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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20459

FORM 10-K

|(Mark One)                                                    |                                                                                         
|------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                                             | 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 No. 0-23282

NMS COMMUNICATIONS CORPORATION(Exact name of registrant as specified in its charter)

|DELAWARE(State or other jurisdiction of incorporation or organization)                         |  | 04-2814586(I.R.S. employer identification number)
|---------------------------------------------------------------------------------------------- |  | -------------------------------------------------
|100 Crossing Boulevard, Framingham, Massachusetts 01702(Address of principal executive office)
|508-271-1000(Registrant's telephone number, including area code)                              

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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 (Title of class)

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 report), and (2) has been subject to such filing requirements for the past
90 days. Yes ý    No o

Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule 12-b-2 of the Securities Exchange Act of
1934). Yes ý    No o

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

As
of June 30, 2003, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $71.5 million, based on the
closing price on such date of the registrant's Common Stock on the NASDAQ National Market. As of February 24, 2004, 36,938,150 shares of Common Stock, $0.01 par value per share were
outstanding.

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Documents Incorporated by Reference

Portions of the registrant's Proxy Statement relating to the 2004 Annual Meeting of Stockholders of the registrant are incorporated by reference into
Part III of this Form 10-K. Some of the exhibits listed in the accompanying Exhibit Index beginning on page 87 are incorporated by reference.

The following are trademarks and trade names of the company indicated.

NMS Communications,AccessGate, Convergence Generation (CG), e256, Mercury, Natural Access, MyCaller, NMS HearSay, Open Access,
PacketMedia,andSonataare trademarks;Studio Soundand Alliance Generation (AG)are registered trademarks; and NMS is a trade name of the registrant. All other brand names or trademarks appearing in this
Form 10-K are the property of their respective holders.

This
Form 10-K, future filings of the registrant, press releases of the registrant and oral statements made with the approval of an authorized executive officer of the
registrant may contain forward-looking statements. In connection therewith, please see the cautionary statements and risk factors contained in Item 1, "BusinessForward-Looking
Information" and "BusinessFactors That May Affect Future Operating Results," which identify important factors which could cause actual results to differ materially from those in any such
forward-looking statements.

References
in this Form 10-K to the "Company," the "registrant," "we," "our" and "us" refer to NMS Communications Corporation and its subsidiaries.

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PART I

ITEM 1. BUSINESS

Overview

We are a leading provider of enabling technologies, platforms and systems to wireless and wireline telecommunications operators and network equipment and
application providers. Our products, which include systems building blocks, a services delivery system, voice quality systems and a wireless access gateway, address a wide range of our customers'
needs as they seek to develop and deploy enhanced voice and data services and applications, and improve the quality and efficiency of communications networks. Telecommunications operators use our
products to improve customer acquisition and retention, diversify revenue streams and reduce operating costs and capital expenditures. Network equipment and application providers use our products to
help deploy leading technology solutions for their telecommunications and enterprise customers in a timely and cost-effective manner. We sell our products worldwide through our direct
sales force as well as through channel partners. Our customers include leading telecommunications operators and network equipment and application providers such as Verizon Wireless, Cable &
Wireless, France Telecom, Telefonica, Nextel Partners, U.S. Cellular, Alcatel, Avaya, Ericsson, Lucent Technologies, Motorola, Siemens and Aspect Communications.

Industry Overview

The telecommunications industry is a large, rapidly evolving market that includes wireless and traditional wireline communications services, and the related
applications, equipment and infrastructure needed to deliver voice, video and data over circuit, packet and broadband networks. Driven by multiple forces including the growth in Internet traffic,
strong consumer adoption of wireless services, increased use of Internet Protocol (IP) networks, and continued introduction of new technologies, the
telecommunications market is undergoing dramatic change. While this change has created business opportunities, it has also brought about myriad competitive challenges for market participants. Players
particularly affected by this change include telecommunications operators and network equipment and application providers, who help enterprises and operators develop and implement communications
solutions.



Telecommunications operators, who provide wireless and wireline services, face a highly competitive and capital-intensive environment. Key challenges and
initiatives in the industry include:



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Network equipment providers, as well as application providers, who include systems integrators, original equipment manufacturers and independent software vendors,
focus on providing network systems, applications and services to telecommunications operators and enterprises. These offerings include enhanced video, interactive voice response, automatic speech
recognition, media services, conferencing, unified communications and multimedia messaging. For telecommunications operators, these offerings enable them to rapidly deploy premium services for their
customers. For enterprises, these offerings help reduce costs and improve employee communications, especially in light of increased workforce mobility.

Network
equipment and application providers operate in a market dictated largely by rapid changes in technologies and customer requirements. Key challenges they face include:



Our Solution

Our products, which include systems building blocks, a services delivery system, voice quality systems and a wireless access gateway, address a wide range of our
customers' needs as they seek to develop and deploy enhanced voice and data services and applications, and improve the quality and efficiency of communications networks. We believe that our offerings
provide one or more of the following benefits to our customers:

Enable cost-effective and timely deployment of enhanced applications.Our platform solutions offerings provide a
comprehensive framework of communications-enabling technologies, or systems building blocks, for developing and deploying next-generation applications, such as IP conferencing, wireless
video and entertainment and speech-activated services. We also provide wireless telecommunications operators with a services delivery system that allows these operators to host multiple voice and data
applications on the same system. This system enables rapid and cost-effective deployment of customized, innovative services for their subscriber segments.

Improve network service quality.Our voice quality systems offerings leverage our technical expertise in electrical echo
cancellation, acoustic echo control, noise reduction, adaptive level control and noise

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level
compensation for both wireless and wireline deployments, thus allowing operators to provide improved quality of service. These systems are designed to provide better price performance and higher
capacity relative to other alternatives. Our systems are highly flexible and designed to integrate with all major telecommunications switch vendors.

Reduce network infrastructure expenditures.Our wireless access gateway system offering allows wireless operators to save
operating expenses by reducing voice and data traffic (backhaul) expenses, principally those relating to T1 and E1 lines, between cell sites and the operators' switching sites while enabling
accelerated deployment of future infrastructure and services. Our wireless access gateway system uses aggregation and bandwidth reduction techniques to provide up to 2:1 bandwidth savings by reducing
the number of required leased line connections in the radio access network in Global System for Mobile Communications (GSM) networks.

Speed deployment cycles for network equipment and application providers.Network equipment and application providers leverage
our offerings to provide lower cost, higher quality telecommunications systems more quickly to meet the demands of their operator and enterprise customers. Our offerings are designed for flexibility
in various development and network environments, utilizing open interfaces and industry standards. We believe that with our offerings, our network equipment and application
provider customers are able to reduce product lifecycle costs, increase competitive value and remain focused on their core competencies and technologies.

Provide flexible, interoperable, scalable and low cost of ownership solutions.Our products are designed to provide maximum
flexibility in designing and upgrading applications, by utilizing open interfaces, industry standards and network flexibility for public switched telephone network (PSTN), signaling system 7 (SS7) and
IP networks. Our products are also highly scalable and can address needs ranging from a handful of users to millions of subscribers. Additionally, our systems and systems building blocks leverage
mass-market components and custom silicon, with the objective of price-performance leadership. Our products have lower acquisition costs, are space-efficient and consume minimal power,
resulting in low cost of ownership.

Products and Services

We offer a comprehensive products and services offering that addresses a wide range of our customers' needs as they seek to develop and deploy enhanced voice and
data services and applications, and improve the quality and efficiency of communications networks. Our products include systems building blocks, a services delivery system, voice quality systems and a
wireless access gateway. We offer these products through three business segments, Platform Solutions (PS), Voice Quality Systems (VQS) and Network Infrastructure (NI). In addition, we offer a range of
technical, systems and training services related to our products.



Our Platform Solutions business segment provides products that allow our customers to develop next-generation voice, data, and video applications and
services. Our comprehensive offering of systems building blocks, calledOpen Access, is composed of hardware and software elements. The hardware
elements consist principally of printed circuit boards that are used in computer systems or subsystems. The software elements consist primarily of media processing and switching functions, as well as
APIs and a complete application development environment. Utilizing technology from ourOpen Accessproducts, we have developed our NMS HearSaymobile
services delivery platform, and, in collaboration with content partners, theMyCallermobile entertainment application, which is offered on theNMS HearSayplatform.

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OurOpen Accessproducts provide hardware and software functions that enable application providers to rapidly
develop and deploy new services, applications and infrastructure. Our standards-based, IP-enabled products are used to develop and deploy next-generation voice, data and video
applications and services such as IP conferencing, wireless video and entertainment and speech-activated services.

OurOpen Accessproducts offer a broad range of network interfaces, including analog and digital PSTN, IP and asynchronous transport mode
(ATM), and protocol compatibility, including channel associated (tone) signaling, integrated services digital network (ISDN) and SS7, providing interoperability with most legacy and
next-generation networks and services around the world. We utilize low-latency digital signal processor (DSP) technology for voice, fax and video media processing that supports
the diverse media requirements of new, enhanced services such as unified messaging and mobile video conferencing. OurOpen Accessproducts are utilized
by many of the world's leading application developers and, in some instances, telecommunications operators. These products are deployed in over 90 countries in enhanced communications services,
network infrastructure and enterprise applications.

OurOpen Accessproducts include the following:



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Launched in 2002,NMS HearSayis an open, ready-to-deploy, services delivery system that
makes it possible for wireless operators worldwide to deploy market-specific enhanced communications services.NMS HearSayallows telecommunications
operators to host multiple, integrated voice and data applications on the same system.

NMS HearSayis a highly scalable, standards-based system that allows telecommunications operators to deploy multiple different
applications in any type of network.NMS HearSayincorporates our extensive knowledge and experience with technologies including voice recognition,
text-to-speech processing and VXML to shield application developers from the complexities of call management and speech engines.

Launched
in 2003 in collaboration with content providers and our systems integrator partners,MyCalleris an example of the type of
application enabled by ourNMS HearSayplatform.MyCallerallows wireless subscribers to select original
recordings of popular or other commercial music, sounds and voices for callers to hear in place of the conventional ringback tone.



Since our acquisition of Lucent's voice quality business in 2001, we have provided carrier-grade voice quality and echo cancellation systems that allow wireless
and wireline telecommunications operators to bring superior voice quality to their networks. Our VQS products, which were built on pioneering innovations that originated at Bell Labs, are available as
a stand-alone system with multiple network interfaces or as embedded technology on blades (high-availability carrier-grade circuit boards), modules and chips. These products incorporate electrical
echo cancellation and acoustic echo control technology to reduce or eliminate the echo inherent in long distance, wireless and voice over IP (VoIP) networks. Utilizing our custom technology and
patented voice quality software, we are able to provide a high density solution that dramatically improves the quality of voice conversations through noise reduction, automatic gain control, noise
compression and dynamic speech restoration. Our voice quality systems incorporate monitoring and measurement tools that give telecommunications operators the ability to observe and analyze the
performance of their network via direct interaction with our voice quality systems. Our VQS products have been deployed in the networks of over 100 leading wireless and wireline telecommunications
operators worldwide.

Our
Voice Quality Systems products include the following:



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Launched in 2003,AccessGateis a wireless access gateway system that utilizes patent pending technology designed
to optimize the efficiency of wireless networks. Our technology allows our customers to carry up to twice as much voice and data traffic over backhaul connections in GSM networks, thereby reducing
their backhaul expenses without compromising voice or data quality.

Key
features of ourAccessGatesolution include:



We offer a complete range of technical, systems and training services to support our customers throughout the product lifecycle including planning and design,
evaluation, development and deployment. Our service offerings span basic customer service and support to advanced architecture and system design based on the needs of our customers. Our services
include the following:



Growth Strategy

Our objective is to be the leading provider of enabling technologies, platforms and systems for telecommunications operators and network equipment and application
providers that allow our

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customers
to develop and deploy enhanced services and applications quickly and cost-effectively and improve the quality and efficiency of communications networks. Our strategy for
achieving this objective includes the following elements:

Leverage our existing customer base to introduce new technologies and applications.As telecommunications operators increasingly focus on
deploying new enhanced services and underlying network technologies, we intend to leverage our current customer relationships to introduce new technologies and applications. For example, in our
platform solutions business, we are adding products designed to support video applications, which we believe represent a large market opportunity. In addition, we believe that many of our current
voice quality systems customers are seeking replacement products that embed echo cancellation functionality into mobile switching centers. We have significant expertise in developing embedded voice
quality systems and plan to target deployments for these solutions as wireless operators make this transition. We also intend to target cross-selling opportunities with our existing customer base for
our new products.

Focus on wireless telecommunications and other high growth markets.In addition to adding new technologies and applications
to our existing products, we plan to aggressively market our new product platforms designed for wireless operators,NMS HearSayand AccessGate. OurNMS HearSayplatform allows us to leverage our traditional systems building blocks
business into a complete systems-level enhanced services delivery platform. In collaboration with content and application provider partners, we have been marketing value-added applications, such as MyCaller, to our customer base that will allow them to realize the benefits of deploying theNMS HearSayplatform. In addition, we believe ourAccessGatewireless gateway system addresses a significant market opportunity for wireless operators to reduce the
costs of backhaul transport in their networks, particularly as they upgrade to 3G infrastructure. We intend to leverage the in-network expertise and relationships developed with wireless
operators through our voice quality systems business to introduce theAccessGateopportunity.

Extend our technology leadership.We have assembled a team of approximately 160 engineers and technical personnel involved in
research, design and development of innovative technologies and
services. We have over 20 years of experience in the communications industry and have developed significant expertise in voice and media processing, including echo cancellation, background
noise suppression, dynamic speech restoration, voice extensible markup language (VXML) technology, speech-based applications, global network interface and protocol technologies, DSP software, and
specialized silicon for media processing. We intend to continue investing in our technological expertise in the future.

Strengthen and expand relationships with strategic customers.Our customer strategy is to establish and maintain
long-term working relationships with leading telecommunications operators and network equipment and application providers. We dedicate sales and technical services personnel to
approximately 30 telecommunications operators and 20 network equipment and application providers worldwide. By focusing on large customers, we believe we can address a significant portion of our
market opportunity while controlling the cost and complexity of our marketing efforts. We work closely with our customers to design our products to integrate into their offerings. By working with
these customers early in their product design and development stages, we can gain valuable insights into future industry requirements and trends.

Expand market reach and improve coverage through channel partners.We have increasingly used channel partners to reach a
broader market of operators and network equipment and application providers and expand our geographic reach. These channel partners provide support, fulfillment, and credit services to our end-user
customers. We intend to continue leveraging the resources of channel partners to extend our global marketing and distribution capabilities, broaden the range of application areas that we address and
reach additional vertical market segments.

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Acquire new products and technologies to address selected market opportunities.We have acquired certain
technologies and
product lines, such as our voice quality systems, that we believe addressed near-term market opportunities that leveraged our underlying technologies or customer relationships. We
continually evaluate acquisitions of companies and technologies that could extend our product offerings, technology expertise, industry knowledge or global customer base.

Customers

We sell on a direct basis as well as through channel partners (which include value-added resellers, distributors, systems integrators and equipment providers) to
telecommunications operators and network equipment and application providers. Our network equipment and application provider customers also sell our products to enterprises. We do not believe that any
single end-user customer accounted for more than 10% of 2003 revenues, but two channel partners, Lucent Technologies and Channel Access, a Carlo Gavazzi Group company, represented 15.6%
and 12.6%, respectively, of our 2003 revenues. Revenues from customers based outside North America were 47% in 2003, 37% in 2002 and 37% in 2001. The tables below set forth a representative list of
our customers and channel partners:

Telecommunications Operators

Network Equipment ProvidersCable and Wireless
France Telecom
Hutchinson Telecom
NTT
NTT DoCoMo
Nextel Partners
Telefonica
U.S. Cellular
Verizon Wireless

Alcatel
Avaya
Cisco Systems
Comverse
Ericsson
Fujitsu
General Dynamics

Lucent Technologies
Motorola
NEC
Nortel
Raytheon
Siemens


Channel Partners

Application ProvidersAvnet
Beijing Linkhead
Channel Access
Comnet Supply
Crystal Group
Hagemeyer
Lucent Technologies
Shenzen Founder

Aspect Communications
Cisco Systems
Concerto Software
Edify Corporation
European Computer Telecommunications
WiseSpot


Sales and Marketing

We sell our products on a direct basis as well as through channel partners. Our direct sales and marketing efforts for our three business segments are focused on
approximately 30 telecommunications operators and 20 network equipment and application providers. As of December 31, 2003, our sales and marketing organization consisted of 94 employees in 18
offices worldwide, including 51 in North America, 22 in Europe and 21 in Asia. Historically, our direct sales force has been focused on selling systems building blocks offered by our Platform
Solutions business to network equipment and application providers. We have recently shifted the focus of our direct sales force to selling more complex system-level products to telecommunications
operators and large network equipment providers. As a result, we have recruited channel partners to assume primary responsibility for the sales of our systems building blocks products. In addition to
our Platform Solutions business, we also use channel partners to sell products offered by our Voice Quality Systems business in order to reach a broader

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market,
including other network equipment and application providers and telecommunications operators, as well as additional geographies and selected vertical markets like defense and aerospace. In
addition to performing a sales and marketing function, these channel partners provide pre- and post-sales support, systems integration, fulfillment and credit services. For
2003, 44% of worldwide total company revenues were generated by direct sales, with 56% coming through channel partners.

Our
marketing strategy consists of three primary methods to increase awareness and create demand for our offerings. Our public relations efforts are focused on industry-related media
relationships, which increase general awareness of our business and products, and industry analysts who can act as independent references and provide opinions on our technologies. With our direct
marketing effort, we target specific audiences with a variety of promotional materials consisting of mostly web-based communications. We also participate in selected industry trade shows.

Manufacturing

We utilize third-party contract manufacturing partners to assemble all of our systems building blocks and other product offerings. Through a supply agreement, we
outsource the manufacturing and order fulfillment of all printed circuit board products and subassemblies to Plexus Corp., a provider of advanced electronics design, testing and manufacturing
services. Teradyne Corporation, a leading provider of advanced interconnection systems, manufactures our wire frame equipment.

We
seek to use industry-standard components for our products. Many of these components are generally available from multiple suppliers, including our current supplier, Texas
Instruments Inc. However, we also use certain custom integrated circuits and other devices in our products that are sourced from a single supplier, Agere Systems Inc. Although we believe
we could develop other sources
for each of these custom devices, the process could take several months. The manufacturing processes for our products are designed to comply with Federal Communications Commission (FCC), Canadian
Standards Association (CSA) and Underwriters Laboratories (UL) safety requirements and to IPC-610 standards of assembly workmanship. Additionally, we maintain a formal product-specific
structure for all required international regulatory and compliance testing. Consistent with our commitment to provide the highest quality products and services to our customers, in 2002 we received
ISO 9001:2000 certification. This certification includes all design and development activities.

Research and Product Development

We believe that the extension and enhancement of existing products, the development of new products and the development of open technologies proprietary to us are
critical to our future success. Therefore, we undertake direct research and development, engage in joint product development with selected partners and participate in the development of industry
standards where appropriate. Our research and development activities are primarily focused on opportunities relating to emerging wireless applications, network infrastructure efficiencies and emerging
IP-based services, including VoIP. During 2003, 2002 and 2001, we spent $30.3 million, $38.2 million and $37.2 million, or 35%, 37% and 46%, respectively, of our
revenue, on research and development. As of December 31, 2003, our current product development is conducted by 130 employees located at our headquarters in Framingham, Massachusetts, and at our
offices in Red Bank, New Jersey, Schaumburg, Illinois, and St.-Hubert, Quebec.

Intellectual Property

Our success depends in part on proprietary technology and know-how. We rely primarily on a combination of trade secret and copyright laws and
restrictions on access to protect our trade secrets and proprietary rights. We hold several issued patents. In addition, we have filed a patent application relating to our AccessGatetechnology, which,
we believe, will be of strategic importance to our business

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if
issued. We distribute our software products under license agreements, which grant customers a non-exclusive license to use the software and contain certain terms and conditions
prohibiting its unauthorized reproduction or transfer. We enter into confidentiality agreements with our suppliers and customers when we disclose proprietary information to them. In addition, we enter
into confidentiality agreements and assignment of invention agreements with our employees and consultants. Despite these precautions, unauthorized third parties may copy aspects of our products or
obtain information that we regard as proprietary. We believe that our products and technology do not infringe on any existing proprietary rights of others.

We
depend on development, supply, marketing, licensing and other relationships with companies for complementary technologies necessary for us to offer a broad range of products. These
relationships are generally non-exclusive and run for a finite term.

We
believe that, due to the rapid pace of innovation within the industry in which we participate, factors such as the technological and creative skills of our personnel and ongoing
reliable product maintenance and support are more important in establishing and maintaining a leadership position within the industry than are the legal protections for technologies conferred by
intellectual property laws.

Competition

Competition in the high growth markets that we target for our products is intense and diverse. There is always the potential for new competitors to enter the
markets we serve in the future. A significant number of our target customers, both telecommunications operators and network equipment and application providers, currently use in-house
development to provide products and solutions similar to our offerings. While we must compete against these companies' in-house efforts, we believe that a trend towards outsourcing this
type of development will continue to broaden our market opportunity. Current competitors for our product areas include:



We
believe that the key competitive differentiators in these markets include product quality and functionality, ease-of-use, integration capabilities, price
performance, cost of ownership, speed of deployment and installation and technical support and service.

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Employees

As of December 31, 2003, we had 332 full-time employees, consisting of 65 in sales, 29 in marketing and business development, 130 in research
and development, 33 in services, 25 in operations and 50 in administration and finance. None of our employees are represented by a labor union. We have never experienced a work stoppage and consider
our relations with our employees to be good.

Additional Information

We maintain a website with the address www.nmscommunications.com. We are not including the information contained on our website as a part of, or incorporating it
by reference into, this Annual Report on Form 10-K. We make available, free of charge through our website, our proxy statements, registration statements, Annual Reports on
Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable
after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission (SEC). Our SEC filings are also available over the Internet at the SEC's website at
www.sec.gov. You may also read and copy any document we file by visiting the SEC's public reference rooms in Washington, D.C. and Chicago, Illinois. Please call the SEC at
1-800-SEC-0330 for further information about the public reference rooms.

Forward-Looking Information

This Form 10-K includes and incorporates by reference forward-looking statements that involve substantial risks and uncertainties and are
"forward-looking statements" within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these
forward-looking statements by our use of the words "believes," "anticipates," "plans," "expects," "may," "will," "would," "intends," "estimates," "predicts," "potential," "continue" and similar
expressions, whether in the negative or affirmative. We cannot guarantee that we actually will achieve these plans, intentions and expectations disclosed in the forward-looking statements we make.
Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Factors That May Affect Future Operating Results" below, as well as other risks and
uncertainties referenced in this Form 10-K. We do not assume any obligations to update any of the forward-looking statements after the date of this Form 10-K to
conform these statements to actual results.

Sometimes
we communicate with securities analysts. It is against our policy to disclose to analysts any material non-public information or other confidential commercial
information. You should not assume that we agree with any statement or report issued by any analyst regardless of the content of the statement or report. If reports issued by securities analysts
contain projections, forecasts or opinions, those reports are not our responsibility.

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Factors That May Affect Future Operating Results

The risks presented below may not be all of the risks that we may face. These are the factors that we believe could cause actual results to be different from
expected and historical results. Other sections of this report include additional factors that could have an effect on our business and financial performance. The industry in which we compete is very
competitive and changes rapidly. Sometimes new risks emerge, and management may not be able to predict all of them, or be able to predict how they may cause actual results to be different from those
contained in any forward-looking statements. You should not rely upon forward-looking statements as a prediction of future results.

We have experienced recent operating losses and may not become profitable.

We experienced operating losses in each of the last five fiscal years. These operating losses have adversely affected our working capital, total assets and
stockholders' equity. Our operating plan has established a cost structure that, based on expected revenues, targets operating income break-even for the first quarter of 2004. If revenues
do not increase in accordance with our current expectations, or if expenses are greater than we anticipate, we may continue to experience losses. Continuing losses could force us to curtail our
operations or otherwise adversely affect our business.

Our operating results fluctuate and are difficult to predict, which could cause our stock price to decline.

Our revenues and net income, if any, in any particular period may be lower than revenues and net income, if any, in a preceding or comparable period. Factors
contributing to fluctuations, some of which are beyond our control, include:



In
addition, we have historically operated with no significant backlog and a customer order pattern that is skewed toward the later weeks of the quarter. Any significant deferral of
orders for our products would cause a shortfall in revenues for the quarter. If our quarterly revenue or operating results fall below the expectations of investors or public market analysts, our
common stock price may decline substantially.

Higher
average selling prices and installation obligations for our products stemming from our offering of systems may result in sharper fluctuations in our financial results in any
particular quarter as the delay of any given sale or installation will have a greater impact on our revenues from period to period. We may receive one or more large orders in one quarter from a
customer and then receive no orders from that customer in the next quarter. As a result, our revenues may vary significantly from quarter to quarter.

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We may not be able to raise additional financing for our future capital needs on favorable terms, or at all, which could limit our ability to continue our growth and to repay
our outstanding obligation under our convertible notes.

We may need to raise additional capital in the future to continue our growth and to repay the remaining outstanding obligation under our convertible subordinated
notes maturing in October 2005. As of December 31, 2003, there was $57.7 million of principal remaining to be paid. We cannot be certain that we will be able to obtain additional
financing on commercially reasonable terms, or at all. This could inhibit our growth, increase our financing costs and result in our inability to pay the remaining outstanding obligation under our
notes.

