMY L. NEWMARKAmy L. Newmark               |  | Director                                                                                                                                      |  | March 15, 2004
|                                              
|/s/ STEVEN A. ODOMSteven A. Odom               |  | Chief Executive Officer and
    Chairman of the Board
    (Principal Executive Officer)                                                       |  | March 15, 2004
|                                              
|/s/ STEPHEN E. RAVILLEStephen E. Raville       |  | Director                                                                                                                                      |  | March 15, 2004
|                                              
|/s/ JULIET M. REISINGJuliet M. Reising         |  | Executive Vice President, Chief
    Financial Officer, Secretary, Treasurer
    and Director (Principal Accounting
    and Financial Officer) |  | March 15, 2004
|                                              
|/s/ JOSEPH R. WRIGHT, JR.Joseph R. Wright, Jr. |  | Director                                                                                                                                      |  | March 15, 2004



---



##### 



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



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##### 



|            |      |         |  |                                                                                                                                                                                                                                                                                                                                                                                                                   |  |                                                                                                                                                   
|----------- | ---- | ------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                                                                                                                                                                                                                                                                 
|            |      |         |  |                                                                                                                                                                                                                                                                                                                                                                                                                  
|            | 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.                          
|            | 2.27 |         |  | 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.                          
|            | 2.28 |         |  | Agreement and Plan of Merger dated as of
    April 21, 2003, among the Registrant, Mickey Acquiring Sub,
    Inc. and MCK Communications, Inc. (The schedules to the
    Agreement and Plan of Merger have been omitted from this Report
    pursuant to Item 601(b)(2) of Regulation S-K, and the
    Registrant agrees to furnish copies of such omitted schedules
    supplementally to the SEC upon request.) |  | Incorporated by reference to Exhibit 2.1 to
    the Registrants Current Report on Form 8-K filed on
    April 23, 2003.                          
|            | 2.29 |         |  | First Amendment to the Agreement and Plan of
    Merger dated as of April 21, 2003, among the Registrant,
    Mickey Acquiring Sub, Inc. and MCK Communications, Inc.                                                                                                                                                                                                                                             |  | Incorporated by reference to Exhibit 2.2 to
    the Registrants Current Report on Form 8-K filed on
    April 23, 2003.                          
|            | 2.30 |         |  | Second Amendment to the Agreement and Plan of
    Merger dated as of June 13, 2003, among the Registrant,
    Mickey Acquiring Sub, Inc. and MCK Communications, Inc.                                                                                                                                                                                                                                             |  | Incorporated by reference to Exhibit 2.3 to
    the Registrants Current Report on Form 8-K filed on
    June 17, 2003.                           
|            | 2.31 |         |  | Securities Purchase Agreement dated as of
    February 20, 2004, among the Registrant and each of the
    Investors signatory thereto. (The schedules to the Securities
    Purchase Agreement have been omitted from this Report pursuant
    to Item 601(b)(2) of Regulation S-K, and the
    Registrant agrees to furnish copies of such omitted schedules
    supplementally to the SEC upon request.)        |  | Incorporated by reference to Exhibit 2.1 to
    the Registrants Current Report on Form 8-K filed on
    February 26, 2004.                       
|            | 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).                     

3



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##### 



|            |      |         |  |                                                                                                                                                                                                         |  |                                                                                                                                                    
|----------- | ---- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                                                       
|            |      |         |  |                                                                                                                                                                                                        
|            | 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  |         |  | 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).
|            | 4.6  |         |  | 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).
|            | 4.7  |         |  | 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).
|            | 4.8  |         |  | 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).
|            | 4.8  |         |  | 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).
|            | 4.10 |         |  | 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).
|            | 4.11 |         |  | 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.      
|            | 4.12 |         |  | 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.      
|            | 4.13 |         |  | 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



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##### 



|            |      |         |  |                                                                                                                                                                                                                                 |  |                                                                                                                                               
|----------- | ---- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                                                                               
|            |      |         |  |                                                                                                                                                                                                                                
|            | 4.14 |         |  | 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.
|            | 4.15 |         |  | 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.
|            | 4.16 |         |  | 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.
|            | 4.17 |         |  | 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.
|            | 4.18 |         |  | 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.
|            | 4.19 |         |  | 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.      
|            | 4.20 |         |  | 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.      
|            | 4.21 |         |  | 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.      
|            | 4.22 |         |  | 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.                       
|            | 4.23 |         |  | 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.                       
|            | 4.24 |         |  | 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.                       
|            | 4.25 |         |  | 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.                       

