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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20459

                               ----------------

                                   FORM 10-K

(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
   ACT OF 1934

  For the fiscal year ended December 31, 2000

[_]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

                               ----------------

                       NATURAL MICROSYSTEMS CORPORATION
            (Exact name of registrant as specified in its charter)

              Delaware                                 04-2814586
                                                    (I.R.S. employer
    (State or other jurisdiction                 identification number)
  of incorporation or organization)

            100 Crossing Boulevard, Framingham, Massachusetts 01702
                    (Address of principal executive office)

                                 508-620-9300
             (Registrant's telephone number, including area code)

                               ----------------

          Securities registered pursuant to Section 12(b) of the Act:

           Title of class                    Name of each exchange on which
    Common stock, $.01 per share                       registered
                                                 NASDAQ National Market

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

  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 [X] No [_]

  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. [_]

  As of February 28, 2001, the aggregate market value of the voting stock held
by non-affiliates of the registrant was approximately $314.3 million, based on
the closing price on such date of the registrant's Common Stock on the NASDAQ
National Market. As of February 28, 2001, 36,444,051 shares of Common Stock,
$.01 par value per share were outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

  Portions of the registrant's Proxy Statement relating to the 2001 Annual
Meeting of Stockholders of the registrant are incorporated into Part III of
this Form 10-K. The exhibits listed in the accompanying Exhibit Index
beginning on page 61 are filed or incorporated by reference as part of this
Form 10-K.

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EXHIBIT INDEX ON PAGE 61

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

  Natural MicroSystems Corporation, Natural MicroSystems, CT Access, Fusion,
Natural Access, Natural Call Control, Convergence Generation, NaturalEdge,
NaturalFax, PacketMedia, HearSay, PowerBlade and PolicyPoint are trademarks;
Alliance Generation is a registered trademark; and Natural MicroSystems 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--
Risk Factors," 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 Natural MicroSystems Corporation and its subsidiaries.

                                       2
<PAGE>

                                    PART I

Item 1. Business

Overview

  We provide enabling technologies to the world's leading suppliers of
networking and communications equipment. We target original equipment
manufacturers, system suppliers and other strategic customers and seek to
provide them with essential enabling components for their system offerings.
Our customers incorporate our software and hardware products and technologies
into their solutions in order to enable service providers and enterprises to
rapidly and cost-effectively deploy data, voice and fax applications and
enhanced services in converged networks.

  Our products, which use technologies including digital signal processing
(DSP), specialized silicon for packet media processing, speech processing and
recognition, media processing, signal protocol processing, switching and
packet classification, are essential components in networking and
communications equipment deployed in the wireline and wireless Internet and
the public switched telephone network (PSTN). We also provide our customers
with software development tools and systems architecture and engineering
design services. These products, tools and services facilitate the rapid
creation and deployment of enhanced services and applications while conforming
to the high quality, availability, scalability and manageability required in
service provider networks. Our products and technologies are compliant with
open industry standards to insure interoperability and compatibility, and
leverage mass-market components, such as general purpose microprocessors,
digital signal processors and operating system software.

  Demand for our solutions arises from the explosive growth in data traffic
coupled with the need of networking and communications system vendors and
service providers to bridge the gap between the Internet protocol (IP) network
and the PSTN. In addition, deregulation and the emergence of new service
providers, coupled with rapid technological changes and increasing
competition, has led these system vendors to purchase subsystems and enabling
technologies from outside suppliers, such as Natural MicroSystems. Our
products and enabling technologies help our customers achieve a reduced time
to market and allow them to focus their development efforts on new service
creation and next generation infrastructure.

  During 2000, we grew revenue substantially, improved important operational
metrics including days sales outstanding and inventory turns, added new
customers in high growth, high value market segments, increased business with
existing customers, established or strengthened development and marketing
relationships, launched several innovative products, won industry awards for
several of our products, completed a strategic acquisition and successfully
financed the company to ensure capacity to exploit market opportunities.

  Our new customers include: Yahoo!, BeVocal, Tellme and Messageblaster,
important forces in the voice portal market; GenSoft ITT and Mercury Mobile,
suppliers of wireless communications solutions; JetStream, TdSoft and
MetaSwitch, acknowledged innovators in voice-over-Broadband products; Telit
Networks, a supplier of GSM network equipment; Henan Mobile Communications and
Liaoning Mobile Communications, exclusive wireless communication service
providers in the two most populous Chinese provinces; and CyberUMS and LOCUS,
the dominant suppliers of unified messaging solutions in Korea.

  We increased our business with our existing customers, including Ericsson,
Cisco, Nortel, Alcatel, Motorola, Siemens, NEC, Comverse and Clarent. We
continued important development and marketing relationships with Sun
Microsystems, Force Computers, and Motorola Computer Group, as well as with
speech recognition vendors Nuance, SpeechWorks and Philips. We launched the
following products, all of which were technology leaders and industry
innovators: PacketMedia; HearSay; CG6000; PowerBlade; and a new version of our
signaling system #7 (SS7) software. The CG6000c, PolicyPoint platform, and
HearSay were designated "Product of the Year" by the publications Internet
Telephony, Computer Telephony, and Communications Solutions, respectively.

                                       3
<PAGE>

  In July, we acquired Inno Media Logic (I.M.L.) Inc. ("IML"), a leading
provider of enabling technology used in voice over digital subscriber line
(VoDSL) gateways and other network access solutions. Our IML group, based in
Montreal, introduced the PowerAccess architecture and first products in that
line in mid-January 2001.

  We also completed an offering of common stock in March 2000 that yielded
$175 million in capital and an offering of $175 million of convertible
subordinated notes in October 2000. These two successful financing initiatives
contributed to our year-end cash and marketable securities position of nearly
$310 million.

Industry Background

  The networking and communications industries have experienced dynamic change
and rapid growth over the past few years. These changes have led to growing
challenges for service providers as well as networking and communications
equipment vendors. We are now in the midst of a broad-based economic slowdown
affecting most technology sectors and communications in particular. We are
uncertain of the depth and duration of this slowdown. Upon recovery of the
economy, we expect the resumption of dynamic change and rapid growth in the
telecommunications sector. The primary factors driving this change and growth
include those described below.