The telecommunications industry may not emerge from the slowdown of the past three years, which could limit our ability to achieve anticipated revenue levels.

For the last several years, the telecommunications industry has experienced a severe slowdown characterized by economic uncertainty and substantial curtailment of
infrastructure development and related capital spending. These broad-based industry conditions have contributed to our operating losses and reduced our ability to forecast future operating results.
There is continued uncertainty as to the future spending patterns of telecommunications operators and the other enterprises that are the end-users of our products. If the adverse economic
conditions in our industry were to continue or worsen, we may experience additional adverse effects on our revenues, net income and cash flow.

The markets we target may not develop in the manner or at the growth rate that we anticipate, which could limit our future revenues and harm our business.

We currently operate in three areas of the communications market: mobile and IP-based enhanced services; voice quality systems for the global wireless
market; and wireless access gateways. Although we expect growth in these areas, each of these market areas is characterized by emerging product categories and rapid technological change, and we may
fail to generate demand for our products at the levels we anticipate, which could limit our future revenues and harm our business.

We have launched a significant initiative involving new markets, products and sales and marketing strategies but may not be successful with this initiative, which could result
in reduced revenues and/or increased expenses.

Historically, our direct sales force has been focused on selling systems building blocks to network equipment and application providers. We have recently shifted
the focus of our sales force to selling more complex system-level products to telecommunications operators and large network equipment providers. These are more complex sales with a longer sales
cycle. In order to succeed in this initiative, we must be successful in selling to our customers' laboratories for evaluation and field trial, to their purchasing decision-makers, to their new
services decision-makers, and to the appropriate network operations staff in order to achieve customer acceptance of our systems products. Repeated customer acceptance is required to achieve market
acceptance of our systems offerings. There can be no assurance that we will be successful at implementing our initiatives, and if we fail, our revenues could be reduced and/or our expenses increased.

We are dependent on channel partners to sell a substantial portion of our revenues and on other third parties to perform other functions important to our business.

In concert with our greater emphasis on systems offerings, we shifted the primary sales method of our systems building blocks to indirect sales through channel
partners and network equipment providers. These channel partners are companies in the business of reselling communications products like those we produce to application developers, systems integrators
and others. In the past, we have

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sold
the vast majority of these products directly with our own sales force. As a result, we are increasingly reliant on the effectiveness of channel partners' and network equipment providers' sales,
marketing, and distribution capabilities to generate and fulfill demand for our products. In 2003, 56% of our revenues was attributable to channel partners.

We
are also increasingly reliant on strategic alliances with hardware, software, technology, application, and content partners to bring our offerings to market and to reach targeted
customers.

Similarly,
we have outsourced maintenance and technical support of our systems building blocks products to external suppliers. We are increasingly reliant on these outsource partners,
therefore, to maintain the quality of our systems building blocks products and to provide timely and effective technical support to a segment of our customer base. Moreover, we do not control the
amount of resources that these outsource partners commit to marketing our products or products incorporating our technologies or performing these other functions. If they do not commit sufficient
resources to these activities, our revenues could suffer.

Our revenue growth depends significantly on the timely development and launch of new products and product enhancements, and we cannot be sure that our new products will gain
wide market acceptance.

The communications industry is characterized by rapid technological change, which requires continual development and introduction of new products and product
enhancements that respond to evolving market needs and industry standards on a timely and cost-effective basis. Successfully developing new products requires us to accurately anticipate
technological evolution in the communications industry as well as the technical and design needs of our customers. In addition, new product development and launch require significant commitments of
capital and personnel well in advance of when they can be expected to result in revenue. We are continuing to invest significant research and development resources into new product categories,
including voice applications and IP infrastructure, and supporting technologies. The market acceptance and commercial viability of these new product categories have not been proven. Failure to
successfully update and enhance current products and to develop and launch new products would harm our business.

We
have experienced, and may in the future experience, delays in developing and releasing new products and product enhancements. These delays have led to, and may in the future lead to,
delayed sales, increased expenses and lower quarterly revenues than anticipated. Our failure to timely introduce a new product or product enhancement could harm our reputation with our customers or
reduce demand for that product, which could harm our business.

The markets we serve are highly competitive, and we may be unable to compete effectively, which could adversely affect demand for our products.

There are numerous companies currently marketing products that compete directly with our products. Moreover, our competitors and customers may be able to develop
products and services that are superior to our products and services, that achieve greater customer acceptance or that have significantly improved functionality as compared to our existing and future
products and services. Moreover, many of our competitors have significantly greater financial resources than we do and therefore are better able to invest in the research and development activities
necessary to bring innovative new products to market. By focusing all of their efforts on a specific niche of the market, some of our competitors may succeed in introducing products that change the
competitive dynamic in that market niche and adversely affect demand for our products. Certain of our competitors may be able to negotiate alliances with strategic partners on more favorable terms
than we are able to negotiate. Many of our competitors have well-established relationships with our existing and prospective customers, including those on which we have focused significant
sales and marketing efforts. These

15

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competitive
factors could render one or more of our products obsolete, which would adversely affect our revenues.

Internal development efforts by our customers may adversely affect demand for our products.

Many of our customers, including the large network equipment and application providers on which we focus a significant portion of our sales and marketing efforts,
have the technical and financial ability to design and produce components replicating or improving on the functionality of most of our products. These organizations often consider in-house
development of technologies and products as an alternative to doing business with us. We cannot be certain that these customers will resolve these "make-buy" decisions in favor of working
with us, rather than attempting to develop similar technology and products internally or obtaining them through acquisition. If our customers choose to produce internally rather than purchase from us,
it will decrease the size of the market for our products.

Offering to sell system-level products that compete with the products manufactured by our customers could negatively affect our business.

We have broadened our product offerings from systems building blocks to subsystems and platforms, as well as full systems. These products could compete with
products offered by some of our customers. These customers could decide to decrease purchases from us because of this competition. This could result in a material adverse effect on our results of
operations.

Our products typically have long sales cycles, causing us to expend significant resources before achieving agreements, "design wins" or "successful trials" and recognizing
revenue.

The length of our sales cycle typically ranges from six to 18 months and varies substantially from customer to customer. Prospective customers generally
must commit significant resources to test and evaluate our products and integrate them into their operating environment or product offering. This evaluation period is often prolonged due to delays
associated with approval processes that typically accompany the design and testing of new communications equipment by our customers. In addition, the rapidly emerging and evolving nature of the
markets in which our customers and we compete may cause prospective customers to delay their purchase decisions as they evaluate new technologies and develop and implement new systems. During the
period in which our customers are evaluating whether to place an order with us, we often incur substantial sales and marketing expenses, without any assurance of future orders or their timing. Even
after we achieve an agreement, "design win" or "successful trial" and our product is expected to be utilized in a product or service offering being developed by our customer, the timing of the
development, introduction and implementation of the product is controlled by, and can vary significantly with the needs of, our customers and may exceed several months. This complicates our planning
processes and reduces the predictability of our revenues. If sales forecasted from a specific customer for a particular quarter are not realized in that quarter, we may fail to achieve our revenue
goals.

Our three-year supply agreement with Lucent ends in December 2004, and we may not be able to compensate for revenue from that source.

As part of our acquisition of Lucent's voice quality business in December 2001, we entered into a three-year supply agreement with Lucent in
which Lucent agreed to purchase from us, on an exclusive basis for Lucent's resale purposes, any of our products that Lucent requires which incorporate the acquired voice quality products. Lucent
incorporates our products into products it markets to others. The supply agreement gives Lucent the right to extend for a 12-month period on a non-exclusive basis, and after
that, as mutually agreed. We have opened discussions with Lucent regarding extension of the supply agreement. We are relying on sales to Lucent to continue to generate a significant portion of our
near-term revenue for such products and have incorporated this expectation in our operating plan.

16

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Revenues
from Lucent for the year ended December 31, 2003 were approximately 15.6% of our total revenues. Accordingly, any delays, reductions or other disruptions in Lucent's purchasing volume,
any significant disputes we might become involved in regarding our commercial relationship with Lucent or a termination of this supply agreement would have a significant and material adverse effect on
our revenues.

We rely on third parties to assemble, and in certain cases, to ship, distribute and install our products, which could subject us to product shortages or quality assurance
problems, which, in turn, could lead to an increase in the cost of manufacturing or assembling our products.

We do not have in-house manufacturing capabilities and currently rely on third-party contract manufacturers to assemble our systems building blocks
and systems. Our manufacturing requirements are primarily fulfilled by Plexus Corp. In addition, Plexus ships some of our products directly to our customers from its fabrication facility. Our supply
agreement with Plexus expires in October 2004 but automatically extends for a one-year period unless either party gives notice 120 days prior to expiration. We also rely on other third parties
to provide distribution and installation services. This reliance could subject us to product shortages or quality assurance problems, which, in turn, could lead to an increase in the cost of
manufacturing or assembling our products. Any problems that occur and persist in connection with the manufacture, delivery, quality or cost of the assembly of our products could affect our ability to
ship product and recognize revenue, harm our relationship with our customers and harm our business.

We depend on sole source suppliers for certain components used in our products; any interruption in our supplies could harm our business.

We rely on vendors to supply components for our products, and we rely on sole source suppliers for certain custom integrated circuits and other devices that are
components of one or more of our
products. In particular, Texas Instruments is our sole source for the DSPs used in many of our products and customarily requires order lead times of 12 to 14 weeks or more to ensure delivery in
desired quantities. In addition, Agere Systems, Inc. is our sole source supplier for integrated circuit components used in many of our products and customarily requires order lead times of 13
weeks or more. Neither Texas Instruments nor Agere is under a contractual obligation to supply us with our needs for these devices. An interruption in supply from or a termination of the relationship
with either Texas Instruments or Agere would disrupt production, thereby adversely affecting our ability to deliver products to our customers and record associated revenues. Converting to an
alternative source for key components could require a large investment in capital and manpower resources and might cause significant delays in introducing replacement products. Although we believe we
could identify alternative sources for all of our components, that process could take several months, and any interruption in our supplies could harm our business. Additionally, our agreement with
Plexus specifies that if Plexus's inventory related to manufacture of our products is not turned eight times per year, we are required to purchase enough inventory to bring Plexus up to eight turns.
This is assessed on a quarterly basis.

We do not obtain binding purchase commitments from our customers and rely on projections prepared by our customers in assessing future demand for our products.

Our volume purchase agreements, pursuant to which we sell products, do not require our customers to purchase any minimum number of products. Therefore, there can
be no assurance that these agreements will result in purchase orders for our products. After we begin receiving initial orders for a product from a customer, we rely heavily on the customer's
projections as to future needs for our product, without having any binding commitment from the customer as to future orders. Because our

17

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expenses
are based on forecasting of future orders, a substantial reduction or delay in orders for our products from our customers could harm our business.

We may acquire other businesses or technologies; if we do, we may be unable to integrate them with our business or our financial performance may suffer.

If we are presented with appropriate opportunities, we may acquire businesses or technologies. We may not be able to identify, negotiate, or finance any future
acquisition successfully. If we engage in an acquisition transaction, the process of integration may produce unforeseen operating difficulties and expenditures and may absorb significant attention of
our management that would otherwise be available for the ongoing development of our business. If we make future acquisitions, we may issue shares of stock that dilute other stockholders, incur debt,
assume contingent liabilities, or create additional expenses related to amortizing intangible assets, any of which might harm our financial results and cause our stock price to decline. Any financing
that we might need for future acquisitions may only be available to us on terms that restrict our business or that impose on us costs that reduce our net income.

We may be unable to attract and retain management or key personnel we need to succeed.

The loss of any of our senior management or key technical, sales or marketing personnel, particularly if lost to competitors, could harm our business. Our future
success will depend in large part on our ability to attract, retain and motivate highly skilled employees.

We may not be able to adequately protect our intellectual property, which may facilitate the development of competing products by others.

We rely on a combination of trade secret and copyright laws, restrictions on disclosure, and patents to protect our intellectual property rights. Despite our
efforts to protect our proprietary rights, third parties may copy or otherwise obtain and use our products or technology. The laws of some foreign countries do not protect our proprietary rights to as
great an extent as the laws of the United States. If we fail to adequately protect our intellectual property rights, it will be easier for our competitors to sell competing products.

Our products may infringe on the intellectual property rights of third parties, which may result in lawsuits and prohibit us from selling our products.

There is a risk that third parties have filed or will file applications for, or have received or will receive, patents or obtain additional intellectual property
rights relating to materials or processes that we use or propose to use. As a result, from time to time, third parties may assert patent or other intellectual property rights to technologies that are
used in our products or are otherwise important to us. In addition, third parties may assert claims or initiate litigation against us or our manufacturers, suppliers or customers with respect to
existing or future products or other proprietary rights. We generally undertake to indemnify our customers against intellectual property infringement claims asserted against them with respect to the
products we sell to them. Any claims against us or customers that we indemnify against intellectual property claims, with or without merit, may be time-consuming, result in costly
litigation and diversion of technical and management personnel or require us to develop non-infringing technology. If a claim is successful, we may be required to obtain a license from the
parties claiming the infringement. If we are unable to obtain a license, we may be unable to market our affected products. Limitations on our ability to market our products and delays and costs
associated with monetary damages and redesigns in compliance with an adverse judgment or settlement could harm our business.

18

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Defects in our products or problems arising from the use of our products together with other vendors' products may seriously harm our business and reputation.

Products as complex as ours may contain known or undetected errors or performance problems. Defects are frequently found during the period immediately following
introduction and initial implementation of new products or enhancements to existing products. Although we attempt to resolve errors before implementation, our products are not error-free.
These errors or performance problems could result in lost revenues or customer relationships and could be detrimental to our business and reputation generally. Additionally, reduced market acceptance
of our services due to errors or defects in our technology would harm our business by reducing our revenues and damaging our reputation. In some of our contracts, we have agreed to indemnify our
customers against certain liabilities arising from defects in our products, but we do not carry insurance policies covering this type of liability. In addition, our customers generally use our
products together with their own products and products from other vendors. As a result, when a problem occurs in the network, it may be difficult to identify the source of the problem. These problems
may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts, and cause significant customer relations problems.
To date, defects in our products or those of other vendors' products with which ours are used by our customers have not had a material negative effect on our business. However, we cannot be certain
that a material negative effect will not occur in the future.

Because we derive a significant portion of our revenues from international sales, our business could be adversely affected by downturns in economic conditions in countries
outside the United States and other risks associated with international operations.

Sales to customers outside North America accounted for approximately 47% of our revenues in 2003, and we believe a material portion of our domestic sales results
in the use of our products outside North America. Because of our dependence upon international sales, we are subject to a number of risks, including volatility in currency exchange rates, political
and economic instability in other countries, the imposition of trade and tariff regulations by foreign governments and the difficulties in managing operations across disparate geographic areas. These
or other factors may limit our ability to sell our products in other countries, which could have a material adverse effect on our business, financial condition and operating results.

Future regulation or legislation could restrict our business or increase our costs.

We are unable to predict the impact, if any, that future legislation, legal decisions or regulations relating to our target markets may have on our business,
financial condition and results of operations. Regulation may focus on, among other things, assessing access or settlement charges, or imposing tariffs or regulations based on the characteristics and
quality of products and services, either of which could restrict our business or increase our cost of doing business.

Anti-takeover provisions in Delaware law and our corporate documents may affect the value of our common stock.

Provisions of Delaware law and our corporate documents may make it difficult and expensive for a third party to remove our board of directors or management or to
acquire us. For example, our certificate of incorporation provides for the election of members to our board of directors for staggered three-year terms, we have adopted a shareholder
rights plan, and under the indenture related to our notes, we are unable to sell our business or our assets without the consent of the debt holders. The existence of these anti-takeover
provisions may substantially impede the ability of a third party to acquire control of us or accumulate large blocks of our common stock, which may adversely affect our stock price.

19

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ITEM 2. PROPERTIES

We lease two facilities totaling approximately 145,000 square feet for our corporate headquarters in Framingham, Massachusetts. The leases on these facilities
expire in May 2012.

We
lease facilities in Red Bank, New Jersey and Schaumburg, Illinois, in which we conduct design and engineering operations. We own a facility in St.-Hubert, Quebec that is also used to
conduct design and engineering operations. We also lease a facility in Chaville, France that serves as our European sales and service headquarters. In addition, we have short-term leases
for 8 sales offices throughout North America, Europe and Asia.

We
believe our facilities are adequate for our current needs and that we will be able to secure suitable space as needed in the future.

ITEM 3. LEGAL PROCEEDINGS

From time to time, we are a party to various legal proceedings incidental to our business. We have no material legal proceedings currently pending, except as
described below:

We
are the defendant in an action by Connectel, LLC initially filed in August 2000 in the U.S. District Court for the Eastern District of Virginia. This action has been
transferred by court order to the U.S. District Court for the District of Massachusetts. The plaintiff alleges that one or more of our products infringe upon two related United States patents owned by
it and seeks injunctive relief and damages in an unspecified amount. The patents relate to a specific routing protocol. In December 2002, the parties participated in a hearing before the court,
pursuant to which the judge will construe certain patent claims. We are awaiting the judge's opinion. We have reviewed the allegations with our patent counsel and believe that none of our products
infringe upon the patents. We are defending the claim vigorously.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

None during the fourth quarter of 2003.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Price Range of Common Stock

Our common stock is quoted on the NASDAQ National Market under the symbol "NMSS." The table below shows the high and low sale prices per share of our common
stock, as reported on the NASDAQ National Market, for the periods indicated.

Year Ended December 31, 2002

High

LowFirst Quarter

$
6.53

$
3.36Second Quarter


5.39


1.45Third Quarter


2.21


1.17Fourth Quarter


2.45


0.95Year Ended December 31, 2003First Quarter

$
2.10

$
1.35Second Quarter


2.12


0.70Third Quarter


2.75


1.52Fourth Quarter


6.66


2.15


As
of February 24, 2004, we had approximately 231 stockholders of record of our common stock.

Dividend Policy

We have never declared or paid any dividends on our common stock. We do not anticipate paying any cash dividends in the foreseeable future. We currently intend to
retain future earnings to fund the development and growth of our business.

Issuance of Unregistered Securities

We acquired Inno Media Logic Company (IML) of St.-Hubert, Quebec in July 2000 for a combination of cash and stock. We and our wholly owned Canadian
subsidiaries issued to the stockholders of IML 982,296 shares of our common stock and shares exchangeable into an additional 1,653,004 shares of our common stock. As of December 31, 2003, an
aggregate of 1,225,374 additional shares of our common stock had been issued in exchange for exchangeable shares. The shares of our common stock and the exchangeable shares were issued, as to
acquirers in the United States, in reliance on the exemption set forth in Section 4(2) of the Securities Act of 1933 (the Act) and, as to acquirers outside the United States, pursuant to
Regulation S under the Act. We registered on Form S-3 under the Act, effective August 25, 2000, for public sale in the United States, all the shares of our common
stock which were or are to be issued to the former shareholders of IML.

21

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ITEM 6. SELECTED FINANCIAL DATA

Components of selected financial information consist of the following:

|                                                                     |                   | Year Ended December 31, |        
|-------------------------------------------------------------------- | ----------------- | ----------------------- | -------
|
|
|Revenues                                                             |                   | $                       | 79,476 
|Gross profit                                                         |                   |                         | 47,956 
|Operating loss                                                       |                   |                         | (17,869
|Loss before income taxes                                             |                   |                         | (17,688
|Income tax expense (benefit)                                         |                   |                         | 1,000  
|Net loss                                                             |                   |                         | (18,688
|Net loss per share:                                                  |                   |                         |        
|                                                                     | Basic and diluted |                         | $      
|Weighted average common shares used in computing net loss per share: |                   |                         |        
|                                                                     | Basic and diluted |                         |        

|               |  | December 31,
|-------------- |  | ------------
|
|
|Total assets   |  | $           
|Long-term debt |  |             

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Overview

We are a leading provider of enabling technologies, platforms and systems to wireless and wireline telecommunications operators and network equipment and
application providers. Our products, which include systems building blocks, a services delivery system, voice quality systems and a wireless access gateway, address a wide range of our customers'
needs as they seek to develop and deploy enhanced voice and data services and applications, and improve the quality and efficiency of communications networks. Telecommunications operators use our
products to improve customer acquisition and retention, diversify revenue streams and reduce operating costs and capital expenditures. Network equipment and application providers use our products to
help deploy leading technology solutions for their telecommunications and enterprise customers in a timely and cost-effective manner. We sell our products worldwide through our direct
sales force as well as through channel
partners. Our customers include leading telecommunications operators and network equipment and application providers such as Verizon Wireless, Cable & Wireless, France Telecom, Telefonica,
Nextel Partners, U.S. Cellular, Alcatel, Avaya, Ericsson, Lucent Technologies, Motorola, Siemens and Aspect Communications.

In
the third quarter of 2003, we merged our Network Solutions business unit into our Platform Solutions business unit. Our three business segments are now comprised of the Platform
Solutions (PS) business unit, the Voice Quality Systems (VQS) business unit and the Network Infrastructure (NI) business unit. The PS business unit consists of products and services, which we refer to
as systems building blocks, that provide connectivity to communications networks, call processing, real-time media processing, APIs and other application development software tools. Also
included in this business unit are a multi-application enhanced services delivery system and a wireless entertainment offering. The

22

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VQS
business unit consists of our voice quality enhancement and echo cancellation products, systems and services. The NI business unit consists of our wireless access gateway product, AccessGate, that can
dramatically lower carriers' operating expenses in TDMA, GSM, universal mobile telecommunications system (UMTS) and EDGE networks
by reducing the number of radio access network leased lines through advanced optimization techniques, without affecting voice and data quality.

The
downturn in the telecommunications industry, which began in late 2000, continued through fiscal year 2003. As a result of the unfavorable economic conditions and continued weakness
in capital spending by telecommunications operators and enterprises, our revenues declined 15% from $102.7 million in 2002 to $87.1 million in 2003. Revenues from our VQS offerings
declined by 29% from 2002 to 2003 and revenues from our PS offerings declined by 10% from 2002 to 2003. Geographically, revenues from North American customers decreased 28%, while revenues from
international customers increased 7% from 2002 to 2003. Despite the year-over-year revenue decline in 2003, we had four consecutive quarters of sequential growth in revenue during the year.

Over
the past three years, we responded to the decline in revenues by taking actions to realign our business with changes in the industry and our expectations for the future, while at
the same time, continuing to invest in new and enhanced product offerings.

In
an effort to reduce our operating expenses and align our workforce with revenue expectations, over the last three years we engaged in restructuring efforts resulting in the recording
of restructuring and other related charges. Additionally, in accordance with FAS 142, "Financial Accounting and Reporting for Acquired Goodwill and Other Intangible Assets", and FAS 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," over the same period we recorded impairment charges related to the goodwill, intangible and tangible assets associated
with the VQS, MessageMachines, Inc. ("MMI," part of the PS business unit) and Mobilee Inc. ("Mobilee," part of the PS business unit) acquisitions. Our restructuring actions and
impairments have resulted in reducing our quarterly operating expenses.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including
those related to revenue recognition, accounts receivable, inventories, long-lived assets and goodwill, income taxes, restructuring and other related charges, and accounting for
acquisitions. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or
conditions.

We
believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:



23

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24

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25

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Results of Operations

The following table sets forth, for the periods indicated, certain items from our consolidated statements of operations as a percentage of revenues.

|                             |                                         | Year Ended December 31, |                         
|---------------------------- | --------------------------------------- | ----------------------- | ------------------------
|
|Revenues                     |                                         | 100.0                   | %                       
|Cost of revenues             |                                         | 51.1                    |                         
|                             |                                         |                         |                         
|                             | Gross profit                            |                         | 48.9                    
|Operating expenses:          |                                         |                         |                         
|                             | Selling, general and administrative     |                         | 106.6                   
|                             | Research and development                |                         | 45.9                    
|                             | Impairment charges                      |                         | 68.6                    
|                             | Restructuring and other related charges |                         | 13.6                    
|                             |                                         |                         |                         
|                             |                                         |                         | Total operating expenses
|                             |                                         |                         |                         
|Operating loss               |                                         | (185.8                  | )                       
|Other income (expense), net  |                                         | 11.3                    |                         
|                             |                                         |                         |                         
|Loss before income taxes     |                                         | (174.5                  | )                       
|                             |                                         |                         |                         
|Income tax expense (benefit) |                                         | 1.7                     |                         
|                             |                                         |                         |                         
|Net loss                     |                                         | (176.2                  | )%                      
|                             |                                         |                         |                         

Revenues.Revenues consist primarily of product sales and, to a lesser extent, sales of services provided to our customers by
our PS and VQS business units. The PS business unit revenues consist of sales of our systems building block products and services as well asNMS HearSayproducts. FutureMyCallerrevenues, if any, will be recorded as PS business unit sales. The VQS business unit revenues consist of sales of our voice
quality enhancement and echo cancellation products, systems and services. The NI business unit revenues consist of our wireless access gateway product and services.

Cost of revenues.Cost of revenues consists primarily of product cost, cost of services provided to our customers, overhead
associated with testing and fulfillment operations and the amortization of acquired completed technology.

Selling, general and administrative expenses.Selling, general and administrative expenses consist primarily of salaries,
commissions and related personnel expenses for those engaged in our sales, marketing, promotional, public relations, executive, accounting and administrative activities, amortization of intangible
assets and non-cash compensation and other general corporate expenses.