5



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##### 



|            |      |         |  |                                                                                                                                                                                                       |  |                                                                                                                                                           
|----------- | ---- | ------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                                                     
|            |      |         |  |                                                                                                                                                                                                      
|            | 4.26 |         |  | 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.                                   
|            | 4.27 |         |  | 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.
|            | 4.28 |         |  | 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.                                 
|            | 4.29 |         |  | 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.                    
|            | 4.30 |         |  | 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.                    
|            | 4.31 |         |  | 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.                                 
|            | 4.32 |         |  | 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.                 
|            | 4.33 |         |  | 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.                 
|            | 4.34 |         |  | 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.                 
|            | 4.35 |         |  | 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.                 
|            | 4.36 |         |  | 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.                    
|            | 4.37 |         |  | 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.                   
|            | 4.38 |         |  | 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.                   

6



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##### 



|            |      |         |  |                                                                                                                                                                            |  |                                                                                                                                                       
|----------- | ---- | ------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Exhibit |  | Method of Filing                                                                                                                                                          
|            |      |         |  |                                                                                                                                                                           
|            | 4.39 |         |  | 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.               
|            | 4.40 |         |  | 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.                                    
|            | 4.41 |         |  | 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.                              
|            | 4.42 |         |  | 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.                              
|            | 4.43 |         |  | 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.                              
|            | 4.44 |         |  | Form of Warrant issued in connection with the
    Registrants October 2002 private placement offering.                                                                    |  | Incorporated by reference to Exhibit 4.45 to
    the Registrants Annual Report on Form 10-K for the
    period ending December 31, 2002.             
|            | 4.45 |         |  | Form of Registration Rights Agreement entered
    into in connection with the Registrants October 2002
    private placement offering.                                    |  | Incorporated by reference to Exhibit 4.46 to
    the Registrants Annual Report on Form 10-K for the
    period ending December 31, 2002.             
|            | 4.46 |         |  | Warrant Agreement dated as of August 17,
    1999 to purchase 35,250 shares of AIM Group, Inc.s stock
    granted to Randall P. Stern.                                    |  | Incorporated by reference to Exhibit 4.10 to
    the Registrants Registration Statement on Form S-1 filed
    September 8, 2003 (File No. 333-108613).
|            | 4.47 |         |  | Warrant Agreement dated as of October 29,
    1999 to purchase 11,750 shares of AIM Group, Inc.s common
    stock granted to Randall P. Stern.                            |  | Incorporated by reference to Exhibit 4.11 to
    the Registrants Registration Statement on Form S-1 filed
    September 8, 2003 (File No. 333-108613).
|            | 4.48 |         |  | Warrant Agreement dated as of February 8,
    2000 to purchase 85,500 shares of Cereus Technology
    Partners, Inc.s common stock granted to Randall P.
    Stern.       |  | Incorporated by reference to Exhibit 4.12 to
    the Registrants Registration Statement on Form S-1 filed
    September 8, 2003 (File No. 333-108613).
|            | 4.49 |         |  | Warrant Agreement dated as of August 17,
    1999 to purchase 35,250 shares of AIM Group, Inc.s stock
    granted to Burnham Securities, Inc.                             |  | Incorporated by reference to Exhibit 4.13 to
    the Registrants Registration Statement on Form S-1 filed
    September 8, 2003 (File No. 333-108613).
|            | 4.50 |         |  | Warrant Agreement dated as of October 29,
    1999 to purchase 11,750 shares of AIM Group, Inc.s
    common stock granted to Burnham Securities, Inc.                     |  | Incorporated by reference to Exhibit 4.14 to
    the Registrants Registration Statement on Form S-1 filed
    September 8, 2003 (File No. 333-108613).
|            | 4.51 |         |  | Warrant Agreement dated as of February 8,
    2000 to purchase 85,500 shares of Cereus Technology Partners,
    Inc.s common stock granted to Burnham Securities, Inc.    |  | Incorporated by reference to Exhibit 4.15 to
    the Registrants Registration Statement on Form S-1 filed
    September 8, 2003 (File No. 333-108613).
|            | 4.52 |         |  | Warrant Agreement dated as of February 8,
    2000 to purchase 5,250 shares of Cereus Technology
    Partners, Inc.s common stock granted to Burnham
    Securities, Inc. |  | Incorporated by reference to Exhibit 4.16 to
    the Registrants Registration Statement on Form S-1 filed
    September 8, 2003 (File No. 333-108613).