  Explosive growth in data communications traffic. The increasing use of the
Internet has led to an explosive growth in data communications traffic. This
growth has been fueled by the increasing number of users of the Internet, the
increased use of electronic mail, the transmission of multimedia content and
the increased volume of information retrieved from the Internet. According to
International Data Corporation, the number of PC-based users of the Internet
is expected to grow from 142 million at the end of 1998 to 500 million in
2002. Speech recognition technology now extends the potential to access
Internet information to the approximately 1.2 billion telephones around the
world. In addition, organizations are increasingly using the Internet to
communicate with customers and partners, further contributing to the surge in
data traffic. This growth in data traffic is placing huge strains on the
traditional PSTN, creating the need for new types of networking equipment.

  Service provider deregulation and competition. Global deregulation and rapid
technological advances have resulted in the emergence of many new
communications service providers, thereby increasing competition within the
communications market, lowering prices and accelerating the development of
innovative new services to attract and retain customers. This environment is
forcing service providers to differentiate themselves by offering new
services. Many of these service providers are using packet technologies to
gain a competitive advantage through the lower cost of deployment, operation
and expansion of networks and rapid implementation of these new services.
Voice over digital subscriber lines (VoDSL), IP telephony, differentiated IP
service provisioning, customer interaction center/web integration and unified
messaging are examples of such services.

Structure and Evolution of Communications Networks

  Network components. There are three fundamental components of communications
networks. The first component is the medium over which the communications
signal is transmitted, such as conventional copper wires, fiber optic cable or
radio waves. The second component is signaling, switching and other devices
that create and manage the transmission of signals. The third component is
standards or protocols that provide agreed languages that permit the various
signaling, switching and other devices to communicate with one another. For
example, the PSTN includes telephone lines, which transmit signals
incorporating both the sound or data being communicated and the signals that
route and manage the communication; telephones, switches, amplifiers and other
devices that create, route, amplify and reproduce the signals; and numerous
industry and country protocols governing the transmission and routing of the
signals and the management of the network.

  Principal public communications networks today include the PSTN and the
Internet. Although each network is based on a distinct architecture, both the
PSTN and the Internet require sophisticated equipment to transmit, route and
manage communications and protocols that permit the equipment to communicate
with other equipment between and within networks.

                                       4
<PAGE>

  Convergence of voice and data. Historically, voice and data communications
have been transmitted and managed on separate networks, each with distinct
technologies, standards and protocols. Traditional telephone systems require
that a dedicated connection, or circuit, be established and maintained for the
duration of a call in order to transfer voice or data. Dedicated connections
result in the poor use of bandwidth since no traffic travels through the
circuit when users are silent, which can account for a significant amount of
time during a transfer. IP networks differ fundamentally from circuit-switched
networks in that the packet networks' resources and infrastructure can be
shared simultaneously by several users and bandwidth can be flexibly
allocated. Packet-based communications systems format the information to be
transmitted, like e-mail, data, voice and fax, into a series of shorter
digital packages of information called "packets."

  Each of these packets is then transmitted over the network and is
reassembled as a complete communication at the receiving end. IP networks
offer a number of advantages over circuit-switched networks. Rather than
requiring a dedicated circuit for each individual call, IP networks commingle
packets of data, voice and fax from several communications sources on a single
physical link, providing superior utilization of network resources.
Additionally, this integration of voice and data communications makes possible
an enrichment of services and an entire range of new, value-added
applications.

  Access Networks. Deregulation, increased competition and the growth of data
traffic have impacted the development of access networks. Access networks
connect service providers, or provide them with access to their customers and
consist of access lines and access equipment. Access lines, predominantly
copper cables, have had limited capacity, resulting in bottlenecks in many
access networks as data traffic has grown significantly. To overcome the
limitations of existing copper access line capacity, service providers have
been deploying new technologies and access networks that enable them to
deliver high-capacity, or broadband, telecommunications services to their
customers. Access networks based on digital subscriber lines (DSL), a set of
technologies designed to increase capacity over existing copper lines, cable
TV and broadband wireless technologies, enable service providers to offer
high-speed data services.

  Standards and protocols. IP and circuit-switched networks, deployed by
service providers across multiple geographies, rely on an array of standards
and protocols for communicating information among switches and other devices.
The PSTN requires basic signaling software protocols such as integrated
services digital network (ISDN) and SS7 in order to ensure that calls from one
network to another are transmitted correctly. Similarly, the IP network
requires a set of standards and protocols to route information correctly. For
example, these standards include H.323 for the transmission of voice signals
in an IP network. While these networks and protocols are distinct today,
communications equipment vendors are striving to build equipment that enables
the interconnection and interoperability of the different networks, protocols
and standards.

  Interoperability. The evolution of the packet-based network combined with
the extensively deployed circuit-switched network creates the need for
interoperability. Interoperable communications components can interconnect and
work with both circuit and packet networks. Complete interoperability of these
networks presents significant challenges. The PSTN, which consists of
approximately 1.2 billion telephones worldwide, contains a large number of
signaling protocol variants. The Internet utilizes a small number of open
protocols. Many of these are still being defined and implemented by standards
bodies and leading vendors. Interoperability requires the ability to execute
all of the associated protocol variants, as well as the ability to process the
data from its source to its destination format.

Market Needs

  The explosive increase in data traffic, heightened competition, the need for
network interoperability and the emergence of converged network
infrastructures are causing service providers and enterprises to deploy new
enhanced services and applications in order to compete more effectively. In
addition, the increasing use of packet networks, which must interoperate with
existing networks, requires network equipment and applications that can
operate in both packet and circuit networks. Service providers require that
their packet networks have the high levels of quality, availability,
scalability and manageability traditionally associated with circuit networks.
Finally,

                                       5
<PAGE>

the emerging packet networks can support completely new enhanced services and
applications, but only with new technologies such as traffic classification
and bandwidth management.

The Natural MicroSystems Solution

  We provide enabling technologies to the world's leading suppliers of
networking and communications equipment. Our customers incorporate our
software and hardware products and technologies into their solutions in order
to enable communications service providers and enterprises to rapidly and
cost-effectively deploy data, voice and fax applications and enhanced services
in converged networks. Our products, which utilize technologies including
digital signal processing, specialized silicon for packet media processing,
speech processing and recognition, media processing, signal protocol
processing, switching, and packet classification, are essential components in
networking and communications equipment deployed in the wireline and wireless
Internet and PSTN. We also provide our customers with software development
tools and systems architecture and engineering design services. These tools
and services facilitate the rapid creation and deployment of enhanced services
and applications while conforming to the high quality, availability,
scalability and manageability required in service provider networks. Our
products and technologies are compliant with open industry standards to insure
interoperability and compatibility, and leverage mass-market components, such
as general purpose microprocessors, digital signal processors and operating
system software.