Research and development expenses.Research and development expenses consist primarily of salaries, personnel expenses and
prototype fees related to the design, development, testing and enhancement of our products. These costs are expensed as incurred.

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Impairment charges.Impairment charges consist of the reduction to fair value of the goodwill, tangible and
intangible assets
related to our acquisitions.

Restructuring and other related charges.Restructuring charges consist of involuntary severance related costs, legal and
placement costs, facility closures or downsizing and disposal of excess or unused assets.

Other income (expense), net.Other income (expense), net consists primarily of interest expense, interest income, gains
realized on the repurchase of convertible debt and foreign currency translation gains and losses.

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Revenues

Year Ended December 31,2002

2003Amount

% of total

Amount

% of total

Change($ In millions)



($ In millions)PS

$
73.8

71.9
%
$
66.5

76.4
%
(9.8
)%VQS


28.9

28.1


20.5

23.5

(29.1
)NI


0.0

0.0


0.1

0.1

Total revenues

$
102.7

100.0
%
$
87.1

100.0
%
(15.1
)


Total
revenues of $87.1 million for the year ended December 31, 2003 decreased 15.1% from $102.7 million for the year ended December 31, 2002. PS revenues of
$66.5 million for 2003 decreased 9.8% from $73.8 million for 2002. VQS revenues of $20.5 million for 2003 decreased 29.1% from $28.9 million for 2002. VQS revenue for 2003
included a $3.1 million software royalty fee from Lucent compared to $0.4 million for 2002. NI revenue was $0.1 million for 2003 and $0.0 in 2002. The decrease across the PS and VQS business
units was primarily attributable to continued softness in capital spending by enterprise and telecommunications operators in North America. Revenues improved sequentially during the course of 2003 on
an aggregate basis, including year-over-year improvements in the fourth quarter, but full year results still reflected a more constrained spending environment than in 2002.

Year Ended December 31,2002

2003Amount

% of total

Amount

% of total

Change($ In millions)



($ In millions)North America

$
64.6

62.9
%
$
46.6

53.5
%
(27.9
)%International


38.1

37.1


40.5

46.5

6.6Total revenues

$
102.7

100.0
%
$
87.1

100.0
%
(15.1
)


Revenues
from international customers of $40.5 million for 2003 increased 6.6% from $38.1 million for 2002 and represented 46.5% and 37.1% of total revenues for the years
ended December 31, 2003 and 2002, respectively. The increase in revenues from international customers, as a percentage of total revenues, was primarily due to the early adoption of enhanced
services in Asia and Europe combined with the softness in the North American market.

Revenues
from Lucent, our primary VQS reseller to telecommunications operators, represented 15.6% and 27.4% of total revenues for 2003 and 2002, respectively. Revenues from Channel
Access, a

27

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Carlo
Gavazzi Group company and our primary PS channel partner in North America, represented 12.6% in 2003 and less than 10% of total revenues in 2002.

We
do not believe that any single end-user customer accounted for more than 10% of revenues for the year ended 2003 or 2002.

Gross Profit

Year Ended December 31,2002

2003($ In millions)Revenues

$
102.7

$
87.1Cost of revenues


57.8


48.3Gross profit

$
44.9

$
38.8As a percentage of revenues


43.7
%

44.5
%


Gross
profit for 2003 of $38.8 million decreased 13.6% from $44.9 million for 2002. Gross profit represented 44.5% and 43.7% of revenues for 2003 and 2002, respectively.
Our cost of revenues for 2003 consisted primarily of product cost of $25.8 million, cost of services provided to our customers of $7.3 million and overhead associated with testing and
fulfillment operations of $6.9 million. Additionally, included in cost of revenues for 2003 were $0.6 million and $0.3 million of completed technology amortization related to the
VQS and MMI acquisitions, respectively, and $5.3 million, $1.5 million and $0.6 million in impairment charges to reduce the carrying value of completed technology related to the
VQS, MMI and Mobilee acquisitions, respectively.

Included
in cost of revenues for 2002 were $2.9 million of completed technology amortization related to the VQS, Mobilee, MMI and IML acquisitions, $1.2 million inventory
fair value adjustment related to the VQS acquisition and $6.0 million for the impairment of completed technology related to the VQS and IML acquisitions.

Selling, General and Administrative

Year Ended December 31,2002

2003($ In millions)Selling, general and administrative

$
55.4

$
37.6As a percentage of revenues


53.9
%

43.1
%


Selling,
general and administrative expenses of $37.6 million for 2003 decreased 32.1% from $55.4 million for 2002. Selling, general and administrative expenses represented
43.1% and 53.9% of total revenues for 2003 and 2002, respectively. The primary reason for the decrease in selling, general and administrative expenses was the realization of significant cost
reductions resulting from the reductions in force that occurred during 2002 and 2003. Additionally, amortization of intangible assets
and non-cash compensation expense related to the IML and VQS acquisitions decreased $6.0 million due to impairment charges taken during 2002 and 2003.

Included
in selling, general and administrative expenses for 2003 were $1.1 million of amortization of intangible assets related to the VQS acquisition and $1.0 million of
non-cash compensation expense related to the VQS and IML acquisitions.

28

---

Included
in selling, general and administrative expenses for 2002 were $4.7 million of amortization of intangible assets related to the VQS and IML acquisitions and
$3.4 million of compensation expense related to the VQS, Mobilee, IML and MMI acquisitions.

Research and Development

Year Ended December 31,2002

2003($ In millions)Research and development

$
38.2

$
30.3As a percentage of revenues


37.2
%

34.8
%


Research
and development expenses of $30.3 million for 2003 decreased 20.6% from $38.2 million for 2002. Research and development expenses represented 34.8% and 37.2% of
total revenues for 2003 and
2002, respectively. The decrease was primarily due to cost reductions from reductions in force in 2002 and 2003.

Impairment Charges

Year Ended December 31,2002

2003($ In millions)In cost of revenues:Acquired completed technology from IML, Mobilee, MMI and VQS

$
6.0

$
7.4In operating expenses:Goodwill and intangible assets related to IML, MMI and Mobilee


36.4


10.3Fixed assets associated with the VQS and PS business units





4.0Goodwill and intangible assets related to VQS


30.1


4.066.5


18.3Total impairment charges

$
72.5

$
25.7


During
2003, we recorded impairment charges totaling approximately $25.7 million, based on the declining historical and forecasted operating results as they related to earlier
estimates. The value of goodwill and intangible assets related to MMI, Mobilee and the VQS business unit had decreased.
Based on the results of the impairment analyses performed on the goodwill and intangible assets, these assets were written down to their estimated fair value.

The
total impairment charge included $10.3 million to reduce the carrying value of the goodwill and indefinite-lived intangible assets related to the MMI and Mobilee acquisitions
to estimated fair value. This charge is included in the consolidated statement of operations under "Impairment charges" for 2003.

The
balance of the 2003 impairment charge of $8.0 million resulted from a reduction in the carrying values of the amortizable intangible assets related to the VQS, MMI and Mobilee
acquisitions. Of these costs, $3.9 million was related to the reduction in carrying value of a VQS supply agreement and $0.1 million was related to the reduction in carrying value of VQS
trademarks and patents. These charges are included in "Impairment charges" in the statement of operations for 2003. As part of the impairment charge, fixed assets associated with the VQS and PS
business units were written down to their estimated fair value resulting in charges of $1.2 million and $2.8 million, respectively. These charges are included in "Impairment charges" in
the consolidated statement of operations for 2003.

29

---

Additionally,
$0.6 million, $1.5 million and $5.3 million were related to the write-down of acquired completed technology from the Mobilee, MMI and VQS acquisitions,
respectively, and are included in "Cost of revenues" within the consolidated statement of operations for 2003.

As
of December 31, 2003, there was no goodwill or long-lived intangible assets on our balance sheet.

During
2002, we recorded impairment charges totaling approximately $72.5 million related to the goodwill, intangible assets and fixed assets associated with the IML and VQS
acquisitions.

During
the second quarter of 2002, we recorded impairment charges totaling approximately $36.4 million related to the goodwill and intangible assets associated with the IML
acquisition. As a result of our planned intention to reduce overall workforce, including IML employees, the discontinuation of certain IML products as a part of our generally available product
offering and continued declining revenues for IML products, the estimated value of IML's goodwill and intangible assets had decreased. Based on the results of the impairment analysis
performed, these assets were written down to their estimated fair value.

In
addition to this charge, a $2.9 million charge is included in the consolidated statement of operations classification, "Cost of revenues," related to the write-down of
IML-acquired completed technology.

During
the fourth quarter of 2002, we recorded impairment charges totaling approximately $30.1 million related to the goodwill, intangible assets and fixed assets associated with
the VQS acquisition. Based on the declining historical and forecasted operating results of VQS as they related to earlier estimates, the economic condition of the telecommunications industry as a
whole, and our 18% reduction of the VQS workforce, the estimated value of VQS's goodwill, intangible assets and fixed assets had decreased. Based on the results of the impairment analysis performed,
these assets were written-down to their fair value.

In
addition to this charge, a $3.1 million charge is included in the consolidated statement of operations classification, "Cost of revenues," as it relates to the write-down of
VQS-acquired completed technology.

Restructuring and Other Related Charges

Year Ended December 31,2002

2003($ In millions)Involuntary severance related costs

$
2.8

$
4.8Lease termination costs


1.4


0.4Write-down of fixed assets


0.7


1.6Other


0.1


0.1Total restructuring and other related charges

$
5.0

$
6.9


In
an effort to further reduce our expenses and align our workforce and operations with anticipated revenues, we initiated additional restructuring efforts resulting in the recording of
total restructuring and other related charges of $6.9 million for 2003.

30

---

Involuntary severance related costs of $4.8 million resulted from the elimination of approximately 140 positions at our facilities in the United States, Canada, Europe and Asia
based on terminations that were announced in January, April, July and October of 2003. These terminations occurred in all areas of the Company. At December 31, 2003, the remaining accrued
balance for this charge was approximately $1.5 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." We expect the majority of the
remaining accrued balance to be paid by March 2004 and all balances to be paid by the end of the third quarter of 2004.

At
December 31, 2002, we leased a facility in Schaumburg, Illinois that was no longer occupied. At December 31, 2002, we had accrued a total of $1.4 million related to the
termination of this lease. On January 31, 2003, we entered into a lease termination agreement with the landlord of the facility and paid $1.5 million to the landlord to completely
terminate any future rights or obligations under the lease. The $0.1 million excess payment amount over the established accrual was recorded as restructuring and other related charges in 2003.

We
are currently working with real estate agents in an attempt to sub-lease idle facilities that are located in the United States, Canada and throughout Europe. A sublease in
the Tustin, California facility was unexpectedly terminated in 2003. As a result, we recorded a charge for $0.3 million in 2003 representing the value of remaining sublease payments we expected
to receive. At December 31, 2003, the remaining accrued balance for all lease termination costs was approximately $1.7 million and is included in the consolidated balance sheet
classification, "Accrued expenses and other liabilities." We expect to liquidate the remaining accrued balance over the life of the various leases, the last of which expires in the second quarter of
2012.

During
2003, we also wrote down the carrying value of fixed assets that were no longer being utilized as a result of the reductions in force. These fixed assets consisted primarily of
supply chain software and test equipment. The total charge for the fixed assets that was included as restructuring and other related charges in 2003 was $0.6 million.

During
2003, we decided to place certain office buildings in Montreal, Canada for sale, as those buildings were no longer used by us. We classified the buildings as
held-for-sale and wrote down the value of these buildings to estimated fair market value, less cost to sell, and recorded a $1.0 million restructuring loss that is
included as a component of "Restructuring and other related charges" in the statement of operations.

During
2003, we recorded a charge of $0.1 million for legal and placement costs as a result of the reductions in force. The accrued balance for these charges was approximately
$0.1 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." We expect the majority of the remaining accrued balance to be paid by
March 2004 and all balances to be paid by the end of the third quarter of 2004.

During
2002, we completed restructuring efforts resulting in the recording of total restructuring and other related charges of $5.0 million.

Involuntary
severance related costs of $2.8 million included $2.5 million that resulted from the elimination of approximately 105 positions at our facilities in the United States,
Canada, and Europe based on terminations that were announced in July, October and December of 2002. These terminations consisted primarily of engineering and sales positions, but also included
manufacturing and administrative positions. At December 31, 2002, the remaining accrued balance for this charge was approximately $0.7 million and is included in the consolidated balance
sheet classification, "Accrued expenses and other liabilities." We utilized the remaining accrued balance during 2003. The balance of involuntary severance charges of $0.3 million resulted from
an increase in the projected estimate of our termination costs in Europe that were originally recorded during the fourth quarter of 2001 as part of our strategic repositioning. At December 31,
2002, the remaining accrued balance for this charge was

31

---

approximately
$0.1 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." We utilized the remaining accrued balance during 2003.

During
2001, as part of our strategic repositioning, we recorded restructuring and related charges for the difference between the committed lease payments and the estimated
sub-lease rental income for leased facilities that we were no longer occupying. During 2002, we updated our estimates of the sub-lease rental income based on current market
conditions and determined that the difference from the committed lease payments was larger than originally estimated. As a result, we recorded additional restructuring and related charges of
approximately $1.4 million related to these idle leased facilities. At December 31, 2002, the remaining accrued balance for this charge, including the charge that was originally booked
in 2001, was approximately $1.6 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." We expect to utilize the majority of the
remaining accrued balance through 2005

As
a result of the reduction in headcount, we had certain fixed assets that were no longer being utilized. These fixed assets consisted primarily of computer equipment, furniture and
fixtures, and machinery and equipment, and they have been disposed of or set aside for disposal. The total charge for the fixed assets that was recorded as restructuring and other related charges in
2002 was approximately $0.7 million.

Additional
costs of approximately $0.1 million were charged to restructuring and other related charges. These costs consisted of both legal costs incurred and license fee payments
made related to a software license that was no longer utilized. At December 31, 2002, the remaining accrued balance for this charge was approximately $25,000 and is included in the consolidated
balance sheet classification, "Accrued expenses and other liabilities." We utilized the remaining accrued balance during 2003.

Other Income (Expense), Net

Year Ended December 31,2002

2003($ In millions)Interest income

$
2.2

$
0.7Interest expense


(5.8
)

(3.7
)Gain on extinguishment of debt


20.8


2.1Other


2.9


(0.7
)Total other income (expense), net

$
20.1

$
(1.6
)


The
2002 amount reflects the reclassification of the gain on the repurchase of convertible debt from extraordinary gain to other income in accordance with a change in
generally accepted accounting principles.

Included
in other income (expense), net for 2003 were $0.7 million of interest income, $3.7 million of interest expense, which includes $0.4 million of amortization
of convertible debt issuance costs, a
$2.1 million gain realized on the repurchase of convertible debt and $0.7 million of combined net foreign currency translation loss and other items.

Included
in other income (expense), net for 2002 were $2.2 million of interest income, $5.8 million of interest expense, which includes $0.7 million of amortization
of convertible debt issuance costs, a $20.8 million gain realized on the repurchase of convertible debt, $3.8 million foreign currency translation gain generated on the intercompany debt
related to the IML transaction and $0.9 million of combined net foreign currency translation loss and other items.

The
decrease in interest expense in 2003 compared to 2002 was due to the repurchase of convertible debt during 2002 and 2003. The decrease in interest income in 2003 compared to 2002 was

32

---

due
to a decrease in interest rates available on cash and cash equivalents combined with the decrease in our cash and cash equivalents as a result of the repurchase of convertible debt and operating
losses.

Income Tax Expense (Benefit)

Year Ended December 31,2002

2003($ In millions)Income tax expense (benefit)

$
(1.4
)
$
0.1


During
the second quarter of 2002, due to recently enacted U.S. tax legislation that allows for the extension of the federal carryback period, we recorded approximately
$800,000 of income tax benefit. Our effective tax rate decreased in 2003 to (0.2%) from 1.4% in 2002. In 2003 and 2002, the primary
component of the effective tax rate was the maintenance of the full valuation allowance on the deferred tax asset.

For
U.S. federal income tax purposes, we had net operating loss carryforwards available to reduce taxable income of approximately $138.0 million at December 31, 2003, a
portion of which may be limited under Internal Revenue Code Section 382. These carryforwards will begin to expire in 2019. We also had a foreign net operating loss carryforward of approximately
$46.0 million. We had $5.0 million of tax credits that were composed of federal research and development credits and state and local credits. These credits began to expire in 2003.

Based
upon available evidence, management believes that the realization of certain deferred tax assets is more unlikely than not and, accordingly has established a full valuation
allowance against those assets. During fiscal 2003, the deferred tax asset valuation allowance increased by $30.4 million, primarily as the result of additional net operating loss carryforwards
and the amortization of intangible assets. We will continue to assess the valuation allowance and to the extent it is determined that such allowance is no longer required, the tax benefit of the
remaining net deferred tax assets will be recognized in the future. Approximately $4.5 million of the valuation allowance for deferred tax assets relates to benefits for stock option
deductions, which, when realized, will be allocated directly to additional paid-in capital.

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Revenues

Year Ended December 31,2001

2002Amount

% of total

Amount

% of total

Change($ In millions)



($ In millions)PS

$
76.7

94.7
%
$
73.8

71.9
%
(3.8
)%VQS


4.3

5.3


28.9

28.1

575.7Total revenues

$
81.0

100
%
$
102.7

100
%
26.8


Total
company revenues of $102.7 million for the year ended December 31, 2002 increased 26.8% from $81.0 million for the year ended December 31, 2001. The
increase was primarily attributable to the full year of revenue generated by VQS, which we acquired from Lucent on November 30, 2001. VQS revenue for 2002 was $28.9 million as compared
to $4.3 million for the month of December 2001. The VQS sales were made primarily through the supply agreement with Lucent. PS revenues of $73.8 million for 2002 decreased 3.8%
from $76.7 million for 2001. This decrease was a result of the

33

---

on-going
global economic slowdown that continued to significantly impact the telecommunications industry.

Year Ended December 31,2001

2002Amount

% of total

Amount

% of total

Change($ In millions)



($ In millions)North America

$
51.1

63.1
%
$
64.6

62.9
%
26.5
%International


29.9

36.9


38.1

37.1

27.3Total revenues

$
81.0

100.0
%
$
102.7

100.0
%
26.8


Revenues
from international customers of $38.1 million for 2002 increased 27.3% from $29.9 million for 2001 and represented 37.1% and 36.9% of revenues for the years ended
December 31, 2002 and 2001, respectively. The primary reason for the North American revenue increase was the acquisition of the VQS business in November 2001, while the increase in
international revenues was primarily due to increased PS revenues in Asia.

Revenues
from Lucent, our primary VQS reseller to network operators, represented 27.4% of total revenue for 2002. Revenues from Lucent were less than 10% for 2001.

We
do not believe that any single end-user customer accounted for more than 10% of revenues for the years ended December 31, 2002 and 2001.

Gross Profit

Year Ended December 31,2001

2002($ In millions)Revenues

$
81.0

$
102.7Cost of revenues


41.4


57.8Gross profit

$
39.6

$
44.9As a percentage of revenues


48.9
%

43.7
%


Gross
profit for 2002 of $44.9 million increased 13.3% from $39.6 million for 2001, and represented 43.7% and 48.9% of revenues for 2002 and 2001, respectively.

Included
in cost of revenues for 2002 were $2.9 million of completed technology amortization related to the VQS, Mobilee, MMI and IML acquisitions, $1.2 million inventory
fair value adjustment related to the VQS acquisition and $6.0 million for the impairment of completed technology related to the VQS and IML acquisitions.

Included
in cost of revenues for 2001 were $2.1 million of completed technology amortization related to the VQS, Mobilee, IML and ViaDSP acquisitions, $1.5 million
inventory fair value adjustment related to the VQS acquisition, $0.4 million for the impairment of completed technology from the ViaDSP acquisition and a $0.5 million restructuring
charge related to the write-down of IP Services Management inventory.

The
decrease in gross margin percentage for 2002 compared to 2001 was primarily due to a less favorable sales mix of products and increased spending intended to create
efficiencies, such as outsourced manufacturing and order fulfillment, in our supply chain operation.

34

---

Selling, General and Administrative

Year Ended December 31,2001

2002($ In millions)Selling, general and administrative

$
86.4

$
55.4As a percentage of revenues


106.6
%

53.9
%


Selling,
general and administrative expenses of $55.4 million for 2002 decreased 35.9% from $86.4 million for 2001. Selling, general and administrative expenses represented
53.9% and 106.6% of total revenues for 2002 and 2001, respectively. The primary reason for the decrease in selling, general and administrative expenses was the realization of cost reductions
implemented at the end of 2001 as
part of our strategic repositioning and our additional cost reduction initiative implemented in the third quarter of 2002. Additionally, the adoption of SFAS 142 on January 1, 2002
eliminated the amortization of goodwill and indefinite-lived intangible assets. Amortization expense for these assets for the year ended December 31, 2001 was $19.4 million.

Included
in selling, general and administrative expenses for 2002 were $4.7 million of amortization of intangible assets related to the VQS and IML acquisitions and
$3.4 million of compensation expense related to the VQS, Mobilee, IML and MMI acquisitions.

Included
in selling, general and administrative expenses for 2001 were $21.3 million of amortization of goodwill and other intangibles related to the VQS, Mobilee, IML, ViaDSP and
Teknique acquisitions, $14.8 million of compensation expense related to the Mobilee and IML acquisitions, and the reversal of a $4.7 million accrual related to additional compensation
that would not be paid to the employees of IML. This accrual was originally established during the third and fourth quarters of 2000 when it appeared probable that IML would achieve the financial
results outlined in the merger agreement that would entitle certain individuals to additional compensation. Subsequent to the first quarter of 2001, when it became known that these financial results
would not be met, the accrual was reversed.

Research and Development

Year Ended December 31,2001

2002($ In millions)Research and development

$
37.2

$
38.2As a percentage of revenues


45.9
%

37.2
%


Research
and development expenses of $38.2 million for 2002 increased 2.7% from $37.2 million for 2001, and represented 37.2% and 45.9% of total revenues for 2002 and 2001,
respectively. The increase in expense was due to increased development spending for theNMS HearSayand the VQS product lines partially offset by other
cost reductions.

35

---

Impairment Charges

Year Ended December 31,2001

2002($ In millions)In cost of revenues:Acquired completed technology from IML, Mobilee, MMI and VQS

$
0.4

$
6.0In operating expenses:Goodwill and intangible assets related to IML, ViaDSP


55.6


36.4Goodwill and intangible assets related to VQS





30.155.6


66.5Total impairment charges

$
56.0

$
72.5


During
the second quarter of 2002, we recorded impairment charges totaling approximately $36.4 million related to the goodwill and intangible assets associated
with the IML acquisition. As a result of our planned intention to reduce overall workforce, including IML employees, the discontinuation of certain IML products as a part of our generally available
product offering, continued declining revenues for IML products, the estimated value of IML's goodwill, indefinite-lived intangible assets and amortizable intangible assets had decreased. Based on the
results of the impairment analysis
performed, these assets were written down to their estimated fair value. In addition to this charge, a $2.9 million charge is included in the consolidated statement of operations
classification, "Cost of revenues," as it relates to the write-down of acquired completed technology.

During
the fourth quarter of 2002, we recorded impairment charges totaling approximately $30.1 million related to the goodwill, intangible assets and fixed assets associated with
the VQS acquisition. Based on the declining historical and forecasted operating results of VQS as they related to earlier estimates, the economic condition of the telecommunications industry as a
whole, and our 18% reduction of the VQS workforce, the estimated value of VQS's goodwill, intangible assets and fixed assets had decreased. Based on the results of the impairment analysis performed,
these assets were written-down to their fair value.

In
addition to this charge, a $3.1 million charge is included in the consolidated statement of operations classification, "Cost of revenues," as it relates to the write-down of
VQS-acquired completed technology.

During
2001, we recorded impairment charges totaling approximately $56.0 million related to the goodwill associated with the IML acquisition and the goodwill and acquired
technology associated with the ViaDSP acquisition. Based on the declining historical and forecasted operating results of IML as they related to earlier estimates and the economic condition of the
telecommunications industry as a whole, the estimated value of IML's and ViaDSP's goodwill had decreased. Furthermore, based on the uncertain future utilization of the acquired
technology, the estimated value of ViaDSP's acquired technology had decreased. As a result, these assets were written-down to their fair value. The charge of approximately
$55.6 million related to the write-down of goodwill is included in the consolidated statement of operations classification "Impairment charges" while the charge of approximately
$0.4 million related to acquired technology is included in the consolidated statement of operations classification "Cost of revenues."

36

---

Restructuring and Other Related Charges

Year Ended December 31,2001

2002($ In millions)Involuntary severance related costs

$
3.4

$
2.8Lease termination costs


4.4


1.4Write-down of fixed assets


3.1


0.7Other


0.6


0.1Total restructuring and other related charges

$
11.5

$
5.0


In
an effort to further reduce future operating expenses, we initiated restructuring efforts resulting in the recording of total restructuring and other related charges
of $5.0 million for 2002.

Involuntary
severance related costs of $2.8 million recorded in 2002 resulted from the elimination of approximately 105 positions at our facilities in the United States, Canada,
and Europe based on terminations that were announced in July, October and December of 2002. These terminations consisted primarily of engineering and sales positions, but also included manufacturing
and administrative positions. At December 31, 2002, the remaining accrued balance for this charge was approximately $0.7 million and is included in the consolidated balance sheet
classification, "Accrued expenses and other liabilities." We utilized the remaining accrued balance during 2003. The balance of involuntary severance of $0.3 million recorded in 2002 resulted
from an increase in the projected estimate of our termination costs in Europe that were originally recorded during the fourth quarter of 2001 as part of our strategic repositioning. At
December 31, 2002, the remaining accrued balance for this charge was approximately $0.1 million and is included in the consolidated balance sheet classification, "Accrued expenses and
other liabilities." We utilized the remaining accrued balance during 2003.