7



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##### 



|            |       |         |  |                                                                                                                                                               |  |                                                                                                                                                          
|----------- | ----- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                             
|            |       |         |  |                                                                                                                                                              
|            | 4.53  |         |  | Warrant Agreement dated as of February 8,
    2000 to purchase 5,000 shares of Cereus Technology Partners,
    Inc.s common stock granted to Jon M. Burnham. |  | Incorporated by reference to Exhibit 4.17 to
    the Registrants Registration Statement on Form S- 1/ A filed
    October 21, 2003 (File No. 333-108613).
|            | 4.54  |         |  | Warrant Agreement dated as of February 8,
    2000 to purchase 7,750 shares of Cereus Technology Partners,
    Inc.s common stock granted Randall P. Stern.  |  | Incorporated by reference to Exhibit 4.18 to
    the Registrants Registration Statement on Form S- 1/ A filed
    October 21, 2003 (File No. 333-108613).
|            | 4.55  |         |  | Form of Warrant issued by the Registrant to each
    Investor in connection with the Registrants February 2004
    private placement.                        |  | Incorporated by reference to Exhibit 4.1 to
    the Registrants Current Report on Form 8-K filed on
    February 26, 2004.                              
|            | 4.56  |         |  | Form of Registration Rights Agreement among the
    Registrant and the Investors entered into in connection with the
    Registrants February 2004 private.  |  | Incorporated by reference to Exhibit 4.2 to
    the Registrants Current Report on Form 8-K filed on
    February 26, 2004.                              
|            | 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.                                                                                                                   |  | Incorporated by reference to Exhibit 10.10
    to the Registrants Annual Report on Form 10-K for the
    period ending December 31, 2002.               

8



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##### 



|            |       |         |  |                                                                                                                                                                                    |  |                                                                                                                                                                  
|----------- | ----- | ------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                  
|            |       |         |  |                                                                                                                                                                                   
|            | 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.                        
|            | 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 |         |  | 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.                    
|            | 10.20 |         |  | 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.                    
|            | 10.21 |         |  | 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.                    
|            | 10.22 |         |  | 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.                                          

9



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##### 



|            |       |         |  |                                                                                                                                                                                                                                                                                                    |  |                                                                                                                                                               
|----------- | ----- | ------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                                                                                                                                  
|            |       |         |  |                                                                                                                                                                                                                                                                                                   
|            | 10.23 |         |  | 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.                                       
|            | 10.24 |         |  | 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.
|            | 10.25 |         |  | 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.
|            | 10.26 |         |  | 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.                       
|            | 10.27 |         |  | 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.                       
|            | 10.28 |         |  | 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.                       
|            | 10.29 |         |  | 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.                       
|            | 10.30 |         |  | 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.                       
|            | 10.31 |         |  | 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.                       
|            | 10.32 |         |  | 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.                       
|            | 10.33 |         |  | 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



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##### 



|            |       |         |  |                                                                                                                                                                                                         |  |                                                                                                                                                                 
|----------- | ----- | ------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                                       
|            |       |         |  |                                                                                                                                                                                                        
|            | 10.34 |         |  | 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.                         
|            | 10.35 |         |  | 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.                         
|            | 10.36 |         |  | 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.                                            
|            | 10.37 |         |  | 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).
|            | 10.38 |         |  | 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).
|            | 10.39 |         |  | 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).
|            | 10.40 |         |  | 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).
|            | 10.41 |         |  | 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).        
|            | 10.42 |         |  | 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.                                             
|            | 10.43 |         |  | 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.                        
|            | 10.44 |         |  | 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.                        
|            | 10.45 |         |  | 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.                                             
|            | 10.46 |         |  | 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.                                             

11



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##### 



|            |       |         |  |                                                                                                                                                                                           |  |                                                                                                                          
|----------- | ----- | ------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                         
|            |       |         |  |                                                                                                                                                                                          
|            | 10.47 |         |  | 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.      
|            | 10.48 |         |  | 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.      
|            | 10.49 |         |  | 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.      
|            | 10.50 |         |  | 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.      
|            | 10.51 |         |  | 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.
|            | 10.52 |         |  | 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.
|            | 10.53 |         |  | 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.
|            | 10.54 |         |  | 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.
|            | 10.55 |         |  | 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.
|            | 10.56 |         |  | 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.
|            | 10.57 |         |  | 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.
|            | 10.58 |         |  | 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.
|            | 10.59 |         |  | Unsecured Subordinated Promissory Note, 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.