 Our products and services enable our customers to:

 .  Reduce time to market. Our products, technologies and services are designed
   to help reduce our customers' product development cycles, enabling them to
   deliver their products to market more quickly, capture greater market share
   and compete more effectively. Service providers and enterprises, in turn,
   can deploy enhanced services and applications more quickly.

 .  Provide for network interoperability. Our knowledge of emerging Internet
   and established PSTN protocols facilitates the deployment of our solutions
   across diverse networks. As new network deployments are increasingly IP-
   based, our products allow connectivity and interoperability with the PSTN.
   Our customers rely on us to assist them in the deployment of their products
   in networks worldwide.

 .  Meet carrier class requirements. Our products are designed to deliver the
   high quality, availability, reliability, scalability and manageability
   required in service provider networks. These, combined with our solutions
   for network interoperability, enable the deployment and scaling of enhanced
   services and applications across diverse network infrastructures. We
   provide an easy-to-use open development environment that allows our
   customers to develop differentiated systems and solutions for the converged
   network. In addition, this capability facilitates upgrades and enhancements
   to deployed network systems, reducing the life-cycle cost of ownership.

 .  Create and deploy enhanced services. We provide the foundation for the
   creation and deployment of enhanced services, such as unified messaging and
   speech access to web-based information, in both the IP network and the PSTN
   environments. Our products and technologies enable the delivery of
   differentiated packet services, including service provisioning and traffic
   classification based on application type and per-flow metering. This
   capability enables equipment vendors, service providers and enterprises to
   build new classes of enhanced services and applications.

Strategy

  Our objective is to be the leading provider of enabling technologies to the
premier networking and communications systems original equipment manufacturers
addressing converged network solutions. The following are key elements of our
strategy:

                                       6
<PAGE>

  Focus on high growth market segments. We believe that our technologies,
products and services are critical to several high growth market segments. We
focus our technology, sales and marketing resources on the following four
market segments:

 Examples of Applications

<TABLE>
<CAPTION>
Market Segment        Existing                           Emerging
--------------        --------                           --------
<S>                   <C>                                <C>
Network Access        Voice over Internet protocol       VoDSL gateways
                      (VoIP) Gateways                    Wireless Internet
                      SS7 Gateways
                      Analog cellular services

Network Solutions     Prepaid and debit card calling     Unified messaging
                      services                           Speech access to Internet data

Enterprise Solutions  Voicemail                          Customer interaction centers/web
                                                         integration
                                                         Private branch exchanges for packet
                                                         based networks

Premium IP Service    Internet access                    Guaranteed service levels for voice
 Management                                              and e-commerce
</TABLE>

  Extend our technology leadership. We invest heavily in developing enabling
technologies that are essential to providing high performance voice, data and
fax transmission over and connectivity to both packet and circuit networks. We
provide products and technologies essential to the creation and deployment of
enhanced services on converged networks. We have assembled a team of
approximately 342 engineers and technical personnel who are currently
dedicated to this market. Over our 17 years of experience, we have developed
significant expertise in digital signal processing software, media stream
protocol processing, global network interface and protocol technologies and a
comprehensive software development environment. We intend to continue to
invest in our technological expertise through in-house development and
strategic acquisitions.

  Strengthen and expand relationships with strategic customers. Our strategy
is to establish and maintain long term working relationships and to sell our
products and services to leading original equipment manufacturers in the
networking and communications industries. We dedicate over 125 sales and
technical services personnel to approximately 100 networking and
communications systems vendors worldwide. We also target emerging companies
addressing high growth markets. We use indirect channel partners to reach a
broader market. By focusing on leading equipment manufacturers with large
volume potential, we believe that we reach the largest portion of our
potential customer base while minimizing the costs and complexity of our
marketing efforts. These customer relationships also provide us with multiple
sales opportunities across our customers' product lines. We work closely with
our customers to design our software and hardware solutions into their
products and use consulting and support services to facilitate and reinforce
these relationships. By working with leading customers early in their product
design and development stages, we gain valuable insights into future industry
requirements and trends.

  Broaden our product offering. We believe that breadth of product line is one
of the principal attributes that equipment manufacturers consider in selecting
suppliers of enabling technology. We offer a broad selection of enabling
technologies for networking and communications equipment vendors, and we
intend to continue to broaden our product offering. For example, in July 2000
we acquired IML, a developer of enabling technologies for VoDSL and other
access gateway technologies. In December 1999 we acquired QWES.com, Inc., the
developer of PolicyPoint, an enabling technology for differentiated packet-
based services. Our strategy is to continue to expand our product offerings,
both by internal development and acquisitions.

  Support open architecture and drive evolving standards. We will continue to
support open architectures, allowing developers of high performance, high
value applications to utilize standards-based products or components. We
expect that this will in turn reduce development time and enable customers to
take advantage of advances made in complementary technologies. Our products
are accessible to developers and allow them,

                                       7
<PAGE>

through the use of our software development environment, to develop software
and algorithms for their products. We have a record of developing and
promoting open industry standards and intend to continue our leadership role.

  Strengthen customer relationships through consulting and support
services. Our consulting and support services extend from initial product
conception and design through implementation, field trial and deployment.
These fee-based service relationships increase our visibility to our customers
and facilitate the design-in process while providing us with insight into
future market requirements.

Products and Services

  The principal functions addressed by our products include connectivity to
communications networks, call processing, real-time media processing, media
stream protocol processing, service classification and quality of service.
These capabilities are accessed through a series of application programming
interfaces that expose the hardware and firmware functions to the developer
for the purpose of creating an application or system.

  Our products are developed for global markets and allow customers to
integrate their applications and systems into the IP network and the PSTN. Our
products are compatible with signaling protocols and are approved for use in
many countries. In order to have a presence in the fastest growing and largest
international markets, we use our technological expertise, open architecture,
and familiarity with international regulatory requirements to obtain the
approvals required for use of our products in principal foreign markets. Our
products have been incorporated into products sold to end users in over 65
countries.