During
2001, as part of our strategic repositioning, we recorded restructuring and related charges for the difference between the committed lease payments and the estimated
sub-lease rental income for leased facilities that we were no longer occupying. During 2002, we updated our estimates of the sub-lease rental income based on current market
conditions and determined that
the difference from the committed lease payments was larger than originally estimated. As a result, we recorded additional restructuring and other related charges of approximately $1.4 million
related to these idle leased facilities. At December 31, 2002, the remaining accrued balance for this charge, including the charge that was originally booked in 2001, was approximately
$1.6 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." We expect to utilize the majority of the remaining accrued balance
through 2005.

As
a result of the reduction in headcount, we had certain fixed assets that were no longer being utilized. These fixed assets consisted primarily of computer equipment, furniture and
fixtures, and machinery and equipment, and they were disposed of or set aside for disposal. The total charge for the fixed assets that was recorded as restructuring and other related charges in 2002
was approximately $0.7 million.

Additional
costs of approximately $0.1 million were charged to restructuring and other related charges. These costs consisted of both legal costs incurred and license fee payments
made related to a software license that was no longer being utilized. At December 31, 2002, the remaining accrued balance for this charge was approximately $25,000 and is included in the
consolidated balance sheet classification, "Accrued expenses and other liabilities." We utilized the remaining accrued balance during 2003.

During
2001, we recorded restructuring and other special charges of approximately $11.5 million. These charges consisted of approximately $2.3 million for the closing of
the IP Services Management operation in Tustin, California, approximately $2.6 million related to a long-term lease obligation, and

37

---

approximately
$6.6 million related to our strategic repositioning of our Company. For this total charge of $11.5 million, approximately $0.5 million was related to the
write-down of IP Services Management inventory and is included in the consolidated statement of operations classification, "Cost of revenues." The remaining $11.0 million is
included in the statement of operations classification, "Restructuring and other related charges."

During
2001, we announced a plan to close our IP Services Management operation, which resulted in restructuring and other special charges of $2.3 million. As part of this plan,
all 30 employees of the IP Services Management operation were terminated. The charge consisted of approximately $0.6 million of involuntary severance related costs, approximately
$0.7 million of fixed asset write-downs, approximately $0.5 million of inventory write-downs, approximately $0.4 million of lease termination costs and approximately
$0.1 million of other administrative closing costs. At December 31, 2001, the remaining accrued balance for this charge was approximately $0.5 million and is included in the
consolidated balance sheet classification, "Accrued expenses and other liabilities." We utilized the majority of the remaining accrued balance during 2002.

We
leased a facility in Schaumburg, Illinois that was not being occupied by us and will not be occupied by us in the future. This facility was sub-leased by us to a third
party tenant for a sub-lease term equivalent to the original lease term, which ends on September 30, 2008. In April 2001, we were notified that the tenant had filed for
bankruptcy protection and we would be required to resume primary responsibility for the lease payments on this facility. We have estimated that the difference between the committed lease payments over
the life of the lease and the sub-lease rental income will approximate $2.6 million, and this amount was included as restructuring and other related charges in 2001. At
December 31, 2001, the remaining accrued balance for this charge was approximately $2.2 million and is included in the consolidated balance sheet classification, "Accrued expenses and
other liabilities." In 2003, we entered into a lease termination agreement with the landlord of the facility.

During
2001, we eliminated approximately 160 positions at our facilities in the United States, Canada, Europe and Asia. These terminations consisted primarily of engineering positions,
but also included manufacturing, sales and administrative positions. Severance costs related to these terminations of approximately $2.8 million have been recorded as restructuring and other
related charges during 2001. At December 31, 2001, the remaining accrued balance for this charge was approximately $1.6 million and is included in the consolidated balance sheet
classification, "Accrued expenses and other liabilities." We utilized the remaining accrued balance during 2002.

Due
to this strategic repositioning, certain facilities and fixed assets were no longer utilized by us and will not be utilized by us in the future. We are currently working with real
estate agents in an attempt to sub-lease the idle facilities that are located in the United States, Canada and throughout Europe. We estimated that the difference between the committed
lease payments over the lives of the leases and the sub-lease rental income will approximate $0.7 million, and this amount was included as restructuring and other related charges in
2001. At December 31, 2001, the remaining accrued balance for this charge was approximately $0.7 million and is included in the consolidated balance sheet classification, "Accrued
expenses and other liabilities." We utilized the remaining accrued balance during 2002. We disposed of the fixed assets that were no longer being utilized. These fixed assets consisted primarily of
leasehold improvements on the idle leased facilities and computer equipment, furniture and fixtures and machinery and equipment that were used in connection with activities that had been discontinued.
The total charge for the fixed assets included as restructuring and other related charges in 2001 was $2.4 million. At December 31, 2001, there was no accrual balance related to this
charge.

Additional
costs of approximately $0.7 million related to the strategic repositioning were charged to restructuring and other related charges. These costs consisted primarily of
contract termination charges and legal fees. At December 31, 2001, the remaining accrued balance for this charge was

38

---

approximately
$0.5 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." We utilized the remaining accrued balance during 2002.

Other Income (Expense), Net

Year Ended December 31,2001

2002($ In millions)Interest income

$
12.6

$
2.2Interest expense


(9.4
)

(5.8
)Gain on extinguishment of debt


18.9


20.8Other


(12.8
)

2.9Other income (expense), net

$
9.3

$
20.1


The
2001 and 2002 amounts reflect the reclassification of the gain on the repurchase of convertible debt from extraordinary gain and income tax to other income in
accordance with a change in generally accepted accounting principles.

Included
in other income (expense), net for 2002 were $2.2 million of interest income, $5.8 million of interest expense, which includes $0.7 million of amortization
of convertible debt issuance costs, a $20.8 million gain realized on the repurchase of convertible debt and $3.8 million foreign currency translation gain generated on the intercompany
debt related to the IML transaction and $0.9 million of combined net foreign currency translation loss and other items.

Included
in other income (expense), net for 2001 were $12.6 million of interest income, $9.4 million of interest expense, which includes $1.1 million of amortization
of convertible debt issuance costs, a $18.9 million gain realized on the repurchase of convertible debt and $4.7 million of foreign currency
translation loss related to the remeasurement of intercompany debt related to the IML transaction, $7.0 million of impairment loss for the write-down to fair market value of a minority
investment, a $0.2 million gain on the sale of a minority investment, and $1.3 million of combined net foreign currency translation loss and other items.

The
decrease in interest expense in 2002 compared to 2001 was directly due to the repurchase of convertible debt during 2002 and 2001. The decrease in interest income in 2002 compared to
2001 was due to falling interest rates combined with the decrease in our cash, cash equivalents and marketable securities as a result of the repurchase of convertible debt and operating losses.

Income Tax Expense (Benefit)

Year Ended December 31,2001

2002($ In millions)Income tax expense (benefit)

$
1.4

$
(1.4
)


During
the second quarter of 2002, due to U.S. tax legislation that allows for the extension of the federal carryback period, we recorded $0.8 million of income tax
benefit. Our effective tax rate increased in 2002 to 1.4% from (1.0)% in 2001. In 2002 and 2001, the primary component of the effective tax rate was the maintenance of the full valuation allowance on
the deferred tax asset.

For
U.S. federal income tax purposes we had net operating loss carryforwards available to reduce taxable income of approximately $84.0 million at December 31, 2002, which
may be subject to limitation pursuant to Internal Revenue Code Section 382. These carryforwards will begin to expire in 2019. We also had a foreign net operating loss carryforward of
approximately $22.6 million at December 31, 2002. We had $4.4 million of tax credits, which were composed of federal research, and development credits and state and local credits.
These credits began to expire in 2003. We believe that

39

---

the
realization of the net deferred tax asset is more unlikely than not and, accordingly, a full valuation allowance has been established.

Liquidity and Capital Resources

December 31,2002

2003($ In millions)Cash, cash equivalents and marketable securities

$
85.8

$
59.9Working capital


89.0


58.6


As
of December 31, 2003, our principal sources of liquidity included cash and cash equivalents of $59.9 million. As of December 31, 2003, our working
capital was approximately $58.6 million. We had no significant capital spending or purchase commitments other than facilities leases and open purchase orders in the ordinary course of business.

We
elected not to renew our bank line of credit that expired on May 13, 2003. No borrowings were made under the line of credit.

In
the short term, through the period ending December 31, 2004, we believe that our available cash and cash equivalents will be sufficient to meet our operating expenses, capital
requirements and contractual obligations.

Effective
October 11, 2000, we issued $175.0 million of convertible subordinated notes (the "notes"). The notes are convertible into shares of our common stock at any time
after 90 days following the last day of the original issuance of the notes and before the close of business on the business day immediately preceding the maturity date, at a conversion price of
$63.125 per share, subject to specified adjustments. The notes bear interest at a rate of 5% per year which is payable semiannually on April 15 and October 15 of each year, commencing on
April 15, 2001. The notes, which are unsecured obligations of the Company, will mature on October 15, 2005, unless previously redeemed or repurchased, and have no sinking fund
requirement. At December 31, 2003, we had $57.7 million of notes outstanding.

We
may require or desire additional funds to support our operating expenses and capital requirements or for other purposes, such as acquisitions or for competitive reasons, and may seek
to raise such additional funds through public or private equity financing or from other sources. Specifically, we will need to refinance or acquire additional funds to retire the debt that will mature
in the third quarter of 2005. We cannot provide assurance that additional funding will be available at all or that, if available, such financing will be obtainable on terms favorable to us and would
not be dilutive to our earnings. Our future liquidity and cash requirements will depend on numerous factors, including, but not limited to, the level of revenue we will be able to achieve in the
future, the successful introduction of new products and potential acquisitions of related businesses and/or technologies.

Cash
Flow:

Year Ended December 31,2001

2002

2003($ In millions)Net cash provided by (used in):Operating activities

$(35.4
)
$(24.1
)
$(16.5
)Investing activities

(133.6
)
37.3

26.8Financing activities

(27.5
)
(39.9
)
(8.2
)


We
incurred a net loss of $142.7 million, $98.5 million, and $56.0 million for the years ended December 31, 2001, 2002 and 2003, respectively.
Included in our net loss for 2001, 2002 and 2003 were non-cash charges for depreciation and amortization of property and equipment, amortization of

40

---

goodwill
and other intangibles, amortization of debt issuance costs and amortization of deferred stock compensation expense and debt issuance costs totaling $49.5 million, $22.9 million
and $10.8 million, respectively. We recorded a loss on impairment of goodwill, other intangibles and property and equipment totaling $59.1 million, $72.5 million and
$27.6 million for the years ended December 31, 2001, 2002 and 2003, respectively. We also realized gross gains on the extinguishment of long-term debt of
$18.9 million, $20.8 million and $2.1 million in 2001, 2002 and 2003, respectively. We recognized a loss on investments of $7.0 million and $0.4 million in 2001 and
2002. There were no investment gains or losses in 2003. We recognized a currency loss of $(4.7) million and a currency gain related to remeasurement of intercompany debt from the IML
transaction of $3.8 million in 2001 and 2002, respectively. No gain or loss related to the intercompany debt from the IML transaction, was recognized in 2003 or will be recognized in future
periods as a result of the debt being reclassified as permanent debt in connection with IML's impairment in 2002. The change in our working capital generated positive cash flow of $5.8 million,
$3.2 million and $4.7 million in 2001, 2002 and 2003, respectively.

Cash
of $254.5 million, $150.0 million and $23.8 million was used to purchase marketable securities, with cash of $206.0 million, $197.9 million and
$53.1 million provided from maturities of marketable securities for 2001, 2002 and 2003, respectively. Capital expenditures were $12.8 million, $7.7 million and
$2.4 million for 2001, 2002 and 2003, respectively. In 2001, we spent a total of $73.8 million to acquire VQS and Mobilee, and in 2002, we spent $3.0 million to acquire MMI.

In
2001, we used cash of $27.4 million to extinguish $46.6 million face value of convertible debt and $1.9 million to repurchase 400,000 shares of our outstanding
common stock, while cash of $1.7 million was provided by the exercise of stock options and the sale of stock through our employee stock purchase plan. In 2002, we used cash of
$37.9 million to extinguish $59.4 million face value of convertible debt and $2.8 million to purchase 515,000 shares of common stock through our repurchase plan, while cash of
$0.8 million was provided by the exercise of stock options and the sale of stock through our employee stock purchase plan. In 2003, we used cash of $9.3 million to extinguish
$11.3 million face value of convertible debt, and cash of $1.0 million was provided by the exercise of employee stock options.

We
do not have any off-balance sheet financing arrangements, other than property operating leases that are disclosed in the contractual obligations table below and in our
consolidated financial statements, nor do we have any transactions, arrangements or other relationships with any special purpose entities established by us, at our direction or for our sole benefit.
The following table details our future payments due under contractual obligations.

|                              |  | Payments Due by Period
|----------------------------- |  | ----------------------
|
|
|
|Property leases               |  | $                     
|Open purchase orders          |  |                       
|Convertible notes             |  |                       
|                              |  |                       
|Total contractual obligations |  | $                     
|                              |  |                       

Open purchase orders are defined as agreements to purchase goods or services that are enforceable and legally binding and that specify all
significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable pricing provisions; and the approximate timing of the transactions. These obligations primarily
relate to components, software licenses and services and equipment maintenance services. The amounts are based on our contractual commitments; however, it is possible we may be able to negotiate lower
payments if we choose to exit these contracts earlier.

41

---

Recent Accounting Pronouncements

In November 2002, the FASB issued FIN No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN No. 45 clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing
the guarantee. We adopted FIN No. 45 on January 1, 2003.

In
January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB 51 and issued a revision to that guidance, FIN
No. 46-R, in December 2003. FIN No. 46 and FIN No. 46-R provide guidance on the identification of entities for which control is achieved through means other than through voting
rights, called "variable interest entities" or "VIEs," and how to determine when and which business enterprise should consolidate the VIE (the "primary beneficiary"). This model for consolidation
applies to an entity in which either (1) the equity investors (if any) do not have a controlling financial interest, or (2) the equity investment at risk is insufficient to finance that
entity's activities without receiving additional subordinated financial support from other parties. In addition, these interpretations require both the primary beneficiary and all other enterprises
with a significant variable interest in a VIE to make additional disclosures. The provisions of FIN No. 46 are applicable to us for any interests entered into after January 31, 2003, and
the provisions of FIN No. 46-R will be effective in the quarter ended March 31, 2004. We do not have any interests that would change our current reporting entity or require the
additional disclosures outlined in FIN No. 46 or FIN No. 46-R.

On
January 1, 2003, the Company adopted SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146), which addresses significant issues regarding the
recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities. SFAS 146 requires recognition of a liability for costs
associated with an exit or
disposal activity at fair value when the liability is incurred, or for certain one-time employee termination costs over a future service period. Previously, a liability for an exit cost was recognized
when a company committed to an exit plan. As a result, SFAS 146 may affect both the timing and amounts of the recognition of costs associated with future restructuring actions.

In
April 2003, the FASB issued Statement of Financial Accounting Standards No. 149 (SFAS 149), "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." This statement amends SFAS 133 to provide clarification on the financial accounting and reporting of derivative instruments and hedging activities, and requires contracts with
similar characteristics to be accounted for on a comparable basis. The adoption of SFAS 149 has had no effect on our financial condition or results of operations.

In
May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 has had no effect on our financial condition or results of
operations.

42

---

Quarterly Information (Unaudited)

The following tables set forth unaudited selected financial information for the periods indicated, as well as certain information expressed as a percentage of
total revenues for the same periods. This information has been derived from unaudited consolidated financial statements, which, in the opinion of management, include all adjustments necessary for a
fair presentation of such information. This information has not been audited by our independent accountants in accordance with standards established for such reviews. The results of operations for any
quarter are not necessarily indicative of the results to be expected for any future period.

|                                            |                                         | Quarter Ended            |        
|------------------------------------------- | --------------------------------------- | ------------------------ | -------
|
|
|
|Revenues                                    |                                         | $                        | 28,217 
|Cost of revenues                            |                                         |                          | 15,445 
|                                            |                                         |                          |        
|Gross profit                                |                                         |                          | 12,772 
|Operating expenses:                         |                                         |                          |        
|                                            | Selling, general and administrative     |                          |        
|                                            | Research and development                |                          |        
|                                            | Impairment charges                      |                          |        
|                                            | Restructuring and other related charges |                          |        
|                                            |                                         |                          |        
|                                            |                                         | Total operating expenses |        
|                                            |                                         |                          |        
|Operating loss                              |                                         |                          | (13,573
|Other income (expense), net                 |                                         |                          | 214    
|                                            |                                         |                          |        
|Loss before income taxes                    |                                         |                          | (13,359
|Income tax expense (benefit)                |                                         |                          | 167    
|                                            |                                         |                          |        
|Net loss                                    |                                         | $                        | (13,526
|                                            |                                         |                          |        
|Basic and diluted net loss per common share |                                         | $                        | (0.37  
|                                            |                                         |                          |        

|                               |                                         | Quarter Ended            |     
|------------------------------ | --------------------------------------- | ------------------------ | ----
|
|
|Revenues                       |                                         | 100.0                    | %   
|Cost of revenues               |                                         | 54.7                     |     
|                               |                                         |                          |     
|                               | Gross profit                            |                          | 45.3
|Operating expenses:            |                                         |                          |     
|                               | Selling, general and administrative     |                          | 58.7
|                               | Research and development                |                          | 34.7
|                               | Impairment charges                      |                          |    
|                               | Restructuring and other related charges |                          |    
|                               |                                         |                          |     
|                               |                                         | Total operating expenses |     
|Operating loss                 |                                         | (48.1                    | )   
|Other income (expense), net    |                                         | 0.8                      |     
|                               |                                         |                          |     
|Loss before income taxes       |                                         | (47.3                    | )   
|Income taxes expense (benefit) |                                         | 0.6                      |     
|                               |                                         |                          |     
|Net loss                       |                                         | (47.9                    | )%  
|                               |                                         |                          |     

On a sequential basis, revenues in the first two quarters of 2002 increased by 31% and 3%, respectively. This growth was primarily driven by our
purchase of the VQS business unit in November of 2001. Revenues sequentially decreased by 11% in the third quarter and 25% in the fourth quarter as softness in the telecommunications industry
continued in the second half of the year. In 2003, revenues increased sequentially in each of the four quarters by 7.6%, 1.3%, 3.4% and 7.6%, respectively.

43

---

Our
cost of revenues as a percentage of revenues have fluctuated between 45% to 80% for each quarter included in the two-year period ended December 31, 2003. During
the second quarter of 2002, cost of revenues was 59%, due in part to the inclusion of a $2.9 million impairment charge related to IML-acquired completed technology. During the third quarter of
2002, cost of revenues were 45%, due in part to favorable product mix during the quarter and the realization of cost reductions implemented at the end of 2001. During the fourth quarter of 2002, cost
of revenues were 69%, due in part to the inclusion of a $3.1 million impairment charge related to VQS-acquired completed technology. During the second quarter of 2003, cost of revenues were
80%, due in part to the inclusion of a $7.4 million impairment charge related to the VQS, MMI and Mobilee acquisitions.

On
a sequential basis, the dollar amounts of our selling, general and administrative expenses generally decreased over the two-year period ended December 31, 2003.
This was due to our strategic repositioning and restructuring that was implemented in the third quarter of 2001 and continued during 2002 and 2003, with the execution of additional cost saving
measures. There was a bonus accrual reversal in the fourth quarter of 2002 of $1.7 million. These amounts had been previously accrued in the prior quarters of 2002.

Over
the two-year period ended December 31, 2003, the dollar amount of our research and development expenses fluctuated, but the eight-quarter trend was down on a
dollar basis. This variation was primarily due to the realization of expense reductions resulting from our strategic repositioning and restructuring and our additional cost saving measures, offset by
our acquisitions over 2001 and 2002. These expenditures increased sequentially during the second quarter of 2002 due to our acquisition of MMI on April 1, 2002. During the third and fourth
quarters of 2002, these expenditures decreased on a sequential basis due to the execution of additional cost saving measures during each of these quarters. There was a bonus accrual reversal in the
fourth quarter of 2002 of $0.8 million. These amounts had been previously accrued in the prior quarters of 2002.

During
the fourth quarter of fiscal 2003, we recorded two foreign currency transaction adjustments, netting to $0.3 million, which decreased loss before income taxes, reversed a
vacation accrual, which resulted in a decrease to loss before income taxes of $0.9 million, and made an adjustment to decrease overhead costs capitalized in inventories totaling
$0.8 million, which increased cost of revenues and, therefore, loss before income taxes.

Our
quarterly operating results may fluctuate as a result of a number of factors, some of which are beyond our control, including, but not limited to: fluctuations in our customers'
businesses; demand for our customers' products incorporating our products; timing and market acceptance of new products or enhancements introduced by us or our competitors; availability of components
from our suppliers and the manufacturing capacity of our subcontractors; timing and level of expenditures for sales, marketing and product development; and changes in the prices of our products or of
our competitors' products. We will continue to closely monitor our operating expenses in an effort to achieve profitability.

In
addition, we have historically operated with less than one quarter's worth of backlog and a customer order pattern that is skewed toward the later weeks of the quarter. Any
significant deferrals of orders for our products would cause a shortfall in revenue for the quarter. Accordingly, we cannot be sure that we will be profitable in any particular quarter.

We
believe that our revenues and results of operations have not been significantly impacted by inflation.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. Our investment portfolio of cash equivalents,
marketable securities and non-marketable securities are subject to interest rate fluctuations, but we believe this risk is immaterial

44

---

due
to the short-term nature of these investments. At December 31, 2003, we had $57.7 million of long-term debt outstanding. A hypothetical 10% decrease in our
weighted-average borrowing rate at December 31, 2003 would not have materially affected the year-end carrying value of the debt. Our exposure to currency exchange rate fluctuations
has been moderate due to the fact that the revenues are billed primarily in U.S. dollars. During 2000, two of our subsidiaries, a U.S. subsidiary and a Canadian subsidiary, entered into an
intercompany debt arrangement whereby the U.S. subsidiary issued a loan to the Canadian subsidiary. The debt was denominated in U.S. dollars and was to be settled during the ordinary course of
business. In the first six months of 2002, and the year ended December 31, 2001, as a result of remeasuring the debt at each reporting period, we incurred a foreign exchange (loss) gain of
approximately $(4.7) million and $3.8 million, respectively. On July 1, 2002, due to an amendment in payment terms, this debt was reclassified
from short-term to long-term. Based on the amended payment terms, repayment of this intercompany debt is not planned or anticipated in the foreseeable future. As a result of
this reclassification, the gain or loss generated by the remeasurement of the debt at each reporting period is now being recorded as a component of accumulated other comprehensive income (loss) within
stockholders' equity. Further transaction losses or gains, which may be material, will be recorded in future reporting periods based upon changes in currency rates at the reporting dates.

45

---



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Report of Independent Auditors

To
the Board of Directors and Stockholders of NMS Communications Corporation:

In
our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of NMS Communications Corporation
and its subsidiaries (collectively, the "Company") at December 31, 2002 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements
and the financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and the financial statement schedule
based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

As
discussed in Note 1 to the consolidated financial statements, the Company changed its accounting method for goodwill and intangible assets. As discussed in Note 1 to the
consolidated financial statements, these consolidated financial statements, for the years ended December 31, 2001 and 2002 have been restated to reclassify gains on extinguishment of debt in
compliance with Statement of Financial Accounting Standards ("SFAS") No. 145, Recission of SFAS Nos. 4, 44 and 64, Amendment of
SFAS No. 13 and Technical Corrections as of April 2002, which was adopted by the Company as of January 1, 2003.