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##### 



|            |       |         |  |                                                                                                                                                                                         |  |                                                                                                                                          
|----------- | ----- | ------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                       
|            |       |         |  |                                                                                                                                                                                        
|            | 10.60 |         |  | 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.               
|            | 10.61 |         |  | 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.               
|            | 10.62 |         |  | 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.               
|            | 10.63 |         |  | 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.               
|            | 10.64 |         |  | Settlement Agreement dated November 6, 2002,
    between the Registrant and WA Telcom Products Co., Inc.                                                                                |  | Incorporated by reference to Exhibit 10.65
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.65 |         |  | Assignment and Collection Agreement dated
    December 5, 2002, between the Registrant and WA Telcom
    Products Co., Inc.                                                             |  | Incorporated by reference to Exhibit 10.66
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.66 |         |  | Cross-Corporate Continuing Guaranty dated as of
    February 12, 2003, among the Registrant, Telemate.Net
    Software, Inc., NACT Telecommunications, Inc. and Clarent Canada
    Ltd. |  | Incorporated by reference to Exhibit 10.67
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.67 |         |  | Lease for 1221 West Mineral Avenue, dated as of
    February 11, 2003, between the Registrant and A.S. Burger
    Investments, LLC.                                                     |  | Incorporated by reference to Exhibit 10.68
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.68 |         |  | Movable Hypothec dated as of February 20,
    2003, between the Registrant and Silicon Valley Bank.                                                                                     |  | Incorporated by reference to Exhibit 10.69
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.69 |         |  | Movable Hypothec dated as of February 20,
    2003, between the Clarent Canada Ltd. and Silicon Valley Bank.                                                                            |  | Incorporated by reference to Exhibit 10.70
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.70 |         |  | Settlement Agreement and Full Release of Claims
    dated as of February 12, 2003, between the Registrant and
    John M. Good.                                                         |  | Incorporated by reference to Exhibit 10.71
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.71 |         |  | Arbitration Award Agreement dated
    February 3, 2002, and among the Registrant, Clunet R.
    Lewis and CLR Enterprises, Inc.                                                         |  | Incorporated by reference to Exhibit 10.72
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.72 |         |  | Arbitration Award Agreement dated
    February 3, 2002, among the Registrant, William P.
    OReilly and Montana Corporation.                                                          |  | Incorporated by reference to Exhibit 10.73
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.

13



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##### 



|            |       |         |  |                                                                                                                                                                                   |  |                                                                                                                                          
|----------- | ----- | ------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | Exhibit |  | Method of Filing                                                                                                                                                                 
|            |       |         |  |                                                                                                                                                                                  
|            | 10.73 |         |  | Consulting Agreement dated as of March 14,
    2003, between the Registrant and William P. OReilly.                                                                              |  | Incorporated by reference to Exhibit 10.74
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.74 |         |  | Consulting Agreement dated as of March 14,
    2003, between the Registrant and Clunet R. Lewis.                                                                                  |  | Incorporated by reference to Exhibit 10.75
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.75 |         |  | Amendment to Loan Documents dated April 7,
    2003, among the Registrant, Telemate.Net Software, Inc., NACT
    Telecommunications, Inc. and Silicon Valley Bank.                |  | Incorporated by reference to Exhibit 10.76
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 10.76 |         |  | Amendment to Loan Documents (Exim Program) dated
    April 7, 2003, among the Registrant, Telemate.Net Software,
    Inc., NACT Telecommunications, Inc. and Silicon Valley Bank. |  | Incorporated by reference to Exhibit 10.77
    to the Registrants Annual Report on Form 10-K for the
    period ended December 31, 2002.
|            | 21.1  |         |  | Subsidiaries of the Registrant.                                                                                                                                                   |  | Filed herewith.                                                                                                                          
|            | 23.1  |         |  | Consent of KPMG LLP.                                                                                                                                                              |  | Filed herewith.                                                                                                                          
|            | 31.1  |         |  | Rule 13a-14(a)/15d-14(a) Certification by
    the Registrants Chief Executive Officer.                                                                                           |  | Filed herewith.                                                                                                                          
|            | 31.2  |         |  | Rule 13a-14(a)/15d-14(a) Certification by
    the Registrants Chief Financial Officer.                                                                                           |  | Filed herewith.                                                                                                                          
|            | 32.1  |         |  | Section 1350 Certification by the
    Registrants Chief Executive Officer.                                                                                                       |  | Filed herewith.                                                                                                                          
|            | 32.2  |         |  | Section 1350 Certification by the
    Registrants Chief Financial Officer.                                                                                                       |  | Filed herewith.                                                                                                                          

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