  Our products are open, accessible, standards-based, layered, network
protocol and operating system-independent, modular and scalable. These
features offer developers significant reduction in time and effort when
developing sophisticated applications and systems.

  Convergence Generation. The Convergence Generation product family consists
of software and hardware components configured specifically for convergence-
centric systems and applications. This product family is designed for an Intel
StrongARM co-processor and Texas Instruments (TI) C54x family of digital
signal processors. The architecture is extensible to hundreds of ports per
slot and capable of integrating high-density IP network and PSTN interfaces
including T3 and OC-3. This product family offers the best price performance
for converged network solutions such as IP telephony gateways and IP media
servers.

  PowerAccess. Our VoDSL products are high density access gateway boards and
software used for VoDSL and voice over wireless local loop (WLL) deployments.
This product family includes the PA HYPER T3 DS3/STS-1 Network Adapter, the M
100 Echo Cancellation and Compression Option (for the PA HYPER T3) and the S-
200 high performance asynchronous transfer mode (ATM) interface. Combined,
these products create a 2 slot, 672 port (T3) access gateway, exploiting our
core application specific integrated circuit (ASIC) and ATM technologies.

  PolicyPoint. The PolicyPoint product family, currently in field trials,
consists of software and hardware components that provide reliable, cost-
effective, predictable and consistent transport of voice, video and data over
packet networks. The product family is designed for the TI C6x family of
digital signal processors and does not require a host processor. It provides
connectivity to any ATM wide area network (WAN) while controlling network and
application specific usage and performance. The PolicyPoint architecture
offers a soft-ASIC capability that allows for the integration of additional
WAN protocols including frame relay, point-to-point protocol, multi-protocol
label switching and differentiated services. We believe the architecture is
extensible to higher density local area network (LAN) and WAN interfaces. We
believe PolicyPoint's architecture delivers a compelling price performance
advantage.

  Alliance Generation. The Alliance Generation is a proven product family with
a field history of over eight years. It consists of software and hardware
components configured to meet the needs of enterprise and enhanced

                                       8
<PAGE>

services applications for circuit-switched environments. This product family
is designed for an Intel x86 co-processor and TI C51 or TI C549 families of
digital signal processors. The port densities offered range from 2 to 120
ports per slot and the Alliance Generation product line is differentiated from
competition due to its unique extensibility. The product family enables
systems to maximize resources, thereby reducing costs.

  Intelligent Networks/SS7.  The Intelligent Networks/SS7 product family
consists of software and hardware components that provide a complete suite of
Intelligent Networking protocols for PSTN connectivity. The product family is
designed for the Motorola 68xxx family of processors. It allows for a full
implementation of the SS7 protocol stack with access at all layers and
contains a set of switch-specific and high availability extensions that meet
service provider requirements and facilitate worldwide deployment and
interoperability.

  Natural Access Software. The Natural Access Software suite consists of CT
Access with Natural Call Control, NaturalFax, ActiveAG, Telephony Applications
Program Interface (TAPI) support, ISDN, Channel Associated Signaling and high
availability extensions. This suite was designed as the development and run-
time environment for the Alliance and Convergence Generation product families
and provides for the rapid development of high performance, scalable
applications. Natural Access allows developers, working with common
programming languages and different programming models, independent of host
platforms and operating systems, to implement applications and systems
requiring communications functionality.

                                       9
<PAGE>

 The following table depicts our product families, capabilities and benefits:

                         Natural MicroSystems Products

<TABLE>
<CAPTION>
Product
Family                          Capabilities                                   Benefits
-------      ----------------------------------------------------  ---------------------------------
<S>          <C>                            <C>                    <C>
Convergence  Hardware Platform Specific:    Software Specific:     . Provides interoperability
Generation     . Integrated on-board PSTN   . Programmable media   with circuit and packet- switched
               and IP network interfaces    streaming              networks
               . Media stream protocol      . Simple Network       . Flexible media streaming
                                              Management
               processing (flexible packet  Protocol (SNMP)        supports new converged
                                             support
               processing)                  . Hot-swap drivers     enhanced services
               --Jitter buffer management   . Hosting environment  . Integrates into carrier grade
                                              for
               --Low latency                speech technologies    solutions
               . Digital Signal Processing  . Media support        . Maximizes system price
               --Echo cancellation          --Play/record          performance
               --Vocoding                   --Transcoding          . Optimized platform for
               --Fax Conferencing                                  speech recognition and text-to-
               . PSTN Interface                                    speech applications
               --Worldwide signaling
               . ISDN
               . Channel associated
                 signaling
               . IP Interface
               --Ethernet
               . Low power consumption
               . Low host-processor
               utilization

PowerAccess    Hardware Platform Specific:  Software Specific:     . Low-cost ATM to PSTN
               . High-density voice         . Data, and voice      connectivity
                 switching
               and time division            . Non-blocking         . Integrates into core network
                multiplexed                   architecture
               (TDM)/IP/ATM voice traffic   . Scalability          environments
               conversion                   . Simple software
                                              interface
               . Support for H.100, H.110
                 and
               other telephony buses
               . Advanced ASIC technology,
               reducing cost per port
               . Standards-based for easy
               integration into
                communication
               networks around the world
               . Uses ATM technology that
               allows data, voice, fax and
                video
               to be carried over a single
               network with inherent
                Quality of
               Service

PolicyPoint    Hardware Platform Specific:  Software Specific:     . Enables service level
               . Integrated LAN and WAN     . Bandwidth shaping    guarantees for differentiated
               network interfaces           --Wirespeed packet     IP applications
               . WAN Interface              classification         . Provisioning of premium IP
               --T1/E1                      --Fine granularity     services
               . LAN Interface              discrimination         . Integrates with existing
               --10/100-BaseT Ethernet      --LAN to WAN           management systems
                                             bandwidth
               . Standalone operation       management and bounds  . Lowers deployment and
               . Integrated Channel         delay                  maintenance costs
                 Service
               Unit (CSU)/Data Service      --Per flow metering
               Unit (DSU)                   . Remote management
                                            --SNMP support
                                            --Web-based
                                             provisioning
                                            --In-field software
                                             upgrades
                                            . Routing support
                                            . Software
                                              programmable
                                            WAN protocol
                                            --ATM
</TABLE>