/s/
PricewaterhouseCoopers LLP

PricewaterhouseCoopers
LLP
Boston, Massachusetts
February 27, 2004

46

---



NMS Communications Corporation        Consolidated Balance Sheets

|                                        |                                                                                                                                                                                                                                                 | December 31,                               |       
|--------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------
|
|
|Assets                                  |                                                                                                                                                                                                                                                 |                                            |       
|Current assets:                         |                                                                                                                                                                                                                                                 |                                            |       
|                                        | Cash and cash equivalents                                                                                                                                                                                                                       |                                            | $     
|                                        | Marketable securities                                                                                                                                                                                                                           |                                            |       
|                                        | Accounts receivable, net of allowance for doubtful accounts of $979 and $995, respectively                                                                                                                                                      |                                            |       
|                                        | Inventories                                                                                                                                                                                                                                     |                                            |       
|                                        | Prepaid expenses and other assets                                                                                                                                                                                                               |                                            |       
|                                        | Income tax receivable                                                                                                                                                                                                                           |                                            |       
|                                        |                                                                                                                                                                                                                                                 |                                            |       
|                                        |                                                                                                                                                                                                                                                 | Total current assets                       |       
|                                        |                                                                                                                                                                                                                                                 |                                            |       
|Property and equipment, net             |                                                                                                                                                                                                                                                 |                                            | 17,955
|Other assets                            |                                                                                                                                                                                                                                                 |                                            | 2,558 
|Goodwill                                |                                                                                                                                                                                                                                                 |                                            | 10,279
|Other intangible assets, net            |                                                                                                                                                                                                                                                 |                                            | 13,495
|                                        |                                                                                                                                                                                                                                                 |                                            |       
|                                        |                                                                                                                                                                                                                                                 | Total assets                               |       
|                                        |                                                                                                                                                                                                                                                 |                                            |       
|Liabilities and Stockholders' Equity    |                                                                                                                                                                                                                                                 |                                            |       
|Current liabilities:                    |                                                                                                                                                                                                                                                 |                                            |       
|                                        | Accounts payable                                                                                                                                                                                                                                |                                            | $     
|                                        | Accrued expenses and other liabilities                                                                                                                                                                                                          |                                            |       
|                                        |                                                                                                                                                                                                                                                 |                                            |       
|                                        |                                                                                                                                                                                                                                                 | Total current liabilities                  |       
|Long-term debt less current portion     |                                                                                                                                                                                                                                                 |                                            | 69,067
|                                        |                                                                                                                                                                                                                                                 |                                            |       
|Commitments and contingencies (note 16) |                                                                                                                                                                                                                                                 |                                            |       
|                                        |                                                                                                                                                                                                                                                 | Total liabilities                          |       
|Stockholders' equity:                   |                                                                                                                                                                                                                                                 |                                            |       
|                                        | Preferred stock, $0.01 par value, 3,000,000 shares authorized at December 31, 2002 and 2003, respectively, no shares issued and outstanding                                                                                                     |                                            |       
|                                        | Common stock, $0.01 par value, 125,000,000 shares authorized; 36,603,018 and 36,738,402 shares issued at December 31, 2002 and 2003, respectively, and 36,067,742 and 36,685,958 shares outstanding at December 31, 2002 and
2003, respectively |                                            |       
|                                        | Additional paid-in capital                                                                                                                                                                                                                      |                                            |       
|                                        | Accumulated deficit                                                                                                                                                                                                                             |                                            |       
|                                        | Accumulated other comprehensive loss                                                                                                                                                                                                            |                                            |       
|                                        | Deferred compensation                                                                                                                                                                                                                           |                                            |       
|                                        | Treasury stock, at cost, 535,276 and 52,444 shares in 2002 and 2003, respectively                                                                                                                                                               |                                            |       
|                                        |                                                                                                                                                                                                                                                 |                                            |       
|                                        | Total stockholders' equity                                                                                                                                                                                                                      |                                            |       
|                                        |                                                                                                                                                                                                                                                 |                                            |       
|                                        |                                                                                                                                                                                                                                                 | Total liabilities and stockholders' equity |       
|                                        |                                                                                                                                                                                                                                                 |                                            |       

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

47

---



NMS Communications Corporation        Consolidated Statements of Operations

|                         |                                         | Year Ended December 31,     |         
|------------------------ | --------------------------------------- | --------------------------- | --------
|
|
|Revenues                 |                                         | $                           | 80,984  
|Cost of revenues         |                                         |                             | 41,354  
|                         |                                         |                             |         
|Gross profit             |                                         |                             | 39,630  
|Operating expenses:      |                                         |                             |         
|                         | Selling, general and administrative     |                             |         
|                         | Research and development                |                             |         
|                         | Impairment charges                      |                             |         
|                         | Restructuring and other related charges |                             |         
|                         |                                         |                             |         
|                         |                                         | Total operating expenses    |         
|                         |                                         |                             |         
|Operating loss           |                                         |                             | (150,527
|Other income (expense):  |                                         |                             |         
|                         | Interest income                         |                             |         
|                         | Interest expense                        |                             |         
|                         | Gain on extinguishment of debt          |                             |         
|                         | Other                                   |                             |         
|                         |                                         |                             |         
|                         |                                         | Other income (expense), net |         
|                         |                                         |                             |         
|Loss before income taxes |                                         |                             | (141,271
|                         | Income tax expense (benefit)            |                             |         
|                         |                                         |                             |         
|Net loss                 |                                         | $                           | (142,658
|                         |                                         |                             |         
|Basic and diluted:       |                                         |                             |         
|                         | Net loss per common share               |                             | $       
|                         |                                         |                             |         
|                         | Weighted average shares outstanding     |                             |         
|                         |                                         |                             |         

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

48

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NMS Communications Corporation  Consolidated Statements of Stockholders' Equity

|                           |                                                          | Common
Stock |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|-------------------------- | -------------------------------------------------------- | ------------ | ---- | - | --- | -- | - | ------- | ------ | - | -------- | -------- | - | ------ | ------ | - | ------- | ------ | -
|
|
|
|Balance, December 31, 2000 |                                                          | 36,401       |      | $ | 364 |    | $ | 375,663 |        | $ | (49,631  | )        | $ | (1,065 | )      | $ | (31,028 | )      | $
|                           |                                                          |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|                           | Exercise of common stock options and warrants            |              | 149  |   |     | 1  |   |         | 464    |   |          |          |   |        |        |   |         |        |  
|                           | Issuance of common stock under employee purchase plan    |              | 295  |   |     | 3  |   |         | (962   | ) |          |          |   |        |        |   |         |        |  
|                           | Stock issued under Mobilee merger agreement              |              | 19   |   |     |   |   |         |       |   |          |          |   |        |        |   |         |        |  
|                           | Stock forfeited under IML merger agreement               |              | (135 | ) |     | (1 | ) |         | (9,129 | ) |          |          |   |        |        |   |         | 9,130  |  
|                           | Deferred compensation                                    |              |      |   |     |    |   |         | 933    |   |          |          |   |        |        |   |         | (1,933 | )
|                           | Amortization of deferred compensation                    |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         | 14,782 |  
|                           | Stock repurchase                                         |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|                           | Debt repayment by common stockholders                    |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|                           | Change in market value of securities available for sale  |              |      |   |     |    |   |         |        |   |          |          |   |        | 113    |   |         |        |  
|                           | Foreign currency translation adjustment                  |              |      |   |     |    |   |         |        |   |          |          |   |        | 569    |   |         |        |  
|                           | Net loss                                                 |              |      |   |     |    |   |         |        |   |          | (142,658 | ) |        |        |   |         |        |  
|                           |                                                          |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|Balance, December 31, 2001 |                                                          | 36,729       |      | $ | 367 |    | $ | 366,969 |        | $ | (192,289 | )        | $ | (383   | )      | $ | (9,049  | )      | $
|                           |                                                          |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|                           | Exercise of common stock options and warrants            |              |      |   |     |    |   |         | (195   | ) |          |          |   |        |        |   |         |        |  
|                           | Issuance of common stock under employee purchase plan    |              |      |   |     |    |   |         | (848   | ) |          |          |   |        |        |   |         |        |  
|                           | Stock issued under Mobilee merger agreement              |              | 9    |   |     |   |   |         | (78    | ) |          |          |   |        |        |   |         |        |  
|                           | Stock forfeited under IML merger agreement               |              | (135 | ) |     | (1 | ) |         | 1      |   |          |          |   |        |        |   |         |        |  
|                           | Amortization of deferred compensation                    |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         | 3,387  |  
|                           | Termination of options issued at below FMV               |              |      |   |     |    |   |         | (3,131 | ) |          |          |   |        |        |   |         | 3,131  |  
|                           | Stock repurchase                                         |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|                           | Payment from officer option exercise                     |              |      |   |     |    |   |         | 58     |   |          |          |   |        |        |   |         |        |  
|                           | Change in market value of securities available for sale  |              |      |   |     |    |   |         |        |   |          |          |   |        | (113   | ) |         |        |  
|                           | Foreign currency translation adjustment                  |              |      |   |     |    |   |         |        |   |          |          |   |        | (2,208 | ) |         |        |  
|                           | Net loss                                                 |              |      |   |     |    |   |         |        |   |          | (98,539  | ) |        |        |   |         |        |  
|                           |                                                          |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|Balance, December 31, 2002 |                                                          | 36,603       |      | $ | 366 |    | $ | 362,776 |        | $ | (290,828 | )        | $ | (2,704 | )      | $ | (2,531  | )      | $
|                           |                                                          |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|                           | Issuance of common stock under employee purchase plan    |              |      |   |     |    |   | $       | (855   | ) |          |          |   |        |        |   |         |        |  
|                           | Amortization of deferred compensation                    |              |      |   |     |    |   |         |       |   |          |          |   |        |        |   |         | 643    |  
|                           | Termination of options issued at below FMV               |              |      |   |     |    |   |         | (1,786 | ) |          |          |   |        |        |   |         | 1,786  |  
|                           | Exercise of common stock options and warrants            |              |      |   |     |    |   |         | (716   | ) |          |          |   |        |        |   |         |        |  
|                           | Adjustment of forfeited stock under IML merger agreement |              | 135  |   |     | 1  |   |         | (1     | ) |          |          |   |        |        |   |         |        |  
|                           | Foreign currency translation adjustment                  |              |      |   |     |    |   |         |        |   |          |          |   |        | 378    |   |         |        |  
|                           | Net loss                                                 |              |      |   |     |    |   |         |        |   |          | (56,006  | ) |        |        |   |         |        |  
|                           |                                                          |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  
|Balance, December 31, 2003 |                                                          | 36,738       |      | $ | 367 |    | $ | 359,418 |        | $ | (346,834 | )        | $ | (2,326 | )      | $ | (102    | )      | $
|                           |                                                          |              |      |   |     |    |   |         |        |   |          |          |   |        |        |   |         |        |  

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

49

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NMS Communications Corporation        Consolidated Statements of Cash Flows

|                                                                                      |                                                                              | Years Ended December 31, |                                                    
|------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | ------------------------ | ---------------------------------------------------
|
|
|Cash flow from operating activities:                                                  |                                                                              |                          |                                                    
|                                                                                      | Net loss                                                                     |                          | $                                                  
|Adjustments to reconcile net loss to cash provided by (used in) operating activities: |                                                                              |                          |                                                    
|                                                                                      | Depreciation and amortization of property and equipment                      |                          |                                                    
|                                                                                      | Amortization of goodwill and other intangibles                               |                          |                                                    
|                                                                                      | Foreign exchange translation loss (gain) on intercompany debt                |                          |                                                    
|                                                                                      | Loss on impairment and disposal of property and equipment                    |                          |                                                    
|                                                                                      | Loss on impairment of goodwill and other intangibles                         |                          |                                                    
|                                                                                      | Loss on investments                                                          |                          |                                                    
|                                                                                      | Gain on extinguishment of long-term debt                                     |                          |                                                    
|                                                                                      | Write-off and amortization of debt issuance costs                            |                          |                                                    
|                                                                                      | Deferred stock compensation expense amortized                                |                          |                                                    
|                                                                                      | Other operating activities                                                   |                          |                                                    
|                                                                                      | Changes in operating assets and liabilities, net of effects of acquisitions: |                          |                                                    
|                                                                                      |                                                                              |                          | Accounts receivable                                
|                                                                                      |                                                                              |                          | Inventories                                        
|                                                                                      |                                                                              |                          | Prepaid expenses and other assets                  
|                                                                                      |                                                                              |                          | Income tax receivable                              
|                                                                                      |                                                                              |                          | Accounts payable                                   
|                                                                                      |                                                                              |                          | Accrued expenses and other liabilities             
|                                                                                      |                                                                              |                          |                                                    
|                                                                                      |                                                                              |                          |                                                    
|                                                                                      |                                                                              |                          |                                                    
|Cash flow from investing activities:                                                  |                                                                              |                          |                                                    
|                                                                                      | Purchases of property and equipment                                          |                          |                                                    
|                                                                                      | Purchases of marketable securities                                           |                          |                                                    
|                                                                                      | Proceeds from the maturity of marketable securities                          |                          |                                                    
|                                                                                      | Acquisitions, net of cash acquired                                           |                          |                                                    
|                                                                                      | Receipts on notes receivable                                                 |                          |                                                    
|                                                                                      |                                                                              |                          |                                                    
|                                                                                      |                                                                              |                          |                                                    
|                                                                                      |                                                                              |                          |                                                    
|Cash flow from financing activities:                                                  |                                                                              |                          |                                                    
|                                                                                      | Repurchase of long-term debt                                                 |                          |                                                    
|                                                                                      | Proceeds from issuance of common stock                                       |                          |                                                    
|                                                                                      | Repurchase of common stock                                                   |                          |                                                    
|                                                                                      | Other financing activities                                                   |                          |                                                    
|                                                                                      |                                                                              |                          |                                                    
|                                                                                      |                                                                              |                          |                                                    
|                                                                                      |                                                                              |                          |                                                    
|Effect of exchange rate changes on cash                                               |                                                                              |                          | 426                                                
|                                                                                      |                                                                              |                          |                                                    
|Net increase (decrease) in cash and cash equivalents                                  |                                                                              |                          | (196,142                                           
|                                                                                      |                                                                              |                          |                                                    
|Cash and cash equivalents, beginning of year                                          |                                                                              |                          | 280,152                                            
|                                                                                      |                                                                              |                          |                                                    
|Cash and cash equivalents, end of year                                                |                                                                              | $                        | 84,010                                             
|                                                                                      |                                                                              |                          |                                                    
|Supplemental cash flow information:                                                   |                                                                              |                          |                                                    
|                                                                                      | Interest paid                                                                |                          | $                                                  
|                                                                                      | Taxes paid                                                                   |                          |                                                    
|Noncash transactions:                                                                 |                                                                              |                          |                                                    
|                                                                                      | Acquisition of business:                                                     |                          |                                                    
|                                                                                      |                                                                              |                          | Fair value of assets acquired, net of cash acquired
|                                                                                      |                                                                              |                          | Fair value of liabilities assumed                  
|                                                                                      |                                                                              |                          |                                                    
|                                                                                      |                                                                              |                          | Acquisition of business, net of cash acquired      

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

50

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Notes to Consolidated Financial Statements

1Summary of Significant Accounting Policies

Business Description

NMS Communications Corporation is a provider of enabling technologies, platforms and systems to wireless and wireline telecommunications operators and network
equipment and application providers. The Company's products, which include systems building blocks, a services delivery system, voice quality systems and a wireless access gateway, address a wide
range of our customers' needs as they seek to develop and deploy enhanced voice and data services and applications, and improve the quality and efficiency of communications networks.
Telecommunications operators use the Company's products to improve customer acquisition and retention, diversify revenue streams and reduce operating costs and capital expenditures. Network equipment
and application providers use the Company's products to help deploy leading technology solutions for their telecommunications and enterprise customers in a timely and cost-effective
manner. The Company sells its products worldwide through its direct sales force as well as through channel partners. The Company's customers include leading telecommunications operators and network
equipment and application providers such as Verizon Wireless, Cable & Wireless, France Telecom, Telefonica, Nextel Partners, U.S. Cellular, Alcatel, Avaya, Ericsson, Lucent Technologies,
Motorola, Siemens and Aspect Communications.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany balances and transactions have been
eliminated in consolidation.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year's presentation. Statement of Financial Accounting Standards No. 145,
"Recision of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Correction SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt,"
which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of income taxes was recorded and as a result, the criteria
in Accounting Principles Board No. 30 (AFB 30) will now be used to classify those gains and losses. On January 1, 2003, the Company adopted SFAS No. 145 and, accordingly,
restated the financial statements for the years ended December 31, 2001 and 2002 to reclassify gains on early extinguishment of debt from an extraordinary item, net of taxes, to operations.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make
estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis,
management evaluates its estimates, including those related to revenue recognition, accounts receivable, inventories, investments, long-lived and intangible assets, income taxes,
restructuring and other related charges, and accounting for acquisitions. Management bases these estimates on historical experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions.

51

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Foreign Currency Translation

Assets and liabilities of the Company's subsidiaries operating outside the United States, which operate in a functional currency other than U.S. dollars, are
translated into U.S. dollars using year-end exchange rates. Revenues and expenses are translated at the average exchange rates effective during the year. Foreign currency translation gains
and losses are included as a component of accumulated other comprehensive income (loss) within stockholders' equity. Gains and losses resulting from foreign currency transactions are included in other
income (expense), net. During 2000, two of the Company's subsidiaries, a U.S. subsidiary and a Canadian subsidiary, entered into an intercompany debt arrangement whereby the U.S. subsidiary issued a
loan to the Canadian subsidiary. The debt is denominated in U.S. dollars and was originally to be settled during the ordinary course of business. For the years ended December 31, 2001 and 2002,
as a result of remeasuring the debt at each reporting period, the Company incurred a foreign exchange (loss) gain of approximately $(4.7) million
and $3.8 million, respectively. On July 1, 2002, because of a change in payment terms, this intercompany debt was reclassified from short-term to long-term.
Repayment of this intercompany debt is not planned or anticipated in the foreseeable future. As a result of this reclassification, the gain or loss generated by the remeasurement of the debt at each
reporting period is recorded as a component of accumulated other comprehensive income (loss) within stockholders' equity instead of as other income (expense) in the statement of operations.

Revenue Recognition

The Company recognizes revenue in accordance with the provisions of the American Institute of Certified Public Accountants' SOP 97-2, Software Revenue
Recognition, and related interpretations. SOP 97-2 requires that revenue be allocated to each element of an arrangement
based on objective evidence that is specific to the Company. If evidence of fair value for each element of the arrangement, or for each of the undelivered elements, does not exist, all revenue for the
arrangement is deferred until such time as evidence of fair value does exist or until all elements of the arrangement are delivered.

Revenue
from product sales is generally recognized upon shipment providing that persuasive evidence of an arrangement exists, the sales price is fixed or determinable, collection is
reasonably assured and title and risk of loss have passed to the customer. If a future obligation to install the system or to obtain customer acceptance exists, revenues are deferred until this
obligation has been met. The Company also sells products through multiple channels, including resellers and distributors. For products sold through these channels, revenue is generally recognized when
the reseller or distributor sells the product to an end-user, upon cash receipt, or upon receipt of a letter of credit. The Company does offer quarterly return rights to a limited number of indirect
channel customers that allow the indirect channel customer to rotate a percentage of its inventory based on its prior quarter purchases. The Company provides for these return rights each quarter in an
amount equal to estimated returns. The Company does not offer rights of return on sales made through its direct sales force.

The
Company's products are generally shipped together as a bundled hardware and software solution. The Company offers a warranty on all of its products that generally provides for it to
repair or replace any defective product within eighteen to twenty-four months of the invoice date. Based upon historical experience and expectation of future conditions, the Company
reserves for the estimated costs to fulfill customer warranty and other contractual obligations upon the recognition of the related revenue. The Company's warranty accrual and provisions are
immaterial for all periods presented.

Shipping
and handling fees, if any, billed to customers are recognized as revenue. The related costs are recognized in cost of revenues.

Service
revenue represents 8.4%, 7.5% and 8.6% of revenue for the years ended December 31, 2001, 2002 and 2003, respectively. Service revenue is primarily comprised of consulting
services and technical support services. Consulting services consist of hardware and/or software customization

52

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projects
provided to customers through consulting contracts. The Company recognizes revenue for non-recurring engineering services based on the percentage-of-completion method
for fixed fee contracts and as the services are performed for time and materials contracts. Technical support services, which are sold separately from products, consist of on-site support,
telephone support, system hosting and training. The Company recognizes revenue for technical support services ratably over the contractual period or as services are provided, based on the nature of
the service.

Cash Equivalents

Cash equivalents include short-term investments with remaining maturities of three months or less at date of purchase.

Accounts Receivable

The Company establishes reserves against its accounts receivable for potential credit losses when it determines receivables are at risk for collection based upon
the length of time the receivables are outstanding, as well as various other criteria. Receivables are written off against these reserves in the period they are determined to be uncollectible.

The
Company does not require collateral on accounts receivable or letters of credit on foreign export sales. The Company evaluates its customers' creditworthiness before extending credit
and performs periodic credit reviews on customers with existing credit.

Investments

The Company classifies all of its investments in marketable securities as available-for-sale securities. These securities are stated at
market value, with unrealized gains and losses reflected in other comprehensive loss in stockholders' equity. The amortized cost of debt securities is adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization and accretion are included in interest income. Realized gains and losses on marketable securities are included in earnings and are derived using
the specific identification method
for determining the cost of securities. Other equity investments in which the Company does not have the ability to exercise significant influence and for which there is not a readily determinable
market value are accounted for under the cost method of accounting. The Company periodically evaluates the carrying value of its investments for other than temporary impairment.

Advertising

Advertising costs are expensed in the period when incurred and were immaterial for each of the years presented.

Inventories

Inventories are valued at the lower of cost (first-in, first-out method) or market. Valuation allowances related to excess and obsolete
inventory are based primarily on estimated forecast of product demand and production requirements over the next twelve months.

53

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Property and Equipment

Property and equipment are recorded at cost. Depreciation is based on the following estimated useful lives of the assets using the straight-line
method:

Machinery and equipment

3 yearsComputer software and equipment

3-5 yearsFurniture and fixtures

5 yearsTelecommunications computer equipment

5 yearsBuilding

20 yearsLeasehold improvements

Shorter of the lease term or economic life


Expenditures
for additions, renewals and betterments of property and equipment are capitalized. Expenditures for repairs and maintenance are charged to expense as incurred. As assets are
retired or sold, the related cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations.

Long-lived Assets and Goodwill

The Company reviews goodwill and long-lived intangible and tangible assets for impairment on an annual basis and whenever events or changes in business
circumstances indicate that the carrying value of the assets may not be fully recoverable in accordance with SFAS 142, "Financial Accounting and Reporting for Acquired Goodwill and Other
Intangible Assets", and SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets

Factors
the Company considers important which could trigger an impairment review include the following: significant underperformance relative to expected historical or projected future
operating results; significant changes in the manner of its use of the acquired assets or the strategy for its overall business; significant negative industry or economic trends; significant decline
in its stock price for a sustained period; and market capitalization relative to net book value.

In
performing this assessment, the Company assigns long-lived assets and goodwill to reporting units and then performs a two-step analysis to test for impairment.
The first step is used to identify a potential impairment loss by comparing the estimated undiscounted cash flows to be generated from the assets of each reporting unit to the unit's carrying value.
In assessing the recoverability of these assets, the Company must project cash flows that are based on various operating assumptions such as revenue budgets and forecasts, projected expenditures and
terminal value of each reporting unit. The Company develops these cash flow projections on a periodic basis and continuously reviews the projections based on actual operating trends and economic
developments around the globe and within the telecommunications industry in particular.

The
second step is used to measure the amount of an impairment loss, if any, by comparing the fair value of the reporting unit's assets, including goodwill, with the carrying value of
the reporting unit's assets. If the carrying value of the reporting unit's assets is greater than the fair value of its assets, including goodwill, an impairment loss is recognized for the excess.

Different
assumptions regarding a reporting unit's cash flow projections and fair value, both of which are highly dependent upon future revenue projections, could result in a change in
the timing and amount of impairment losses, if any.

The
adoption of SFAS No. 142 eliminated the amortization of goodwill and indefinite-lived intangible assets from the Company's consolidated statement of operations for the year
ended December 31, 2002 and 2003. In accordance with SFAS No. 142, during the first quarter of 2002, the Company assigned its goodwill and indefinite-lived intangible assets to reporting
units and tested these assets for impairment and no impairment of goodwill or indefinite-lived intangible assets was indicated.

54

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Therefore,
no impairment charge was recorded by the Company based upon its adoption of SFAS No. 142. After adoption, SFAS No. 142 requires the Company to test goodwill and
indefinite-lived intangible assets for impairment at least annually and if an impairment is indicated, a charge will be taken in the appropriate reporting period to reflect the reduction of the
carrying value of the goodwill or indefinite-lived intangible asset to its fair value.

The
following schedule provides a reconciliation of previously reported net loss, basic and diluted loss per common share, net loss and basic and diluted net loss per common share to
adjusted net loss, adjusted basic and diluted loss per common share, adjusted net loss and adjusted basic and diluted net loss per common share as if the adoption of SFAS No. 142 had taken
place on January 1 2001:

|                                                        |  | Twelve Months Ended |         
|------------------------------------------------------- |  | ------------------- | --------
|
|
|Net loss as reported                                    |  | $                   | (142,658
|Amortization of goodwill                                |  |                     | 19,033  
|Amortization of indefinite-lived intangible assets      |  |                     | 408     
|                                                        |  |                     |         
|Adjusted net loss                                       |  | $                   | (123,217
|                                                        |  |                     |         
|Weighted average basic and diluted shares outstanding   |  |                     | 36,551  
|Basic and diluted net loss per common share as reported |  | $                   | (3.90   
|                                                        |  |                     |         
|Adjusted basic and diluted loss per common share        |  | $                   | (3.37   
|                                                        |  |                     |         

Research and Development

Research and development expenses consist primarily of salaries, personnel expenses and prototype fees related to the design, development, testing and enhancement
of the Company's products. All research and development costs are expensed as incurred.

Capitalized Software Development Costs

The Company capitalizes software development costs incurred after a product's technological feasibility has been established and before it is available for
general release to customers. Amortization of capitalized software costs is computed on an individual product basis and is the greater of a) the ratio that current gross revenues for a product
bear to the total of current and anticipated future gross revenues of that product or b) the straight-line method over the estimated economic life of the product. Costs qualifying
for capitalization have been immaterial for all periods presented and, accordingly, have not been capitalized.

Financial Instruments

The Company's financial instruments include cash, marketable securities, accounts receivable, debt and accounts payable. The fair value of marketable securities,
accounts receivable and accounts payable are equal to their carrying value at December 31, 2002 and 2003. Fair value of long-term debt at December 31, 2002 and 2003 is
approximately $40.1 million and $53.4 million, respectively. Long-term debt is recorded at its face value.