                                       10
<PAGE>

<TABLE>
<CAPTION>
Product Family                         Capabilities                                       Benefits
--------------       --------------------------------------------------- -------------------------------------------
<S>                  <C>                            <C>                  <C>
Alliance Generation  Hardware Platform Specific:    Software Specific:   . Allows for private branch exchange
                        . Digital Signal Processing . SNMP support       (PBX) integration
                        --Echo cancellation         . Hot-swap drivers   . Provides interoperability with circuit-
                        --Vocoding                  . Hosting            switched networks worldwide
                                                      environment for
                        --Fax                       speech technologies  . Integrates into carrier grade solutions
                        --Conferencing              . Media support      . Maximizes system price performance
                        . PSTN Interface            --Simultaneous       . Optimized platform for speech recognition
                                                     play/record
                        --Worldwide signaling       --Transcoding        and text-to-speech applications
                        . ISDN
                        . Channel associated
                          signaling
                        . Analog interfaces
                        . Station interfaces
                        . Low power consumption
                        . Low host-processor
                          utilization

Intelligent             Hardware Platform Specific: Software Specific:   . Programmability allows wireless network
 Networks/SS7           . PSTN Interface            . Multiple layers    components to interact with PSTN
                        --T1/E1                     --Message Transfer   . Facilitates the creation of enhanced
                                                     Parts 1-3
                        --V.35                      (MTP)                services platforms and applications
                        --10-BaseT Ethernet         --Signaling          . Hardware implementation enables host
                                                     Connection
                                                    Control Part (SCCP)  to operate independently
                                                    --Transaction
                                                     Capabilities
                                                    Action Part (TCAP)
                                                    --Telephone User
                                                     Part (TUP)
                                                    . Fully redundant
                                                    . 4-16 Links

Natural Access          Software development        Features:            . Development environment allows for
 Software               environment:                .Natural call        operational compatibility
                                                    control
                        . Alliance Generation       . Access to global   . Simplifies development of switching and
                                                      signaling
                        . Convergence Generation    protocols            call processing applications
                        . Windows NT                . High availability  . Simplifies development of extensions to
                                                      and
                        . SPARC Solaris             manageability        deployed systems
                        . Intel Solaris             . Point-to-point
                                                      switching
                        . Unixware                  . Configuration and
                                                      installation
</TABLE>

  Fusion. In addition, we market Fusion, a branded package incorporating
several of our products. It is a scalable, high performance development
platform for standards-based IP telephony solutions. Fusion provides a
software development environment designed specifically for the creation of IP
telephony gateway solutions. Fusion's modular architecture allows support for
existing protocols such as the International Telecommunication Union's H.323
specification and a growing list of emerging protocols like Media Gateway
Control Protocol (MGCP) and Session Initiation Protocol (SIP). Fusion enables
developers to create application solutions with configurations from four
analog ports to multiple T1s/E1ss with no increase in latency or decrease in
performance.

  Recent Product Introductions. Over the past year, we have announced the
following new products:

    PacketMedia. PacketMedia is a standards-based, carrier-class IP media
  server solution with real-time media streaming and a broad range of media
  processing capabilities for carrier-grade sound quality and functionality.
  PacketMedia enables communications equipment providers to rapidly deliver
  to carriers new hardware/software platforms capable of supporting a wide
  range of next-generation IP-based applications and enhanced services.

    HearSay. HearSay is an integrated, extensible voice portal platform for
  the development and deployment of voice-driven Internet applications, voice
  portal solutions and V-Commerce (voice-enabled

                                      11
<PAGE>

  e-commerce) solutions. HearSay integrates leading vendors' speech
  recognition algorithms, such as Nuance and SpeechWorks International, into
  the Natural Access development environment, executes call processing on
  dedicated hardware, and streams voice to the host processor for speech
  recognition.

    PowerBlade. PowerBlade is a carrier-grade system in a slot for creating
  VoIP gateways, IP media servers and enterprise communications servers with
  built-in scalability, high availability and expandability. PowerBlade
  integrates high-density hardware, a packet voice software platform and
  development environment and an embedded PC processor for dedicated
  processing of packet voice applications. Plug-and-play packaging also
  enables expansion and extends system availability. The integrated
  PowerBlade processor drives applications independently of the chassis' bus
  and main system processor enabling service providers to add VoIP solutions
  and packet voice services without jeopardizing availability or increasing
  processing bottlenecks. Additional VoIP ports can be added by hot plugging
  more PowerBlades into a chassis, permitting applications to be added
  without interrupting existing applications.

    PowerAccess. This product family of boards and software is focused on the
  voice over broadband gateway applications including voice over DSL and
  voice over WLL. These applications require high capacity PSTN and ATM
  network interfaces and the high availability of CompactPCI. Use of ASICs
  and the latest DSP devices provides a high number of ports per board and
  lower costs. Costs are further reduced by the inclusion of a unique
  auxiliary data bus for voice traffic called the PowerAccess Bus. This
  additional TDM voice bus increases system capacity several times, spreading
  the cost of the CompactPCI chassis over a larger number of ports and
  reducing cost per port.

    Services and Customer Support. To complement our hardware and software
  products, we also offer engineering consulting and technical support
  services. NMS Consulting Services offers design, development, integration,
  and customization services in four broad areas: DSP-related technologies,
  hardware design, middleware applications and protocols.

  NMS' Technical Services delivers technical support to networking and
communications suppliers worldwide, including problem identification and
problem resolution via the web, on-site, email, telephone or fax. These
programs are designed to assist in all stages of the product lifecycle--
evaluation, development, and deployment. Technical support supplements the
standard NMS product warranty.

Technology

  We offer high performance software and hardware component technologies for
converged network solutions such as communications gateways and enhanced
service platforms for IP, ATM, DSL, wireless and wireline communications
networks. Our technology components include a flexible software architecture
that allows our technology to be readily adopted by major communications
equipment suppliers. Our technology is engineered to provide
telecommunications quality and availability while leveraging the broad
capabilities of mass-market computing platforms. Our software technology is
available on board-level products for open computing platforms or as hardware
reference designs for embedded applications and systems. To facilitate the
development of specific solutions, we provide sample applications and
demonstration programs. Our architecture includes software and hardware
reference designs, as well as hardware and firmware implementations of these
core technologies:

    Digital signal processing software and related compute engines. We base
  our solutions on high performance commercial digital signal processors
  integrated with proprietary technology to provide high density, scalable
  signal processing arrays.