Income Taxes

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

55

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tax
bases. Deferred tax assets and liabilities are measured using enacted statutory tax rates in effect in the year in which the differences are expected to reverse. A deferred tax asset is
established for the expected future benefit of net operating loss and credit carry-forwards. A valuation reserve against net deferred tax assets is required, if, based upon available evidence, it is
more likely than not that some or all of the deferred tax assets will not be realized.

Stock Option and Stock Purchase Plans

As more fully described in Note 15 to the consolidated financial statements, the Company has stock option and stock purchase plans authorizing various
types of stock-based awards that may be granted to officers and employees. In the consolidated financial statements, the Company applied Accounting Principles Board Opinion No. 25 "Accounting
for Stock Issued to Employees," and related interpretations in accounting for its stock option and employee stock purchase plans. All options granted under the various plans administered by the
Company have a vesting life not to exceed four years, and these options have an expiration date of up to ten years from the date of grant.

In
accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," the fair value of each stock-based award has been estimated on the date of grant using the
Black-Scholes option-pricing model. The weighted average fair value at date of grant for stock options granted during the years ended December 31, 2001, 2002 and 2003 was $3.64, $3.41, and
$1.31 respectively. The weighted average fair value of employee stock purchases during the years ended December 31, 2001, 2002 and 2003 was $2.16, $0.79 and $0.41, respectively. The following
table summarizes the weighted average assumptions used in the Black-Scholes option-pricing model:

2001

2002

2003Risk Free Interest Rate

4.6%

3.8%

3.0%Expected Life

5 years

5 years

5 yearsExpected Volatility

100%

115%

115%Expected Dividend Yield

0%

0%

0%


The
following table illustrates the effect on net loss and basic and diluted loss per common share as if the fair value method prescribed in SFAS No. 123 had been applied to the
Company's stock option and stock purchase plans and recorded in the consolidated financial statements:

|                                                                                                          |                                                          | Year Ended December 31, |         
|--------------------------------------------------------------------------------------------------------- | -------------------------------------------------------- | ----------------------- | --------
|
|
|Net loss, as reported                                                                                     |                                                          | $                       | (142,658
|Add: Stock-based employee compensation expense included in net loss                                       |                                                          |                         | 14,782  
|Less: Total stock-based employee compensation expense determined under Black-Scholes option pricing model |                                                          |                         | (64,832 
|                                                                                                          |                                                          |                         |         
|Pro forma net loss                                                                                        |                                                          | $                       | (192,708
|                                                                                                          |                                                          |                         |         
|Weighted average shares outstanding                                                                       |                                                          |                         | 36,551  
|                                                                                                          |                                                          |                         |         
|Loss per share:                                                                                           |                                                          |                         |         
|                                                                                                          | Basic and diluted net loss per common share, as reported |                         | $       
|                                                                                                          | Basic and diluted net loss per common share, pro forma   |                         | $       

56

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Basic and Diluted Net Loss Per Common Share

Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss
per common share is computed by dividing the net loss by the sum of the weighted-average number of common shares outstanding plus all additional common shares that would have been outstanding if
potentially dilutive common stock equivalents had been issued.

The
number of options that were excluded from the calculation of diluted earning per common share at December 31, 2001, 2002, and 2003 were 9,615,378, 8,674,691 and 8,915,526,
respectively, which represents all outstanding stock options as of December 31, 2001, 2002 and 2003, respectively, as their inclusion would have been anti-dilutive due to the net loss position
of the Company. Additional common stock equivalents related to the Company's Convertible Notes of 2,034,556, 1,094,130 and 914,726 at December 31, 2001, 2002 and 2003, respectively, have been
excluded from the calculation of diluted earnings per common share as their inclusion would have been anti-dilutive due to the net loss position of the Company.

Recent Accounting Pronouncements

In November 2002, the FASB issued FIN No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of
Others. FIN No. 45 clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The
Company adopted FIN No. 45 on January 1, 2003.

In
January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB 51 and issued a revision to that guidance, FIN No. 46-R, in December
2003. FIN No. 46 and FIN No. 46-R provide guidance on the identification of entities for which control is achieved through means other than through voting rights called "variable interest entities" or
"VIEs," and how to determine when and which business enterprise should consolidate the VIE (the "primary beneficiary"). This model for consolidation applies to an entity in which either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity's activities without receiving additional subordinated
financial support from other parties. In addition, these interpretations require both the primary beneficiary and all other enterprises with a significant variable interest in a VIE to make additional
disclosures. The provisions of FIN No. 46 are applicable to us for any interests entered into after January 31, 2003 and the provisions of FIN No. 46-R will be effective in the quarter
ended March 31, 2004. The Company does not have any
interests that would change its current reporting entity or require additional disclosures outlined in FIN No. 46 or FIN No. 46-R.

On
January 1, 2003, the Company adopted SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146), which addresses significant issues regarding the
recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities. SFAS 146 requires recognition of a liability for costs
associated with an exit or disposal activity at fair value when the liability is incurred, or for certain one-time employee termination costs over a future service period. Previously, a liability for
an exit cost was recognized when a company committed to an exit plan. As a result, SFAS 146 may affect both the timing and amounts of the recognition of costs associated with future restructuring
actions.

In
April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This statement amends SFAS 133 to provide
clarification on the financial accounting and reporting of derivative instruments and hedging activities and requires contracts with similar characteristics to be accounted for on a comparable basis.
The adoption of SFAS 149 has had no effect on financial condition or results of operations.

57

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In
May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 had no effect on financial condition or results of
operations.

2Risks and Uncertainties

The Company's future results of operations involve a number of risks and uncertainties. Factors that could affect the Company's future operating results and cause
actual results to vary materially from expectations include, but are not limited to, dependence on suppliers, rapid industry changes, competition, competitive pricing pressures, changes in foreign
laws and regulations, risks associated with indirect channels of distribution, uneven quarterly sales patterns, ability to sustain and manage growth, inability to attract and retain key personnel,
undetected problems in the Company's products, risks associated with acquisitions, investments and alliances, enforcement of the Company's intellectual property rights, litigation, changes in
regulations, demand in the telecommunications market and stock price volatility.

3Acquisitions

MMI

On April 1, 2002, the Company acquired MessageMachines, Inc., (MMI) a privately-held Massachusetts company for a total cost of
$3.0 million, including transaction costs of $365,000. This acquisition was initially integrated into the Company's Network Solutions (NS) business unit which was consolidated into the Platform
Solutions (PS) business unit during the fourth quarter of 2003. In connection with the acquisition, the Company paid net aggregate cash consideration of $2.6 million to the founders and
shareholders of MMI.

MMI's
technology brought capabilities in wireless data and messaging to the Company. MMI's messaging software routes text messages between wireless networks and all types of
real-time communications devices, including mobile phones, pagers and personal digital assistants.

The
acquisition has been accounted for as a purchase business combination. Accordingly, the results of operations of MMI have been included with those of the Company for periods
subsequent to the date of the acquisition. Of the total purchase price of $3.0 million, $2.1 million was allocated to acquired completed technology and $874,000 was recorded as goodwill.
The amount allocated to acquired completed technology was being amortized over a four-year period and this amortization was included in the statement of operations classification, "Costs
of revenues."

Pro
forma data summarizing the combined results of the Company and MMI have been omitted as the results of operations of MMI are immaterial to those of the Company for all prior periods.

During
the second quarter of 2003, the Company recorded an impairment charge of approximately $2.4 million related to the goodwill, amortizable intangible assets and fixed assets
associated with the MMI acquisition. Based on the declining historical and forecasted operating results of NS as they related to earlier estimates, the economic condition of the telecommunications
industry as a whole, and the reduction of the PS workforce, the estimated value of PS's goodwill, indefinite-lived intangible assets, amortizable intangible assets and fixed assets had decreased.
Based on the results of the impairment analysis performed on the goodwill, indefinite-lived intangible assets, amortizable intangible assets and fixed assets, the MMI acquired assets were
written-down to zero.

58

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VQS

On November 30, 2001, the Company acquired the voice quality business of Lucent Technologies Inc. Under the terms of the agreement, the Company paid
cash totaling $60 million for all assets of VQS. The Company also entered into a multi-year agreement to serve as the exclusive supplier of stand-alone voice enhancement and echo
cancellation systems for Lucent, as Lucent continues to supply these systems to its global service provider customers. The Company also received a perpetual license from Lucent for a portfolio of
complementary intellectual property to support the development efforts and growth of the acquired business.

The
VQS acquisition was accounted for as a purchase business combination under the transition guidance of SFAS 141 and 142. Accordingly, the results of operations of VQS have been
included with those of the Company for periods subsequent to the date of the acquisition. Including transaction costs of $1.6 million, the total cost of the acquisition was approximately
$61.6 million. The following table presents the allocation of the purchase price (in thousands) and lives in years:

Amount

Estimated
LifeAcquired technology

$
11,000

6Supply agreement with Lucent


12,000

3Trademarks and tradenames


200

6Net fair value of tangible assets acquired


9,462

Goodwill


28,965

Total purchase price allocation

$
61,627


The
values assigned to acquired technology, supply agreement and trademarks and tradenames were based upon a modified discounted cash flow model. The Company based the
cash flow projections for revenue on the projected incremental increase in revenue that the Company expected to receive from the acquired technology and supply agreement. The Company deducted
estimated operating expenses from estimated revenue to arrive at estimated pre-tax cash flows. Projected operating expenses included cost of revenues, selling, general and administrative
expense, and research and development expense.

The
amounts allocated to acquired technology and trademarks and tradenames were being amortized using the straight-line method over a six-year period, while the
supply agreement between the Company and Lucent was being amortized using the straight-line method over the three-year life of the agreement. The amortization of acquired
technology, trademarks and tradenames and supply agreement is included in the statement of operations classifications, "Cost of revenues", "Research and development", and "Selling, general and
administrative," respectively.

As
result of the multi-year supply agreement between Lucent Technologies, Inc and the Company under which the Company is the exclusive supplier of stand-alone voice enhancement and echo
cancellation systems for Lucent, forward-looking projected information would be necessary in order to provide meaningful pro forma data for the combined results of the Company and VQS. Therefore pro
forma data has been omitted.

During
the fourth quarter of 2002, the Company recorded an impairment charge of approximately $33.2 million related to the goodwill, intangible assets and fixed assets associated
with the VQS acquisition. Based on the declining historical and forecasted operating results of VQS as they related to earlier estimates, the economic condition of the telecommunications industry as a
whole, and the 18% reduction of the VQS workforce, the estimated value of VQS's goodwill, intangible assets and fixed assets had decreased. Based on the results of the impairment analysis performed on
the goodwill, intangible assets and fixed assets, these assets were written-down to their fair value.

59

---

During
the second quarter of 2003, the Company recorded an impairment charge of approximately $9.4 million related to the goodwill, intangible assets and $1.2 million related to
fixed assets associated with the VQS acquisition. Based on the declining historical and forecasted operating results of VQS as they related to earlier estimates, the economic condition of the
telecommunications industry as a whole, and the further reduction of the VQS workforce, the estimated value of VQS's goodwill, intangible assets and fixed assets had decreased. Based on the results of
the impairment analysis performed on the goodwill, intangible assets and fixed assets, the VQS-acquired assets were written-down to zero.

Mobilee

Effective April 10, 2001, the Company acquired Mobilee, Inc., a privately held Massachusetts company, for a total cost of $13.3 million,
including transaction costs of approximately $0.2 million. In connection with the acquisition, the Company paid net aggregate cash consideration of $11.2 million to the founders and
shareholders of Mobilee. An additional $1.0 million was placed in escrow and was released to the founders of Mobilee on April 10, 2002. This amount was recorded as deferred compensation
and was amortized as compensation expense ratably over the one-year escrow period. The Company issued stock valued at approximately $0.3 million to a founder of Mobilee in four
equal quarterly installments beginning July 31, 2001. This amount was recorded as deferred compensation and was amortized as compensation expense ratably over the one-year period.
Mobilee was incorporated into the NS business unit.

The
acquisition was accounted for as a purchase business combination. Accordingly, the results of operations of Mobilee were included with those of the Company for periods subsequent to
the date of the acquisition. The following table presents the allocation of the purchase price (in thousands) and lives in years:

|                                                                   |  | Amount |        | Estimated
Life
|------------------------------------------------------------------ |  | ------ | ------ | --------------
|Acquired technology                                                |  | $      | 1,200  |               
|Workforce                                                          |  |        | 130    |               
|Deferred compensation                                              |  |        | 1,300  |               
|Net fair value of tangible assets acquired and liabilities assumed |  |        | 673    |               
|Goodwill                                                           |  |        | 9,948  |               
|                                                                   |  |        |        |               
|Total purchase price allocation                                    |  | $      | 13,251 |               
|                                                                   |  |        |        |               

The
Company assigned values of $1.2 million and $0.1 million to existing core technology and acquired workforce, respectively. The amounts allocated to
acquired technology, workforce and goodwill were being amortized over a four-year period. The amortization of acquired technology is included in the statement of operations classification,
"Cost of revenues," and the amortization of workforce and goodwill is included in the statement of operations classification, "Selling, general and administrative expenses."

Pro
forma data summarizing the combined results of the Company and Mobilee have been omitted, as the results of operations of Mobilee are immaterial for all prior periods.

During
the second quarter of 2003, the Company recorded an impairment charge of approximately $9.9 million related to the goodwill, intangible assets and $2.8 million related to
fixed assets associated with the NS business unit. Based on the declining historical and forecasted operating results of PS as they related to earlier estimates, the economic condition of the
telecommunications industry as a whole, and the reduction of the PS workforce, the estimated value of PS's goodwill, intangible assets and fixed assets had decreased. Based on the results of the
impairment analysis performed on the goodwill, intangible assets and fixed assets, the Mobilee assets were written-down to zero.

60

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4Goodwill and Other Intangibles

The following schedule details the carrying value of goodwill intangible assets and amortizable intangible assets:

December 31,2002

2003(In thousands)Goodwill and intangible assets:Goodwill

$
10,173

$
Intangible assets


106


Total goodwill and indefinite-lived intangible assets

$
10,279

$
Amortizable intangible assets:Acquired completed technology

$
11,173

$
Supply agreement


9,323


Trademarks and tradenames


143


Licenses and patents


685


Gross amortizable intangible assets


21,324


Accumulated amortization:Acquired completed technology


(2,909
)

Supply agreement


(4,333
)

Trademarks and tradenames


(36
)

Licenses and patents


(551
)

Total accumulated amortization


(7,829
)

Total amortizable intangible assets, net

$
13,495

$



Amortization
expense related to goodwill and other intangible assets was $23.4 million, $8.0 million and $2.0 million for the year ended December 31,
2001, 2002 and 2003, respectively.

2003 Impairment Charges

Year Ended December 31,
2003(In millions)In cost of revenues:Acquired completed technology from IML, Mobilee, MMI and VQS

$
7.4In operating expenses:Goodwill and intangible assets related to IML, MMI and Mobilee


10.3Fixed assets associated with the VQS and PS business unit


4.0Goodwill and intangible assets related to VQS


4.018.3Total impairment charges

$
25.7


During
2003, the Company recorded impairment charges. Due to lower actual and forecasted revenues, as compared to the previous budget for the reporting units that
included these assets as the estimated value of VQS, MMI and Mobilee's goodwill, intangible assets and fixed assets associated with each reporting unit had decreased. Based on the results of the
impairment analyses performed, these assets were written down to their estimated fair value.

61

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The
total impairment charge included $10.3 million to reduce the carrying value of the goodwill and indefinite-lived intangible assets related to the MMI and Mobilee acquisitions
to estimated fair value. This charge is included in the consolidated statement of operations under "Impairment charges" for 2003.

The
balance of the 2003 impairment charge of $8.0 million resulted from a reduction in the carrying values of the amortizable intangible assets and fixed assets related to the
VQS, MMI and Mobilee acquisitions. Of these costs, $3.9 million is related to the reduction in carrying value of a VQS supply agreement and $0.1 million is related to the reduction in
carrying value of VQS trademarks and patents. These charges are included in "Impairment charges" in the statement of operations for 2003. As part of the impairment charge, fixed assets associated with
the VQS and PS business units were written down to their estimated fair value resulting in charges of $1.2 million and $2.8 million, respectively. These charges are included in
"Impairment charges" in the statement of operations 2003.

Additionally,
$0.6 million, $1.5 million and $5.3 million are related to the write-down of acquired completed technology from the Mobilee, MMI and VQS acquisitions,
respectively, and are included in "Cost of revenues" within the statement of operations for 2003.

As
of December 31, 2003, there is no goodwill or long-lived intangible assets on the Company's balance sheet.

2002 Impairment Charges

Year Ended December 31,
2002($ In millions)In cost of revenues:Acquired completed technology from IML, Mobilee, MMI and VQS

$
6.0In operating expenses:Goodwill and indefinite-lived intangible assets related to IML, MMI and Mobilee


36.4Goodwill and indefinite-lived intangible assets related to VQS


30.166.5Total impairment charges

$
72.5


During
the second quarter of 2002, the Company wrote down approximately $36.4 million of impaired long-lived assets related to the goodwill and
intangible assets associated with the IML acquisition. As a result of the Company's planned intention to reduce overall workforce, including IML employees, the discontinuation of certain IML products
as a part of the Company's generally available product offering, continued declining revenues for IML products, the estimated value of IML's goodwill and intangible assets had decreased. Based on the
results of the impairment analysis performed, these assets were written down to their estimated fair value. In addition to this charge, a $2.9 million charge is included in the consolidated
statement of operations classification, "Costs of revenues," as it relates to the write-down of IML-acquired completed technology.

During
the fourth quarter of 2002, the Company wrote down approximately $30.1 million of impaired long-lived assets related to the goodwill, intangible assets and
fixed assets associated with the VQS acquisition. Based on the declining historical and forecasted operating results of VQS as they related to earlier estimates, the economic condition of the
telecommunications industry as a whole, and our 18% reduction of VQS workforce, the estimated value of VQS's goodwill, intangible assets and fixed assets had decreased. Based on the results of the
impairment analysis performed, these assets were written-down to their fair value.

62

---

In
addition to this charge, a $3.1 million charge is included in the consolidated statement of operations classification, "Costs of revenues," as it relates to the write-down of
VQS-acquired completed technology.

2001 Impairment Charges

Year Ended
December 31,2001($ In millions)In cost of revenuesAcquired completed technology from IML, Mobilee, MMI and VQS

$
0.4In operating expensesGoodwill and intangible assets related to IML, ViaDSP


55.6Goodwill and intangible assets related to VQS


55.6Total impairment charges

$
56.0


During
2001, the Company wrote down approximately $56.0 million of impaired long-lived assets which consisted of approximately $55.3 million
related to the goodwill associated with the IML acquisition and approximately $638,000 related to the goodwill and acquired technology associated with the ViaDSP acquisition. Based on the declining
historical and forecasted operating results of IML as they related to earlier estimates and the economic condition of the telecommunications industry as a whole, the estimated value of
IML's and ViaDSP's goodwill had decreased. Furthermore, based on the uncertain future utilization of the acquired technology, the estimated value of ViaDSP's acquired technology had
decreased. As a result, these assets were written-down to their fair value. The charge of approximately $55.6 million related to the write-down of goodwill is included
in the statement of operations classification "Impairment charges" while the charge of approximately $0.4 million related to acquired technology is included in the statement of operations
classification "Cost of revenues."

5Restructuring and Other Related Charges

Restructuring and Other Related Charges Accruals

The following table sets forth restructuring and other related charges accrual activity during the years ended December 31, 2001, 2002 and 2003,
respectively:

|                                                   |  | Employee
Related |        | Facility
Related |   | Impaired
Assets |   | Other |        | Total |  
|-------------------------------------------------- |  | ---------------- | ------ | ---------------- | - | --------------- | - | ----- | ------ | ----- | -
|
|Restructuring and other related charges            |  | $                | 3,463  |                  | $ | 3,688           |   | $     | 3,585  |       | $
|Non-cash utilization                               |  |                  |       |                  |   |                |   |       | (3,585 | )     |  
|Cash payments                                      |  |                  | (1,705 | )                |   | (544            | ) |       |       |       |  
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  
|Restructuring accrual balance at December 31, 2001 |  | $                | 1,758  |                  | $ | 3,144           |   | $     |       |       | $
|Restructuring and other related charges            |  |                  | 2,848  |                  |   | 1,404           |   |       | 704    |       |  
|Non-cash utilization                               |  |                  |       |                  |   |                |   |       | (704   | )     |  
|Cash payments                                      |  |                  | (3,806 | )                |   | (1,414          | ) |       |       |       |  
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  
|Restructuring accrual balance at December 31, 2002 |  | $                | 800    |                  | $ | 3,134           |   | $     |       |       | $
|Restructuring and other related charges            |  |                  | 4,786  |                  |   | 494             |   |       | 1,590  |       |  
|Non-cash utilization                               |  |                  |       |                  |   |                |   |       | (1,590 | )     |  
|Cash payments                                      |  |                  | (4,071 | )                |   | (1,936          | ) |       |       |       |  
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  
|Restructuring accrual balance at December 31, 2003 |  | $                | 1,515  |                  | $ | 1,692           |   | $     |       |       | $
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  

63

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2003

Year Ended December 31,
2003($ In millions)Involuntary severance related costs

$
4.8Lease termination


0.4Write-down of fixed assets


1.6Other


0.1Total restructuring and other related charges

$
6.9


Involuntary
severance related costs of $4.8 million resulted from the elimination of approximately 140 positions at the Company's facilities in the United States, Canada, Europe
and Asia based on terminations that were announced in January, April, July and October of 2003. These terminations involved all areas of the Company. At December 31, 2003, the remaining accrued
balance for this charge was approximately $1.5 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." The Company expects the
majority of the remaining accrued balance to be paid by March 2004 and all balances to be paid by the end of the third quarter of 2004.

At
December 31, 2002, the Company had been leasing a facility in Schaumburg, Illinois that was no longer being occupied. At December 31, 2002, the Company had accrued a
total of $1.4 million related to the termination of this lease. On January 31, 2003, the Company entered into a lease termination agreement with the landlord of the facility and paid
$1.5 million to the landlord to completely terminate
any future rights or obligations under the lease. The $0.1 million excess payment amount over the established accrual was recorded as restructuring and other related charges in 2003.

The
Company is currently working with real estate agents in an attempt to sub-lease idle facilities that are located in the United States, Canada and throughout Europe. A
sublease in the Tustin, CA facility was unexpectedly terminated in 2003. As a result the Company recorded a charge for $0.3 million in 2003 representing the value of remaining sublease payments
the Company had expected to receive. At December 31, 2003, the remaining accrued balance related to their facilities, including 2001 and 2002 actions was approximately $1.7 million and
is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." The Company expects to liquidate the remaining accrued balance over the life of the various
leases the last of which expires in the second quarter of 2012.

During
2003, the Company also wrote down the carrying value of fixed assets that were no longer being utilized as a result of the reductions in force. These fixed assets consisted
primarily of supply chain software and test equipment. The total charge for the fixed assets that was included as restructuring and other related charges in 2003 was $0.6 million.

During
2003, the Company decided to place certain office buildings in Montreal, Canada for sale, as those buildings were no longer used by the Company. The Company has classified the
buildings as held-for-sale and wrote down the value of these buildings to estimated fair market value, less cost to sell, and recorded a $1.0 million restructuring loss
that is included as a component of "Restructuring and other related charges" in the statement of operations.

64

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2002

|                                              |  | Year Ended December 31,
2002
|--------------------------------------------- |  | ----------------------------
|
|Involuntary severance related costs           |  | $                           
|Lease termination costs                       |  |                             
|Write-down of fixed assets                    |  |                             
|Other                                         |  |                             
|                                              |  |                             
|Total restructuring and other related charges |  | $                           
|                                              |  |                             

Involuntary
severance related costs of $2.8 million include $2.5 million recorded in 2002 resulting from the elimination of approximately 105 positions at our facilities in
the United States, Canada, and Europe based on terminations that were announced in July, October and December of 2002. These terminations consist primarily of engineering and sales positions, but also
include manufacturing and administrative positions. At December 31, 2002, the remaining accrued balance for this charge was approximately $0.7 million and is included in the consolidated
balance sheet classification, "Accrued expenses and other liabilities." The Company utilized the remaining accrued balance during 2003. The balance of involuntary severance charges of
$0.3 million resulted from an increase in the projected estimate of the Company's termination costs in Europe that were originally recorded during the fourth quarter of 2001 as part of the
Company's strategic repositioning. At December 31, 2002, the remaining accrued balance for this charge was approximately $0.1 million and is included in the consolidated balance sheet
classification, "Accrued expenses and other liabilities." The Company utilized the remaining accrued balance during 2003.

During
2001, as part of the Company's strategic repositioning, the Company recorded restructuring and related charges for the difference between the committed lease payments and the
estimated sub-lease rental income for leased facilities that the Company was no longer occupying. During 2002, the Company updated its estimates of the sub-lease rental income
based on current market conditions and determined the difference from the committed lease payments was larger than originally estimated. As a result, the Company recorded additional restructuring and
related charges of approximately $1.4 million related to these idle leased facilities. At December 31, 2002, the remaining accrued balance for this charge, including the charge that was
originally booked in 2001, was approximately $1.6 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." The Company expects to
utilize the majority of the remaining accrued balance through 2005.