    Application Specific Integrated Circuits (ASICs). Our VoDSL products use
  the latest silicon technology to create high density, low cost DSL gateway
  technology, enabling voice over DSL services for access networks.

                                      12
<PAGE>

    Media stream protocol processing. Our high performance packet processing
  digital signal processor firmware technology allows for the efficient
  support of media streams on IP and other packet networks and enhanced
  services platforms for packet networks.

    Global network interfaces and protocol technology. We offer many of the
  commonly used digital and analog telephony interfaces as well as Ethernet
  and T1/E1 WAN data interfaces. Our PSTN protocol technologies include all
  major channel-associated signaling variants and ISDN and SS7 signaling, as
  well as leading Voice-over-IP call control protocols such as H.323 and
  MGCP. Our interface and protocol technology allows us to rapidly obtain
  interoperability and approvals for new products in all major markets, and
  to efficiently respond to our customers' requirements for public network
  connections and approvals in other markets.

    Telecommunications switching technology. Our Natural Call Control call
  management software and our efficient hardware implementation of industry
  standard CTBus interfaces combine to provide an extremely flexible,
  scalable and cost-effective platform for telecommunications switching.

    Packet classification and queuing for differentiated IP servicing
  provisioning. Our packet classification and queuing technology supports
  differentiated quality of IP services using ATM and other wide area network
  protocols. The proprietary digital signal processor-based technology
  provides wire speed performance levels with the flexibility of a software-
  only approach.

    Flexible, high performance communications software and systems
  architecture. Our high performance software architecture minimizes the
  computational load on the host processors, freeing system resources for the
  use of our customers' applications while providing the highest possible
  capacity on any specific computing platform. The flexibility of our
  programming interface supports diverse customer software models and
  simplifies our customers' development efforts.

    Carrier class high availability technology. We deliver hot-swap enabled
  CompactPCI products and have established an industry leading software
  infrastructure to support carrier class deployments. We offer systems level
  software that extends system availability during component failures, system
  maintenance and upgrades.

Customers and Market Segments

  Our customers are primarily leading original equipment manufacturers. Our
customers also include system integrators, communications service providers
and international distributors in the networking and communications equipment
industry.

                                      13
<PAGE>

  The table below is a representative list of our customers within each market
segment, together with examples of applications in each segment. Except as
otherwise noted, each of these customers purchased at least $500,000 of our
products and services in 2000.

                                Market Segment

<TABLE>
<CAPTION>
                                 Network               Network              Enterprise         Premium IP Services
                                 Access               Solutions              Solutions              Management
                          --------------------- ---------------------- --------------------- ------------------------
<S>                       <C>                   <C>                    <C>                   <C>
Representative Customers  .Clarent              .Centigram             .Alcatel              Products are currently
                          .ECT                  .Comverse              .Aspect               in lab evaluations
                          .Ericsson             .Nortel                Communications        and limited
                          .JetStream            .Tellme *              .Lucent               field trials
                          .Mockingbird          .BeVocal *             .Mitel
                          .Networks
                          .Motorola
                          .Empirix
                          .Tdsoft *

Examples of Applications  .Programmable         .Unified               .Customer interaction .Voice over IP
                          gateways for carriers Communications         centers               .Voice, intranet and
                          .Emerging gateway     .Billing/payment       .Unified              Internet access on a
                          opportunities such as .Media Servers         Communications        single
                          cable and DSL         .Internet call waiting .Interactive voice    broadband local loop
                          .Programmable         .Speech access to      response              .User and application
                          switches for          Internet data          .Enterprise           specific IP service
                          competitive local                            communications        level agreements
                          exchange carrier                             servers               .Application-specific
                          (CLEC)/PSTN                                                        flow and
                          connectivity                                                       packet bandwidth
                                                                                             management
                                                                                             .Full class of
                                                                                             service and
                                                                                             quality of service
                                                                                             performance to IP
                                                                                             traffic, LAN to LAN
</TABLE>
--------
*  New customer in 2000 which did not reach the $500,000 threshold but is
   considered to be a key representative customer in the respective market
   segment.

Sales and Marketing

  We focus our sales and marketing efforts on selling directly to
approximately 100 leading suppliers of networking and communications systems.
Customers targeted in our direct sales efforts are divided into three groups:

  .  Strategic accounts, including large, multinational companies with
     multiple products, such as Nortel, Alcatel, Lucent and Ericsson, each of
     which is served by a dedicated account team;

  .  Major accounts, including original equipment manufacturers with discrete
     product lines such as Comverse Network Systems; and

  .  Emerging accounts, including new entrants in high-growth markets such as
     BeVocal, Tellme and Yahoo!.

  We serve other customers and prospects through indirect sales-channel
partners. This focus allows us to use our resources on customers that offer us
the largest revenue opportunities.

  Our sales and marketing organization consists of 120 employees in 21 sales
offices worldwide, of which 9 are in the United States, 6 are in Europe, 5 are
in Asia, and one is in Canada. During 2000, 28% of our revenues were from
sales and services to customers based outside North America.

                                      14
<PAGE>

Research and Development

  We believe that the extension and enhancement of existing products, the
development of new products and the support of joint product development
activities are critical to our future success. During 2000, we spent $31.2
million, or 23% of our revenues, on research and development.

  Our current research and development is conducted by 311 employees located
at our headquarters in Framingham, Massachusetts, and at our offices in
Schaumburg, Illinois, Tustin, California, Saint Hubert, Quebec and Chaville,
France. Our current research and development is focused on developing
emerging, high growth technologies, such as IP traffic management, VoDSL, IP
telephony, SS7/IP network integration and wireless/IP network integration. Our
product development investment is focused on bringing these technologies to
market and on increasing scalability and performance, providing high
availability through CompactPCI, hot swap and related technologies, and
enhancing our software development environment to facilitate shorter
development cycles for our customers and partners.

Manufacturing

  We outsource assembly of specific printed circuit boards to two ISO 9002
certified contract manufacturers, who are the primary sources for the products
manufactured.