As
a result of the reduction in headcount, the Company had certain fixed assets that were no longer being utilized. These fixed assets consisted primarily of computer equipment,
furniture and fixtures, and machinery and equipment, and they have been disposed of or set aside for disposal. The total charge for the fixed assets that was recorded as restructuring and other
related charges in 2002 was approximately $0.7 million.

2001

|                                              |  | Year Ended December 31,
2001
|--------------------------------------------- |  | ----------------------------
|
|Involuntary severance related costs           |  | $                           
|Lease termination costs                       |  |                             
|Write-down of fixed assets                    |  |                             
|Other                                         |  |                             
|                                              |  |                             
|Total restructuring and other related charges |  | $                           
|                                              |  |                             

65

---

During 2001, the Company announced a plan to close its IP Services Management operation, which resulted in restructuring and other related charges of $2.3 million. As part of this
plan, all 30 employees of the IP Services Management operation were terminated. The charge consisted of approximately $0.6 million of involuntary severance related costs, approximately
$0.7 million of fixed asset write-downs, approximately $0.4 million of lease termination costs and approximately $0.1 million of other administrative closing costs. In addition to
this, an inventory write-down charge of $0.5 million is included in the consolidated statement of operations classification, "Cost of revenues." At December 31, 2001, the remaining accrued
balance for this charge was approximately $0.5 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." The Company utilized the
majority of the remaining accrued balance during 2002 and 2003.

The
Company leased a facility in Schaumburg, Illinois that was not currently being occupied by the Company and will not be occupied by the Company in the future. This facility was
sub-leased by the Company to a third party tenant for a sub-lease term equivalent to the original lease term, which ends on September 30, 2008. In April 2001, the
Company was notified that the tenant had filed for bankruptcy protection and the Company would be required to resume primary responsibility for the lease payments on this facility. The Company had
estimated that the difference between the committed lease payments over the life of the lease and the sub-lease rental income will approximate $2.6 million, and this amount is
included as restructuring and other related charges in 2001. At December 31, 2001, the remaining accrued balance for this charge was approximately $2.2 million and is included in the
consolidated balance sheet classification, "Accrued expenses and other liabilities." In 2003, we entered into a lease termination agreement with the landlord of the facility.

During
2001, the Company announced a major restructuring and repositioning of its business. As a result of this repositioning, the Company eliminated approximately 160 positions at our
facilities in the United States, Canada, Europe and Asia. These terminations consist primarily of engineering positions, but also include manufacturing, sales and administrative positions. Severance
costs related to these terminations of approximately $2.8 million have been recorded as restructuring and other related charges during 2001. At December 31, 2001, the remaining accrued
balance for this charge was approximately $1.6 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." The Company utilized the
remaining accrued balance during 2002.

Due
to this strategic repositioning, certain facilities and fixed assets were no longer being utilized by the Company and will not be utilized by the Company in the future. The Company
is currently working with real estate agents in an attempt to sub-lease the idle facilities that are located in the United States, Canada and throughout Europe. The Company has estimated
that the difference between the committed lease payments over the lives of the leases and the sub-lease rental income will approximate $0.7 million, and this amount is included as
restructuring and other related charges in 2001. At December 31, 2001, the remaining accrued balance for this charge was
approximately $0.7 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities." The Company expects to utilize the majority of the
remaining accrued balance during 2002. The Company is also in the process of disposing of the fixed assets that are no longer being utilized. These fixed assets consist primarily of leasehold
improvements on the idle leased facilities and computer equipment, furniture and fixtures and machinery and equipment that were used in connection with activities that have been discontinued. The
total charge for the fixed assets that was included as restructuring and other related charges in 2001 was $2.4 million. At December 31, 2001, there was no accrual balance related to
this charge.

Additional
costs of approximately $0.7 million related to the strategic repositioning have been charged to restructuring and other special charges. These costs consist primarily
of contract termination charges and legal fees. At December 31, 2001, the remaining accrued balance for this charge was approximately $0.5 million and is included in the consolidated
balance sheet classification, "Accrued expenses and other liabilities." We utilized the remaining accrued balance during 2002.

66

---

6Business and Credit Concentration

At December 31, 2003, no customer accounted for 10% or more of the Company's accounts receivable balance. At December 31, 2002, two customers,
Lucent and a channel partner in the United States, represented 37.5% and 21.2%, respectively, of the Company's outstanding net accounts receivable balance.

During
2003, two customers, Lucent and a channel partner in the United States, represented 15.6% and 12.6%, respectively, of the Company's total revenues. Revenues from Lucent
represented 27.4% of total revenues for the year ended December 31, 2002. No customer accounted for 10% or more of the Company's revenues for the year ended December 31, 2001.

7Investments

Investments in marketable securities categorized as "available for sale" are carried at fair value and consist of the following:

December 31,2002

2003($ In thousands)Money market mutual funds

$
5,589

$
5,064Corporate securities


59,987


26,460$
65,576

$
31,524Included in cash and cash equivalents


36,520


31,524Marketable securities

$
29,056

$



At
December 31, 2002, all marketable securities were due to mature within one year. There was no unrealized gain (loss) at December 31, 2001 and 2002.
Proceeds from sale of securities for the years ended December 31, 2001, 2002 and 2003 were $206.0 million, $197.9 million, and $53.1 million respectively. There were no
gross realized gains or losses from sale of securities for the years ended December 31, 2001, 2002 and 2003.

The
Company has made equity investments in certain privately held entities. The Company accounts for these investments under the cost method of accounting since the Company does not have
the ability to exercise significant influence over these entities and there is not a readily determinable market value for these investments. The Company periodically evaluates the carrying value of
these investments for other than temporary impairment. During 2001 and 2002, the Company recorded charges of approximately $7.0 million and $0.4 million, respectively, to reflect the
other than temporary decline in fair value of these equity investments. The investee companies for which the charge was recorded have experienced a significant decline in operating and financial
results in comparison to the results forecasted at the time the investment was made. The Company determined the amount of the charge by estimating the fair value of the underlying company based on a
market approach which includes analysis of market price multiples of companies engaged in lines of business similar to the companies being evaluated. This charge is included in the consolidated
statement of operations classification "Other expense." The carrying amount of these investments was $0.0 at both December 31, 2002 and 2003, respectively.

For
the year ended December 31, 2001, gross realized gains from the sale of equity investments was $0.2 million. The Company did not realize any gains or losses related to
equity investments for the years ended December 31, 2002 and 2003.

67

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8Inventories

Inventories consist of the following:

December 31,2002

2003($ In thousands)Raw materials

$
4,026

$
1,021Work in process


1,715


196Finished goods


4,429


1,976$
10,170

$
3,193


9Property and Equipment

Property and equipment consist of the following:

December 31,2002

2003($ In thousands)Computer equipment

$
21,026

$
15,211Computer software


10,392


9,417Furniture and fixtures


2,988


2,818Machinery and equipment


3,123


3,367Land


225


Building


828


Leasehold improvements


6,125


5,15144,707


35,964Less accumulated depreciation


(26,752
)

(28,745
)$
17,955

$
7,219


Depreciation
and amortization expense related to property and equipment was $9.0 million, $9.5 million and $7.5 million for the years ended December 31, 2001,
2002 and 2003, respectively. The large decrease in computer equipment, computer software and building is mainly due to the impairment and restructuring charges.

68

---

10Income Taxes

The components of income tax expense (benefit) consist of the following:

Year Ended December 31,2001

2002

2003($ In thousands)Current income tax expense (benefit):Federal

$


$
(599
)
$
State


160


26


Foreign


400


(863
)

115560


(1,436
)

115Deferred income tax expense (benefit):Federal


827





State








Foreign








827





$
1,387

$
(1,436
)
$
115Deferred tax assets (liabilities) consist of the following:Net operating loss carryforwards

$
36,035

$
62,617

$
70,234Tax credit carryforwards


4,657


4,948


5,023Inventories


7,464


3,427


3,073Accrued expenses


4,069


5,310


15,880Intangible assets


19,361


38,782


50,715Other


3,400


3,574


4,480$
74,986

$
118,658

$
149,405Fixed assets


(337
)

(641
)

(963
)Valuation allowance:


(74,649
)

(118,017
)

(148,442
)Net deferred taxes

$


$


$



For
U.S. federal income tax purposes, the Company has net operating loss carryforwards available to reduce taxable income of approximately $138.0 million at December 31,
2003, a portion of which may be limited under Internal Revenue Code Section 382. These carryforwards will begin to expire in 2019. The Company also has a foreign net operating loss carryforward
of approximately $46.0 million. The
Company has $5.0 million of tax credits that are composed of federal research and development credits and state and local credits. These credits began to expire in 2003.

Management
believes that the realization of certain deferred tax assets were more unlikely than not and, accordingly, has established a full valuation allowance. During fiscal 2003, the
deferred tax asset valuation allowance increased by $30.4 million, primarily as the result of additional net operating loss carryforwards and the amortization of intangible assets. The Company
will continue to assess the valuation allowance and to the extent it is determined that such allowance is no longer required, the tax benefit of the remaining net deferred tax assets will be
recognized in the future. Approximately

69

---

$4.5 million
of the valuation allowance for deferred tax assets relates to benefits for stock option deductions, which, if realized, will be allocated directly to additional paid-in
capital.

Year Ended December 31,2001

2002

2003Computed expected tax expense at U.S. federal statutory rate

34.0
%
34.0
%
34.0
%State income taxes, net of U.S. federal tax benefit

1.9

3.1

5.6Rate differential of foreign operations

1.3

2.0

4.4U.S., federal research and development credits

1.6

0.1

0.9Change in valuation allowance

(36.3
)
(35.7
)
(40.5
)Nondeductible intangibles

(16.9
)
(3.7
)
(5.7
)Other

13.4

1.6

1.1Effective tax rate

(1.0
)%
1.4
%
(0.2
)%


The
domestic and foreign components of loss before income taxes were:

Year Ended December 31,2001

2002

2003($ In thousands)Domestic

$
(34,622
)
$
(52,373
)
$
(52,074
)Foreign


(106,649
)

(47,602
)

(3,817
)$
(141,271
)
$
(99,975
)
$
(55,891
)


11Accrued Expenses and Other Liabilities

Components of accrued expenses and other liabilities consist of the following:

December 31,2002

2003($ In thousands)Accrued compensation and related expenses

$
3,505

$
2,838Accrued interest expense


733


613Income taxes payable


364


703Deferred revenue


1,117


1,638Deferred rent


1,140


1,273Accrued restructuring and other related charges


4,333


3,328Other liabilities


4,145


3,263$
15,337

$
13,656


12Indebtedness

Convertible Notes

Effective October 11, 2000, the Company issued $175 million of convertible subordinated notes (the "Notes"). The Notes are convertible into shares
of NMS common stock at any time after 90 days following the last day of the original issuance of the notes and before the close of business on the business day immediately preceding the
maturity date, at a conversion price of $63.125 per share, subject to specified adjustments. The Notes bear interest at a rate of 5% per year which is payable semiannually on April 15 and
October 15 of each year, commencing on April 15, 2001. The Notes,

70

---

which
are unsecured obligations of the Company, will mature on October 15, 2005, unless previously redeemed or repurchased, and have no sinking fund requirement. The Company is subject to
certain covenants under the related indenture. The Company incurred debt issuance costs aggregating $5.7 million, which have been deferred and are being amortized using the effective interest
rate method as a component of interest expense over the term of the Notes. The unamortized issuance costs, $1.3 million and $0.7 million at December 31, 2002 and 2003,
respectively, are included in the consolidated balance sheet caption "Other assets."

For
the years ended December 31, 2001, 2002 and 2003, the Company paid $27.1 million, $37.9 million and $9.3 million, respectively, to extinguish
$46.6 million, $59.4 million and $11.3 million, respectively, of face value of the Notes. As a result, the Company wrote off $1.2 million, $1.2 million and
$0.2 million, respectively, of unamortized debt issuance costs and recorded a related gain of $18.9 million, $20.8 million and $2.1 million, respectively in other income
and expense on the income statement. The 2002 gain was previously recorded as an extraordinary gain but has been reclassified to other income in accordance with a change in SFAS 145 (see Note 1).

Other Debt

In connection with the IML acquisition, the Company assumed outstanding debt, which consisted of two interest free loans from the Canadian government. The
balances of these loans totaled $323,000 at December 31, 2000 and each loan was paid in full by the Company in January 2001.

As
part of the acquisition of QWES, the Company assumed its outstanding debt which consisted of promissory notes and notes payable. In connection with the issuance of some of the notes,
the Company issued warrants to purchase 169,670 shares of common stock of the Company at an exercise price of $0.04 per share for 141,084 shares and $3.94 per share for the remaining 28,586 shares.
The warrants were exercisable in whole or in part at any time from the date of the grant and expire four years from the date of grant. None of these warrants were exercised during 2000 and 13,720 and
5,342 warrants were exercised during 2001 and 2002, respectively. At December 31, 2002, there were no remaining warrants outstanding.

13Profit Sharing Plans

The Company has established a 401(k) cash or deferred profit sharing plan covering all eligible full-time employees of the Company. Contributions to
the 401(k) plan are made by the participants to their individual accounts through payroll withholding. Additionally, the plan provides for the Company to make profit sharing contributions to the plan
in amounts at the discretion of management. The Company currently matches contributions each pay period at 50% of the employee's contributions up to 6% of employee's compensation, not to exceed the
federal limit of $12,000 per calendar year. The employer contribution for the years ended December 31, 2001, 2002 and 2003 was $1.1 million and $0.9 million and
$0.8 million, respectively.

14Equity

Stock Repurchase Program

During 2001, the Board of Directors approved a stock repurchase program authorizing the Company to repurchase up to 2,500,000 shares of its outstanding common
stock for an aggregate purchase price not to exceed $5.0 million. The Company made no repurchases during 2003 but as of December 31, 2003, the Company had repurchased 915,000 shares for
an aggregate purchase price of $4.7 million.

71

---

Preferred Stock

Under its restated certificate of incorporation the Company has authorized 3,000,000 shares of preferred stock, par value $0.01 per share. On December 31,
2003, the Company had no shares of preferred stock issued and outstanding. In connection with its stockholder rights plan, 15,000 of such shares have been designated "Series A Junior Preferred
Stock", none of which are issued and outstanding. The Company's board of directors has the authority to issue preferred stock in one or more classes or series and to fix the rights, preferences,
privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, exchange rights, voting rights, terms of redemption, redemption prices, liquidation preferences and
the number of shares constituting any class or series or the designation of such class or series, without any further action by the stockholders. Preferred stock, if issued, will not be entitled to
any preemptive or similar rights.

15Stock Option and Stock Purchase Plans

The Company has stock option and stock purchase plans authorizing various types of stock option awards that may be granted to officers and employees. The
following is a summary of all of the plans of the Company:

1989 Stock Option and Stock Purchase Plan

In July 1989, the Company's Board of Directors adopted the 1989 Stock Option and Stock Purchase Plan (the "1989 Plan"), which permitted both incentive and
non-statutory options exercisable for the purchase of shares of common stock to be granted to employees, directors and consultants of the Company. In October 1993, the Board of
Directors amended the 1989 Plan to provide that no further options were to be granted under the 1989 Plan after the effective date of the Company's initial public offering.

1993 Stock Option Plan

In October 1993, the Company's Board of Directors adopted the 1993 Stock Option Plan (the "1993 Plan"). The 1993 Plan permits both incentive and
non-statutory options to be granted to
employees, directors and consultants. In March 1998, the Board of Directors adopted and in April 1998, the Company's stockholders approved (i) an increase in the number of shares
available under the 1993 Plan from 3,000,000 to 3,800,000 and (ii) a requirement that the exercise price of options granted under the 1993 Plan be at least equal to the fair market value of the
Company's common stock on the date of grant. In March 2000, the Board of Directors superseded the 1993 Plan with the 2000 Plan and no further grants under the 1993 Plan will be made after the
adoption of the 2000 Plan. Options granted previously under the 1993 Plan will continue to be governed by the terms of the 1993 Plan.

1993 Employee Stock Purchase Plan

The 1993 Employee Stock Purchase Plan ("Purchase Plan") which was adopted by the Board of Directors in 1993 and amended by the Company's stockholders in 1996,
permits employees and officers of the Company to participate in periodic plan offerings, in which payroll deductions may be used to purchase shares of common stock. The purchase price is 85% of the
lower of the fair market value at the date the offering commences or terminates. The Company has reserved 800,000 shares for the Purchase Plan. In March 1999, the Board of Directors adopted and
in April 1999, the Company's stockholders approved an increase in the number of shares available under the Purchase Plan from 800,000 to 1,400,000 shares. For the years ended
December 31, 2000, 2001 and 2002, 121,220, 295,087 and 271,114 shares, respectively, were issued under the Purchase Plan. As of December 31, 2002, 1,273,149 total shares have been issued
under the Purchase Plan at prices ranging from $0.97 to $34.11

72

---

per
share. Since the adoption of the 2003 Employee stock purchase plan the 1993 Employee Stock Purchase Plan is no longer in use.

1993 Non-Employee Directors Stock Option Plan

In October 1993, the Company's Board of Directors adopted the 1993 Non-Employee Directors Stock Option Plan (the "Directors Plan") which
provides for the purchase of up to 240,000 shares of common pursuant to the grant of non-statutory stock options to directors who are not employees of the Company. In March 1996 the
Board of Directors adopted and in May 1996 the Company's stockholders approved (i) an increase in the number of shares for which options shall be granted to newly elected
non-employee directors from 20,000 to 30,000 and (ii) an increase in the number of shares for which options shall be granted to incumbent non-employee directors from
4,000 to 10,000. In March 1999, the Board of Directors adopted and in April 1999, the Company's stockholders approved an increase in the number of shares available under the Directors
Plan from 240,000 to 480,000 shares. The exercise price of the options may not be less than 100% of the fair market value of the Company's common stock on the date of the grant. In March 2000,
the Board of Directors superseded the Directors Plan with the 2000 Plan and no further grants under the Directors Plan will be made after the adoption of the 2000 Plan. As of December 31, 2003,
280,000 shares had been granted at prices ranging from $2.44 to $24.63 per share.
Options granted previously under the Directors Plan will continue to be governed by the terms of the Directors Plan.

1995 Non-Statutory Stock Option Plan

In October 1995, the Company's Board of Directors adopted the 1995 Non-Statutory Stock Option Plan (the "1995 Plan"). The 1995 Plan permits
non-statutory options to be granted to non-executive officer employees and consultants of the Company. The aggregate number of shares which may be issued under the 1995 Plan,
as amended, is 6,350,000. The exercise price of non-statutory options may not be less than 100% of the fair market value of the company's common stock on the date of grant.

2000 Equity Incentive Plan

In March 2000, the Company's Board of Directors adopted and in April 2000 the Company's stockholders approved the 2000 Equity Incentive Plan (the
"2000 Plan"). The 2000 Plan provides for the grant of incentive stock options and stock appreciation rights to employees and non-statutory stock options, stock bonuses, rights to purchase
restricted stock and other awards based on the Company's common stock (collectively, "Stock Awards") to employees, non-employee directors and consultants. The aggregate number of shares
which may be issued under the 2000 Plan is 5,000,000 plus any shares of the Company's common stock represented by options granted under the 1993 Plan and the Directors Plan (both of which are
superseded by the 2000 Plan) which are forfeited, expire or are canceled. The exercise price of non-statutory and incentive stock options may not be less than 50% and 100%, respectively,
of the fair market value of the company's common stock on the date of grant.

2003 Employee Stock Purchase Plan

The 2003 Employee Stock Purchase Plan which was adopted by the Board of Directors in 2003, permits employees and officers of the Company to participate in
periodic plan offerings, in which payroll deductions may be used to purchase shares of common stock. The purchase price is 85% of the lower of the fair market value at the date the offering commences
or terminates. The Company has reserved 750,000 shares for the Purchase Plan. During 2003, 92,010 shares were issued under the Purchase Plan at a price of $0.765 per share.

73

---

A
summary of the transactions under all stock option plans for the three years ended December 31, 2003 is as follows:

|                                   |  | Year Ended
December 31, 2001 |   | Year Ended
December 31, 2002 |       | Year Ended
December 31, 2003
|---------------------------------- |  | ---------------------------- | - | ---------------------------- | ----- | ----------------------------
|
|Outstanding at beginning of period |  | 7,773,884                    |   | $                            | 20.84 |                             
|Granted                            |  | 3,096,190                    |   |                              | 5.07  |                             
|Exercised                          |  | (134,551                     | ) |                              | 3.42  |                             
|Forfeited or expired               |  | (1,120,145                   | ) |                              | 25.73 |                             
|                                   |  |                              |   |                              |       |                             
|Outstanding at end of period       |  | 9,615,378                    |   |                              | 15.51 |                             
|                                   |  |                              |   |                              |       |                             
|Exerciseable at end of period      |  | 4,782,355                    |   |                              | 15.87 |                             
|                                   |  |                              |   |                              |       |                             

The
following table summarizes outstanding stock options as of December 31, 2003:

|Range of Exercise Prices |              | Number
Outstanding |           | Weighted
Average
Remaining
Contractual
Life |     | Weighted
Average
Exercise Price |   | Number Exercisable |  | Average
Exercise Price
|------------------------ | ------------ | ------------------ | --------- | ------------------------------------------- | --- | ------------------------------- | - | ------------------ |  | ----------------------
|$                        | 1.10-$5.00   |                    | 5,793,172 |                                             | 3.6 |                                 | $ | 2.60               |  | 3,118,951             
|$                        | 5.01-$10.00  |                    | 1,626,007 |                                             | 2.4 |                                 |   | 7.00               |  | 1,603,773             
|$                        | 10.01-$20.00 |                    | 280,889   |                                             | 3.5 |                                 |   | 14.80              |  | 279,863               
|$                        | 20.01-$30.00 |                    | 91,718    |                                             | 4.9 |                                 |   | 24.30              |  | 89,593                
|$                        | 30.01-$40.00 |                    | 637,559   |                                             | 1.3 |                                 |   | 32.70              |  | 637,171               
|$                        | 40.01-$50.00 |                    | 439,002   |                                             | 1.4 |                                 |   | 45.64              |  | 439,002               
|$                        | 50.01-$60.00 |                    | 9,250     |                                             | 1.8 |                                 |   | 56.56              |  | 9,250                 
|$                        | 70.01-$80.00 |                    | 24,217    |                                             | 1.5 |                                 |   | 72.24              |  | 24,217                
|                         |              |                    |           |                                             |     |                                 |   |                    |  |                       
|                         |              |                    | 8,901,814 |                                             | 3.1 |                                 |   | 8.54               |  | 6,201,820             
|                         |              |                    |           |                                             |     |                                 |   |                    |  |                       

As
of December 31, 2003, a total of 11,317,514 shares of common stock have been reserved for issuance upon the exercise of stock options.

Option Forfeiture

On October 28, 2002, certain officers and members of upper management of the Company forfeited a total of 808,000 outstanding common stock options. These
options were granted at various times from April 28, 2000 to October 13, 2000 at exercise prices ranging from $30.94 to $56.69. Upon the date of forfeiture, the fair value of the options
was immaterial. The forfeited option shares will be used for future grants to the Company's employees in the ordinary course of business. Although some or all of the participants in this forfeiture
may from time to time receive future grants in the ordinary course of business, there are no agreements, arrangements or obligations between the Company and these participants for subsequent option
grants to these individuals.

16Commitments and Contingencies

Leases

The Company leases its current corporate headquarters office facilities under non-cancelable leases extending to May 31, 2012. The Company
occupies other facilities under leases, which expire within one to five years. Rental expenses under all operating lease agreements in effect during the years

74

---

ended
December 31, 2001, 2002 and 2003 amount to approximately $4.2 million, $4.5 million and $4.0 million, respectively.

The
Company has various other facilities throughout North America, Europe and Asia that have short-term leases and act as sales offices. The Company believes that the
existing facilities are adequate for its current needs and that suitable space will be available to meet future needs.

At
December 31, 2003, commitments under operating leases for minimum future payments consist of the following, of which $1.7 million of these future operating lease
payments have been accrued as part of the Company's restructuring and other related charges and will not impact the Company's results of operations in future periods:

Year ending December 31,

($ In thousands)2003

$
4,2472004


3,4912005


3,0382006


3,0042007


3,004Thereafter


9,564$
26,348


Litigation

The Company is the defendant in an action by Connectel, LLC initially filed in August 2000 in the U.S. District Court for the Eastern District of Virginia.
This action has been transferred by court order to the U.S. District Court for the District of Massachusetts. The plaintiff alleges that one or more of the Company's products infringe upon two related
United States patents owned by it and seeks injunctive relief and damages in an unspecified amount. The patents relate to a specific routing protocol. In December 2002, the parties participated
in a hearing before the court, pursuant to which the judge will construe certain patent claims. The Company is awaiting the judge's opinion. The Company has reviewed the allegations with its patent
counsel and believes that none of its products infringe upon the patents. The Company is defending the claim vigorously.

Purchase Commitments

The Company's agreement with Plexus requires that Plexus turn its NMS-related inventory eight times per year. If this condition is not met, the
Company must purchase enough material to bring Plexus up to eight turns. This is assessed on a quarterly basis. At December 31, 2003, the Company had met the eight turn goal in all preceeding
quarters.

Guarantees and Indemnification Obligations

The Company enters into standard indemnification agreements in its ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds
harmless and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally the Company's business partners or customers, in connection with any patent,
or any copyright or other intellectual property infringement claim by any third party with respect to the Company's products and assets. The terms of these indemnification agreements vary. The maximum
potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has never incurred costs to defend lawsuits or settle claims
related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal and indemnification agreements were grandfathered under the
provisions of FIN No. 45 in effect prior to December 31, 2002 and are not required to be fair valued. Accordingly, the Company has no liabilities recorded for these agreements as of
December 31, 2003.