  We perform quality control and final testing verification sampling of
completed products at our Framingham facility, for which we received ISO 9002
certification in 1996. Since then, we have participated in all required
processes and audits required to maintain this certification, successfully
completing and ISO Quality Systems re-certification in October 1999. The
British Approvals Board for Telecommunications conducted its most recent audit
in November 2000 and found no nonconformity. All of our products are produced
in accordance with FCC and UL safety requirements and to IPC-610 standards of
assembly workmanship.

  We seek to use industry-standard components for our products. Many of these
components are generally available from multiple sources. However, we acquire
certain custom integrated circuits and other devices which are components on
one or more of our products from single-source suppliers. Although we believe
we could develop other sources for each of these custom devices, the process
could take several months.

Competition

  The market for our products is highly competitive. We have many competitors
whose products compete with one or more of our products. We may also compete
with our existing and potential customers' in-house development teams.
Examples of our current competitors include AudioCodes Ltd., Radisys
Corporation, Brooktrout Technology, Inc. and Dialogic Corp., a wholly owned
subsidiary of Intel Corporation. Some of our competitors may have greater
resources than we have. As we enter new markets, we expect to encounter
competition from additional competitors, some of which may also have greater
resources than we do.

Intellectual Property and Proprietary Rights

  Our success depends on proprietary technology and know-how. We rely
primarily on a combination of copyrights and restrictions on access to our
trade secrets to protect our proprietary rights. In addition, we have four
patents issued, we have received a notice of allowance on three patents which
we expect to issue shortly, and we have applications pending on 17 patents. We
distribute our software products under license agreements which grant
customers a nonexclusive 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. We believe that our products and technology do not
infringe on any existing proprietary rights of others.

                                      15
<PAGE>

  Despite these precautions, it may be possible for unauthorized third parties
to copy aspects of our products or to obtain information that we regard as
proprietary. 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 various legal protections for our
technologies.

  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
nonexclusive, run for a finite term and are renewable with the consent of both
parties.

Employees

  As of December 31, 2000, we had 606 full-time employees, including 91 in
sales, 29 in marketing, 311 in research and development, 68 in services, 49 in
operations and 58 in administration and finance. None of the employees is
represented by a labor union. We have never experienced a work stoppage and
consider our relations with our employees to be good.

Forward-Looking Information

  This Form 10-K includes and incorporates forward-looking statements that
involve substantial risks and uncertainties and fall within the meaning of
Section 27A of the Securities 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 or
expectations. Actual results or events could differ materially from the 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 "Risk Factors" below, as well as other
risks and uncertainties referenced in this Form 10-K. We do not assume any
obligation to update any of the forward-looking statements after the date of
this Form 10-K to conform these statements to actual results.

Risk Factors

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

  We experienced operating losses in all four quarters of 1999 and in the
first, third and fourth quarters of 2000. As a result, for the years ended
December 31, 1999 and 2000, we reported operating losses of approximately
$17.9 million and $35.6 million, respectively. We expect to continue to
increase our levels of research and development and sales and marketing
expenditures, and therefore we can only achieve profitability if we can
significantly increase our revenues. If our revenues do not meet the levels
that we anticipate, or if our costs and expenses exceed our expectations, we
will again sustain losses and the price of our common stock may decline
substantially.

 We are experiencing the impact of a slowdown in some sectors of the
telecommunications industry.

  We are now in the midst of a broad-based economic slowdown affecting most
technology sectors and communications in particular. As a result, many of our
customers are aggressively increasing efficiency in their supply chains and
reducing inventory levels. This is evident as our customers are ordering lower
quantities and, in some cases, deferring orders into future periods. Because
it is difficult to predict how long this slowdown will continue, we may not be
able to meet anticipated revenue levels on a quarterly or annual basis.

 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 these fluctuations, some of which are beyond our
control, include:

                                      16
<PAGE>

  .  fluctuations in our customers' businesses;

  .  demands 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.

  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 deferral of orders for our products
would cause a shortfall in revenue 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.

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

  Many of our customers, including the large equipment manufacturers 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.

 The markets we serve are highly competitive, and we may be unable to compete
effectively.

  Competition in the high growth markets that we target for our products is
intense, and we expect it to intensify as current competitors expand their
product offerings and new competitors enter the market. Although competition
in many of our markets is highly fragmented, our current competitors include
AudioCodes Ltd., Radisys Corporation, Brooktrout Technology, Inc. and Dialogic
Corp., a wholly owned subsidiary of Intel Corporation. Other companies,
including original equipment manufacturers that are current or targeted
customers, may enter our markets in the future. 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. In particular, 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.

 We rely on third parties to assemble our products.

  We do not have in-house manufacturing capabilities and currently rely on one
primary third-party contract manufacturer to assemble our printed circuit
boards and other product offerings. This manufacturer is our sole source for
the products it manufactures for us. 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 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.

  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,

                                      17
<PAGE>

Texas Instruments is our sole source for the digital signal processors used in
many of our products and customarily requires order lead times of 20 to 22
weeks or more to insure delivery in desired quantities. In addition, Lucent is
our sole source supplier for integrated circuit components used in many of our
products and customarily requires order lead times of 16 weeks or more. An
interruption in supply from either Texas Instruments or Lucent would disrupt
production, thereby adversely affecting our ability to deliver products to our
customers. 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.

 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 "design wins" are solely an expression of interest by customers and are
not supported by purchase obligations. Therefore, there can be no assurance
that any "design win" 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 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.

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

  The length of our sales cycle typically ranges from six to eighteen 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 larger systems. 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 we and our customers 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 a "design win" 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 those products
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 earnings. 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.

 The average selling prices of our products may decrease, which could
adversely affect gross margins and revenues.

  Competitive pressures and rapid technological change may cause erosion of
the average selling prices of our products and services. In addition, as many
of our target customers are large original equipment manufacturers with
significant market power, we may face pressure from them for steep volume-
based discounts in our pricing. Any significant erosion in our average selling
prices could impact our gross margins and harm our business.

 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 equipment and services market 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

                                      18
<PAGE>

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. 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 revenue than anticipated. During the development of our products, we
have also experienced delays in the prototyping of our digital signal
processing chips, which in turn have led to delays in product introductions.
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.

 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 appropriate opportunities present themselves, we may acquire businesses,
technologies, services or products that we believe are strategic. We may not
be able to identify, negotiate or finance any future acquisition successfully.
Even if we do succeed in acquiring a business, technology, service or product,
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 goodwill and other 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 and other key personnel we
need to succeed.