75

---

17Segment and Geographic Information

The Company made two changes to its segment reporting in 2003. First, the Company expanded its segment reporting in the first quarter of 2003 to include
information specific to Network Infrastructure. Second, in the third quarter the Company combined the NS business unit into its PS business unit. The Company's business units are now comprised of the
Platform Solutions business unit, Voice Quality Systems business unit, and the Network Infrastructure business unit. Prior periods have been restated to reflect the current business unit structure.
The PS business unit consists of products and services related to the Company's systems building blocks that provide connectivity to communications networks, call processing, and real-time
media processing as well as the HearSay and MyCaller products. The VQS business unit consists of products and services related to the Company's voice quality enhancement and echo cancellation systems.
The NI business unit consists of the Company's wireless access gateway product, AccessGate 500.

The
following table presents the Company's revenues and operating loss, by business unit and by geographic segment. The Company has not recorded any significant revenues for the NI
business units as the systems and products related to this business unit are either in the development or trial phase.

|($ In thousands)                       |      | VQS |   | NI     |   | PS |        | Corporate |   | Total   |  
|-------------------------------------- | ---- | --- | - | ------ | - | -- | ------ | --------- | - | ------- | -
|Revenues:                              |      |     |   |        |   |    |        |           |   |         |  
|                                       | 2003 |     | $ | 20,505 |   | $  | 93     |           | $ | 66,549  |  
|                                       | 2002 |     |   | 28,905 |   |    |       |           |   | 73,788  |  
|                                       | 2001 |     |   | 4,278  |   |    |       |           |   | 76,706  |  
|Income (loss) from operations:         |      |     |   |        |   |    |        |           |   |         |  
|                                       | 2003 |     | $ | (370   | ) | $  | (5,267 | )         | $ | (1,119  | )
|                                       | 2002 |     |   | (1,390 | ) |    | (3,779 | )         |   | (4,584  | )
|                                       | 2001 |     |   | 1,104  |   |    |       |           |   | (16,832 | )
|Total assets:                          |      |     |   |        |   |    |        |           |   |         |  
|                                       | 2003 |     | $ | 4,171  |   | $  | 345    |           | $ | 9,870   |  
|                                       | 2002 |     |   | 21,648 |   |    |       |           |   | 26,959  |  
|                                       | 2001 |     |   | 61,240 |   |    |       |           |   | 66,394  |  
|Long-lived assets:                     |      |     |   |        |   |    |        |           |   |         |  
|                                       | 2003 |     | $ | 106    |   | $  | 252    |           | $ | 1,581   |  
|                                       | 2002 |     |   | 12,877 |   |    |       |           |   | 16,943  |  
|                                       | 2001 |     |   | 51,692 |   |    |       |           |   | 52,340  |  
|Capital expenditures:                  |      |     |   |        |   |    |        |           |   |         |  
|                                       | 2003 |     | $ | 248    |   | $  | 172    |           | $ | 1,388   |  
|                                       | 2002 |     |   | 1,339  |   |    | 138    |           |   | 5,036   |  
|                                       | 2001 |     |   | 16     |   |    |       |           |   | 3,267   |  
|Depreciation and amortization expense: |      |     |   |        |   |    |        |           |   |         |  
|                                       | 2003 |     | $ | 584    |   | $  | 95     |           | $ | 4,150   |  
|                                       | 2002 |     |   | 1,079  |   |    | 169    |           |   | 6,203   |  
|                                       | 2001 |     |   | 72     |   |    |       |           |   | 3,954   |  

Management
makes operating decisions and assesses the performance of individual business segments on a basis that excludes from consideration intangible assets, amortization of
intangible assets, restructuring and other related costs and impairments of long-lived assets. Therefore all goodwill, intangible assets, impairment and restructuring charges have been allocated to
corporate.

As
of December 31, 2003 the Company had operations established in 12 countries outside the United States and its products are sold throughout the world. The Company is exposed to
the risk of changes in social, political and economic conditions inherent in foreign operations and the Company's results of operations and the value of its foreign assets are affected by fluctuations
in foreign currency

76

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exchange
rates. The following table presents the Company's revenues, operating income (loss), total assets, long-lived assets, capital expenditures, and depreciation and amortization
expense by geographic region. Revenues by geographic region are presented by attributing revenues from external customers on the basis of where products are sold. "Rest of World" is Latin America and
properly reflects how the regions are analyzed by senior management. In the previously issued financial statements, the "Rest of World" was comprised of Latin America and Canada. For the years ended
December 31, 2003, 2002 and 2001, the loss from operations for "North America" includes all impairment losses and acquisition related amortization expenses

|($ In thousands)                       |      | North America |   | Europe   |   | Asia |        | Rest of World |   | Total  | 
|-------------------------------------- | ---- | ------------- | - | -------- | - | ---- | ------ | ------------- | - | ------ | 
|Revenues:                              |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2003 |               | $ | 46,597   |   | $    | 15,252 |               | $ | 24,086 | 
|                                       | 2002 |               |   | 64,640   |   |      | 14,038 |               |   | 23,391 | 
|                                       | 2001 |               |   | 51,082   |   |      | 13,403 |               |   | 14,234 | 
|Income (loss) from operations:         |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2003 |               | $ | (67,054  | ) | $    | (2,880 | )             | $ | 14,405 | 
|                                       | 2002 |               |   | (124,082 | ) |      | (8,862 | )             |   | 12,286 | 
|                                       | 2001 |               |   | (153,519 | ) |      | (4,191 | )             |   | 5,417  | 
|Total assets:                          |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2003 |               | $ | 76,683   |   | $    | 6,616  |               | $ | 3,029  | 
|                                       | 2002 |               |   | 140,294  |   |      | 10,664 |               |   | 4,125  | 
|                                       | 2001 |               |   | 308,001  |   |      | 9,622  |               |   | 1,482  | 
|Long-lived assets:                     |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2003 |               | $ | 7,088    |   | $    | 54     |               | $ | 77     | 
|                                       | 2002 |               |   | 40,736   |   |      | 723    |               |   | 270    | 
|                                       | 2001 |               |   | 120,516  |   |      | 1,156  |               |   | 255    | 
|Capital expenditures:                  |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2003 |               | $ | 2,371    |   | $    | 58     |               | $ | 7      | 
|                                       | 2002 |               |   | 7,492    |   |      | 51     |               |   | 130    | 
|                                       | 2001 |               |   | 12,583   |   |      | 126    |               |   | 92     | 
|Depreciation and amortization expense: |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2003 |               | $ | 8,562    |   | $    | 734    |               | $ | 217    | 
|                                       | 2002 |               |   | 16,840   |   |      | 603    |               |   | 89     | 
|                                       | 2001 |               |   | 31,817   |   |      | 445    |               |   | 128    | 

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18Quarterly Information (Unaudited)

|                                            |                                         | Quarter Ended            |        
|------------------------------------------- | --------------------------------------- | ------------------------ | -------
|
|
|
|Revenues                                    |                                         | $                        | 28,217 
|Cost of revenues                            |                                         |                          | 15,445 
|                                            |                                         |                          |        
|Gross profit                                |                                         |                          | 12,772 
|Operating expenses:                         |                                         |                          |        
|                                            | Selling, general and administrative     |                          |        
|                                            | Research and development                |                          |        
|                                            | Impairment charges                      |                          |        
|                                            | Restructuring and other related charges |                          |        
|                                            |                                         |                          |        
|                                            |                                         | Total operating expenses |        
|                                            |                                         |                          |        
|Operating loss                              |                                         |                          | (13,573
|Other income (expense), net                 |                                         |                          | 214    
|                                            |                                         |                          |        
|Loss before income taxes                    |                                         |                          | (13,359
|Income tax expense (benefit)                |                                         |                          | 167    
|                                            |                                         |                          |        
|Net loss                                    |                                         | $                        | (13,526
|                                            |                                         |                          |        
|Basic and diluted net loss per common share |                                         | $                        | (0.37  
|                                            |                                         |                          |        

As reflected above, the Company's quarterly results are affected by charges related to impairments of assets and restructuring actions, among
other items. Additional items affecting our quarterly results are as follows:

During
the second quarter of 2002, cost of revenues included a $2.9 million impairment charge related to IML-acquired completed technology. During the fourth quarter of 2002, cost
of revenues included a $3.1 million impairment charge related to VQS-acquired completed technology. During the second quarter of 2003, cost of revenues included a $7.4 million impairment charge
related to the VQS, MMI and Mobilee acquisitions.

During
the fourth quarter of 2002, there was a bonus accrual reversal in the fourth quarter of 2002 of $1.7 million of selling, general and administrative expenses and of $0.8 million of
research and development expenses. These amounts had been previously accrued in the prior quarters of 2002.

During
the fourth quarter of fiscal 2003, we recorded two foreign currency transaction adjustments, netting to $0.3 million, which decreased loss before income taxes, reversed a
vacation accrual, which resulted in a decrease to loss before income taxes of $0.9 million, and made an adjustment to decrease overhead costs capitalized in inventories totaling
$0.8 million, which increased cost of revenues and, therefore, loss before income taxes.

78

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

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VALUATION AND QUALIFYING ACCOUNTS

Schedule II($ in thousands)

Allowance for Doubtful Accounts

|         |  | Balance at
Beginning of Year |           | Additions |   | Deductions(1) |  | Balance at
End of Year
|-------- |  | ---------------------------- | --------- | --------- | - | ------------- |  | ----------------------
|12/31/01 |  | $                            | 1,260,362 |           | $ | 882,200       |  | $                     
|12/31/02 |  | $                            | 1,177,714 |           | $ | 122,623       |  | $                     
|12/31/03 |  | $                            | 978,860   |           | $ | 123,868       |  | $                     

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Deferred Tax Valuation Allowance

|         |  | Balance at
Beginning of Year |          | Additions |   | Deductions |   | Balance at
End of Year |  
|-------- |  | ---------------------------- | -------- | --------- | - | ---------- | - | ---------------------- | -
|12/31/01 |  | $                            | (26,189  | )         | $ | (48,460    | ) | $                      | 
|12/31/02 |  | $                            | (74,649  | )         | $ | (43,368    | ) | $                      | 
|12/31/03 |  | $                            | (118,017 | )         | $ | (30,425    | ) | $                      | 

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ITEM 9A. CONTROLS AND PROCEDURES

A. Evaluation of Disclosure Controls and Procedures

Based on their evaluation as of a date within 90 days of the filing of this annual report on Form 10-K, the principal executive officer
and principal financial officer of the Company have concluded that the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934) are effective to ensure that the information required to be disclosed by the Company in reports that it
files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

B. Changes in Internal Controls

There were no material changes in the Company's internal controls or other factors that could significantly affect such controls subsequent to the date of their
evaluation and there were no corrective actions with regard to significant deficiencies and material weaknesses.

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following table lists our executive officers and directors as of December 31, 2003:

|Name                      |  | Age |  | Position                                                               
|------------------------- |  | --- |  | -----------------------------------------------------------------------
|Robert P. Schechter       |  | 55  |  | Chairman of the Board, President and Chief Executive Officer           
|William B. Gerraughty, Jr |  | 39  |  | Senior Vice President of Finance, Chief Financial Officer and Treasurer
|Colin Doherty             |  | 42  |  | Senior Vice President, Worldwide Sales and Marketing                   
|Clarke Ryan               |  | 49  |  | Vice President and General Manager, Voice Quality Systems              
|Gerrold Walker            |  | 53  |  | Vice President and General Manager, Platform Solutions                 
|R. Brough Turner          |  | 57  |  | Senior Vice President of Technology                                    
|Alex N. Braverman         |  | 44  |  | Vice President and Corporate Controller                                
|William E. Foster(2)      |  | 59  |  | Director                                                               
|Ofer Gneezy(1)            |  | 52  |  | Director                                                               
|W. Frank King, Ph.D.(1)   |  | 64  |  | Director                                                               
|Pamela D. A. Reeve(1)     |  | 54  |  | Director                                                               
|Ronald W. White(2)        |  | 63  |  | Director                                                               

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Each
member of our board of directors is elected at the annual meeting of stockholders and holds office for three years and until his or her successor is elected and qualified.

Robert P. Schechterhas served as our President and Chief Executive Officer since 1995 and as Chairman of the Board since 1996. From 1987
to 1994, Mr. Schechter held various senior executive positions with Lotus Development Corporation, and from 1980 to 1987 he was a partner of Coopers and Lybrand LLP. Mr. Schechter is
also a director of MapInfo Corporation, a developer of location-based software services and solutions, Moldflow Corporation, a provider of software solutions for optimizing the design and manufacture
of plastic products and Avici Systems, Inc., a provider of purpose-built carrier-class routing solutions for the Internet.

William B. Gerraughty, Jr.joined our Company as Senior Vice President of Finance, Chief Financial Officer, and Treasurer in
May 2003. From 2001 to 2002, Mr. Gerraughty was Senior Vice President and Chief Financial Officer of Infinium Software Inc., a provider of enterprise software. From 1993 to 2000,
Mr. Gerraughty held various positions with Intellution, Inc., a developer of PC-based software for the industrial automation market, including Chief Financial Officer, Chief
Operating Officer and President. Earlier in his career, Mr. Gerraughty, a CPA, was with Coopers and Lybrand LLP.

Colin Dohertyjoined our Company as Senior Vice President of Worldwide Sales in February 2003. During 2002, Mr. Doherty served as
President and Chief Marketing Officer of Carrier Networks for Nortel Europe. Mr. Doherty held various other executive positions with Nortel in both Latin America and the U.S.

Clarke Ryanjoined our Company in December 2001 as Vice President and General Manager of our voice quality business acquired from
Lucent. From 1977 to 2001, Mr. Ryan held numerous executive positions within Lucent, most recently, Signal Processing Systems Director.

Gerrold Walkerjoined our Company in December 1999 as Vice President of Services. Since August 2002, Mr. Walker has been the
Vice President and General Manager of our Platforms Solutions

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business.
Prior to joining our Company, Mr. Walker was Vice President and General Manager of SunExpress Europe, the Sun MicroSystems after-market business unit.

R. Brough Turner, a co-founder of our Company, has served as our Senior Vice President of Technology since 1994. He served as
Vice President of Operations from 1983 to 1994. Prior to co-founding our Company, Mr. Turner spent 13 years in engineering and engineering management at Digilab, Inc.
and at Block Engineering, Inc., both subsidiaries of Bio-Rad Laboratories.

Alex N. Bravermanhas served as our Vice President and Corporate Controller since February 1999. From 1994 to 1998,
Mr. Braverman held senior financial executive positions at Concentra Corporation, a developer of sales and engineering software automation products, most recently as Vice President, Chief
Financial Officer and Treasurer. From 1988 to 1994, Mr. Braverman was Controller of Artel Communications Corporation, a manufacturer of networking products.

William E. Fosterbegan serving as a director of our Company in July 2000. He has been, since 1997, a private investor. In 1980,
Mr. Foster co-founded Stratus Computer, Inc., a manufacturer of fault-tolerant computer systems and served as its Chairman and Chief Executive Officer until 1997. Prior to
1980, Mr. Foster spent 14 years in the computer industry, serving as Vice President of Software for Data General Corporation and in management and technical positions with Hewlett
Packard Company. Mr. Foster is a director of several privately held companies.

Ofer Gneezybegan serving as a director of our Company in July 2000. He was a co-founder, and has been, since 1997,
President, Chief Executive Officer and a director of iBasis, Inc., a provider of Internet-based communications services for international carriers. From 1994 to 1996, Mr. Gneezy served
as President of Acuity Imaging, Inc., a multinational company focused on the industrial automation industry. From 1980 to 1994, he was an executive of Automatix Inc. (a predecessor to
Acuity Imaging), an industrial automation company, most recently serving as its President and Chief Executive Officer.

W. Frank King, Ph.D.has served as a director of our Company since 1997. He has been, since November 1998, a private investor. From
1992 to 1998, he was Chief Executive Officer and a director of PSW Technologies, Inc., a provider of software services. From 1988 to 1992, Dr. King was a Senior Vice President of
Development of Lotus Development Corporation and for the previous 19 years has served in various positions with IBM Corporation, including his last position as Vice President Development for
the entry system division. He is a director of eOn Communications Corporation, formerly known as Cortelco Systems, Inc., a provider of telecommunications applications; Concero, formerly known
as PSW Technologies, Inc., Perficient, Inc., a provider of virtual professional services organizations to Internet software companies; iBasis, Inc., a provider of Internet
telephony services; and Aleri, Inc., a provider of data analytic software.

Pamela D. A. Reevehas served as a director of our Company since 1997. She has served, since 1993, as Chief Executive Officer and a
director and, from 1989 to 1993, as President, Chief Operating Officer and a director of Lightbridge, Inc., a provider of products and services which enable wireless telecommunications carriers
to improve customer acquisition and retention processes. From 1978 to 1989, she was with The Boston Consulting Group, a management consulting firm. Ms. Reeve is a director of American Tower
Corporation, a provider of infrastructure facilities and services to the wireless, Internet and broadcasting industries.

Ronald W. Whitehas served as a director of our Company since 1988. Since 2002, he has been a consultant and private investor. From 1997
until 2002, he was a partner of Argo Global Capital, a venture capital firm. From 1983 until 2002, he was a partner of Advanced Technology Development Fund, also a venture capital firm.
Mr. White is a director of several privately held companies.

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ITEM 11. EXECUTIVE COMPENSATION

The information appearing under the caption "Executive Compensation" (other than the information appearing under the captions "Compensation Committee Report on
Executive Compensation" and
"Comparison of Cumulative Total Stockholder Return") of our Proxy Statement for its Annual Meeting of Stockholders to be held April 22, 2004 is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information appearing under the caption "Stock Ownership of Directors, Executive Officers and Principal Stockholders" and "Equity Compensation Plans" of our
Proxy Statement for its Annual Meeting of Stockholders to be held April 22, 2004 is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

We do not have any relationships, nor were we a party to any transaction, requiring disclosure under Item 404 of Regulation S-K.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information is incorporated herein by reference to our definitive 2004 Proxy Statement.

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PART IV

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

(A)  (1) FINANCIAL STATEMENTS

The following are included in Part II of this report:Report of Independent Auditors
Consolidated Balance Sheets as of December 31, 2002 and 2003.
Consolidated Statements of Operations for the Years Ended December 31, 2001, 2002 and 2003.
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2001, 2002 and 2003.
Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2002 and 2003.
Notes to the Consolidated Financial Statements.

(A)  (2) FINANCIAL STATEMENT SCHEDULES

|The following are included on the indicated pages of this report: |  | Page No.
|----------------------------------------------------------------- |  | --------
|Report of Independent Auditors                                    |  | 46      
|Schedule II - Valuation and Qualifying Accounts                   |  | 80      

Schedules
not listed above are omitted because they are not required or because the required information is given in the Consolidated Financial Statements or Notes thereto.

(A)  (3) EXHIBITS

The Exhibit Index, appearing after the signature page on sequentially numbered page 86, is incorporated herein by reference.

(B)  REPORTS ON FORM 8-K

We filed or furnished the following report(s) on Form 8-K during the year ended December 31, 2003. Information regarding each item
reported on is as follows:

|Date Filed or
Furnished |  | Item
No. |  | Description                                                                                        
|----------------------- |  | -------- |  | ---------------------------------------------------------------------------------------------------
|April 9, 2003           |  | Item 9   |  | On April 9, 2003, we announced our first quarter results for the period ended March 31, 2003       
|July 14, 2003           |  | Item 9   |  | On July 14, 2003, we announced our second quarter results for the period ended June 30, 2003       
|October 14, 2003        |  | Item 9   |  | On October 14, 2003, we announced our third quarter results for the period ended September 30, 2003

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Signatures

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

| |  | NMS COMMUNICATIONS CORPORATION
| |  | ------------------------------
| |  | By:                           
| |  | By:                           

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

|Signature                                               |  | Title                                                                                                   |  | Date         
|------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------- |  | -------------
|/s/ROBERT P. SCHECHTERRobert P. Schechter               |  | President, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer) |  | March 1, 2004
|/s/WILLIAM B. GERRAUGHTY, JR.William B. Gerraughty, Jr. |  | Senior Vice President of Finance, Chief Financial Officer and Treasurer (Principal Financial Officer)   |  | March 1, 2004
|/s/ALEX N. BRAVERMANAlex N. Braverman                   |  | Vice President and Corporate Controller (Chief Accounting Officer)                                      |  | March 1, 2004
|/s/WILLIAM E. FOSTERWilliam E. Foster                   |  | Director                                                                                                |  | March 1, 2004
|/s/OFER GNEEZYOfer Gneezy                               |  | Director                                                                                                |  | March 1, 2004
|/s/W. FRANK KING, PH.D.W. Frank King, Ph.D.             |  | Director                                                                                                |  | March 1, 2004
|/s/PAMELA D. A. REEVEPamela D. A. Reeve                 |  | Director                                                                                                |  | March 1, 2004
|/s/RONALD W. WHITERonald W. White                       |  | Director                                                                                                |  | March 1, 2004

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Exhibit Index

We will furnish to any stockholder who so requests, a copy of this annual report on Form 10-K, as amended, including a copy of any exhibit
listed below, provided that we may require payment of a reasonable fee not to exceed our cost of furnishing such exhibit.

|No.     |  | Title                                                                                                                                                                                                                                         
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.6*    |  | Merger Agreement dated as of May 18, 2000 by and among the Registrant, NMS 3758982 Canada Inc., Michel Laurence, Michel Brule, Stephane Tremblay, and Investissements Novacap Inc. (filed with the Registrant's Form 8-K dated July 20, 2000).
|2.7*    |  | Asset Purchase Agreement dated October 15, 2001 by and between the Registrant and Lucent Technologies Inc. (filed with the Registrant's Form 10-Q for the quarter ended September 30, 2001).                                                  
|3.1*    |  | Fourth Restated Certificate of Incorporation of the Registrant (filed with the Registrant's Form 10-K for the year ended December 31, 1995).                                                                                                  
|3.2*    |  | By-laws of Registrant, as amended (filed with the Registrant's registration statement on Form S-1 (#33-72596)).                                                                                                                               
|3.4*    |  | Certificate of Amendment to Fourth Restated Certificate of Incorporation of the Registrant (filed with the Registrant's Form 8-K dated May 4, 2001).                                                                                          
|4.1*    |  | Specimen Certificate for the Common Stock (filed with the Registrant's registration statement on Form S-1 (#33-72596)).                                                                                                                       
|4.2*    |  | Indenture dated as of October 11, 2000 by and between the Registrant and State Street Bank and Trust Company (filed with the Registrant's Form 8-K dated October 12, 2000).                                                                   
|4.3*    |  | First Supplemental Indenture dated as of October 11, 2000 by and between the Registrant and State Street Bank and Trust Company (filed with the Registrant's Form 8-K dated October 12, 2000).                                                
|4.4*    |  | Form of Global Note (filed with the Registrant's Form 8-K dated October 12, 2000).                                                                                                                                                            
|10.12#* |  | 1993 Stock Option Plan, as amended and restated (filed with the Registrant's registration statement on Form S-8 (333-40940)).                                                                                                                 
|10.13#* |  | 2003 Employee Stock Purchase Plan, as amended and restated (filed with the Registrant's registration statement on Form S-8 (333-40940) on June 19, 2003).                                                                                     
|10.14#* |  | 1993 Non-Employee Directors Stock Option Plan, as amended and restated (filed with the Registrant's registration statement on Form S-8 (333-40940)).                                                                                          
|10.19#* |  | 1995 Non-Statutory Stock Option Plan, as amended and restated (filed with the Registrant's registration statement on Form S-8 (333-40940)).                                                                                                   
|10.20*  |  | Lease Amendment between Registrant and National Development of New England, LLC dated October 1996 (filed with the Registrant's Form 10-K for the year ended December 31, 1996).                                                              
|10.23#* |  | 2000 Equity Incentive Plan (filed with the Registrant's registration statement on Form S-8 (333-40940)).                                                                                                                                      
|10.27*  |  | Lease Agreement between the Registrant and National Development of New England, LLC dated April 1, 2000 (filed with the Registrant's Form 10-Q for the quarter ended March 31, 2001).                                                         
|10.29*  |  | Supply Agreement, dated November 30, 2001, between the Registrant and Lucent Technologies, Inc. (filed with the Registrant's Form 8-K dated December 14, 2001).                                                                               
|        |  |                                                                                                                                                                                                                                               

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|10.30* |  | Intellectual Property Agreement, dated November 30, 2001, by and among the Registrant and Lucent Technologies, Inc. and Lucent Technologies GRL Corporation relating to the sale of Lucent's Voice Quality Business (filed with the Registrant's Form 8-K
dated December 14, 2001).
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|21.1   |  | Subsidiaries of the Company.                                                                                                                                                                                                                                                       
|23.1   |  | Consent of Independent Accountants.                                                                                                                                                                                                                                                
|31.1   |  | Chief Executive Officer certification required by Rule 13a-14(a) (17 CFR 240.13a-14(a)) or Rule 15d-14(a) (17 CFR 240.15d-14(a)).                                                                                                                                                  
|31.2   |  | Chief Financial Officer certification required by Rule 13a-14(a) (17 CFR 240.13a-14(a)) or Rule 15d-14(a) (17 CFR 240.15d-14(a)).                                                                                                                                                  
|32.1   |  | Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                    
|32.2   |  | Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                    

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