  The loss of any of our senior management or other key research, development,
sales and 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 copyright and trade secret laws, restrictions on
disclosure and patents to protect our intellectual property rights. Despite
our efforts to protect our proprietary rights, unauthorized parties may
attempt to 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
exclusive patent or other intellectual property rights to technologies that
are 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. 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 or royalty agreement under the intellectual
property rights of those parties claiming

                                      19
<PAGE>

the infringement. If we are unable to obtain the 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.

 Our products depend upon the continued availability of licensed technology
from third parties.

  We currently license and will continue to license certain technology
integral to our products and services, such as protocols, from third parties.
While we believe that much of this technology is available from multiple
sources, any difficulties in acquiring third-party technology licenses, or in
integrating the related third-party technology into our products, could result
in delays in product development or upgrade until equivalent technology can be
identified, licensed and integrated. We may require new licenses in the future
as our business grows and technology evolves. We cannot assure you that these
licenses will continue to be available to us on commercially reasonable terms,
if at all.

 The ongoing evolution of industry standards may adversely affect demand for
our products and increase our costs.

  Our success depends on both the evolution of industry standards for new
technologies and our products' compatibility with multiple industry standards.
Many technological developments occur prior to the adoption of the related
industry standard. The absence of an industry standard related to a specific
technology may prevent market acceptance of products using that technology, or
may result in the development of products not compatible with ultimately
adopted standards, which would limit demand for our products. We intend to
develop products compatible with other technological advancements and may
develop these products prior to the adoption of industry standards related to
these technologies. As a result, we may incur significant expenses and losses
due to lack of customer demand, unusable purchased components for these
products and the diversion of our engineers from future product development
efforts. Further, we may develop products that do not comply with the eventual
industry standard, which could limit our ability to sell these products. If
the industry develops new standards, we may not be able to design and
manufacture new products in a timely fashion that meet these new standards.
Even after the adoption of industry standards, the future success of our
products depends on widespread market acceptance of their underlying
technologies.

 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 and 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 all
errors that we believe would be considered serious by our customers 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 problems occur 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, we are susceptible to currency fluctuations and other risks.

  Sales to customers outside North America accounted for approximately 28% of
our revenues in 2000, and we believe a material portion of our domestic sales
results in the use of our products outside North America.

                                      20
<PAGE>

Since customers generally evaluate our purchase price as expressed in their
own currency, changes in foreign currency exchange rates may hurt our sales in
other countries. In addition, some of our sales transactions are denominated
in local currency and we do not mitigate the currency risk by engaging in
currency-hedging transactions. An increase in the value of the U.S. dollar
relative to foreign currencies could make our products less competitive on a
price basis in international markets or adversely impact the U.S. dollar yield
from sales transactions denominated in local currency.

  Other risks arising from our international business include political
instability or recessions 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 and services in other countries.

 The market segments we target may not develop as rapidly as we anticipate.

  We operate in four segments of the communications market: enhanced services,
including speech-enabled access to network content; media and access gateways
and infrastructure; enterprise networks; IP services management. Although we
expect growth in these areas, each of these market segments is emerging,
undergoing rapid change or both and may fail to generate demand for our
products at the levels we anticipate, which could limit our future revenues
and harm our business.

 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 market segments 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. For example, the Federal Communications Commission
is currently examining the question of whether certain forms of telephone
services over the Internet should be subject to FCC regulation as
telecommunications services. If the FCC were to determine that Internet
telephony providers, or the services they provide, are subject to FCC
regulations, then some of the service providers that buy equipment from our
customers may be forced to pay access charges and make universal service
contributions. This could have a material adverse effect on those customers'
business and competitive position and could therefore force them to limit or
cut-off their purchases of our products.

 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 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, a third party is prevented from
acquiring us 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.

Item 2. Properties

  We lease a facility totaling approximately 100,000 square feet for our
corporate headquarters in Framingham, Massachusetts. The lease on this
facility expires in May 2012. In December 2000, we entered into another lease
with our landlord for additional space of approximately 45,000 square feet at
our corporate headquarters in Framingham. The term on this lease began in
January 2001 and expires in May 2012.

  We also lease facilities in Chaville, France, Saint-Hubert, Quebec,
Schaumburg, Illinois, and Tustin, California in which we conduct design and
engineering operations. The Chaville office also serves as our European sales
and service headquarters.

                                      21
<PAGE>

  In addition, we have short-term leases for 21 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 filed by Connectel, LLC 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 a United States patent owned by it and seeks injunctive relief and
damages in an unspecified amount. The patent relates to a specific routing
protocol. The action is in the early stages of discovery phase. We have
reviewed the allegations with our patent counsel and believe that none of our
products infringe upon the patent. We intend to deny the allegation of
infringement and defend against the claim vigorously.

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

  None during the fourth quarter of 2000.

                                      22
<PAGE>

                                    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 closing sale prices per share
of our common stock, as reported on the Nasdaq National Market, for the
periods indicated. These prices have been restated to reflect a two-for-one
stock split on August 7, 2000.

<TABLE>
<CAPTION>
                                                                   High   Low
                                                                  ------ ------
<S>                                                               <C>    <C>
Year Ended December 31, 1999
First Quarter.................................................... $ 4.27 $ 2.46
Second Quarter...................................................   5.03   1.53
Third Quarter....................................................   7.25   4.82
Fourth Quarter...................................................  23.44   6.75
Year Ended December 31, 2000
First Quarter.................................................... $42.88 $16.13
Second Quarter...................................................  56.22  22.50
Third Quarter....................................................  76.88  45.31
Fourth Quarter...................................................  57.25   6.03
</TABLE>

  As of December 31, 2000, we had approximately 249 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. In addition, our credit agreement with a bank and our indenture
governing our convertible subordinated notes contain covenants which prohibit
us from paying cash dividends.

Issuance of Unregistered Securities

  We acquired Inno Media Logic (I.M.L.) Inc. ("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, 2000, an aggregate of 160,096 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.

                                      23
<PAGE>

Item 6. Selected Financial Data

  Components of selected financial information consist of the following:

Selected Financial Information

<TABLE>
<CAPTION>
                                           Year Ended December 31,
                                  --------------------------------------------
                                   1996    1997     1998      1999      2000
                                  ------- ------- --------  --------  --------
<S>                               <C>     <C>     <C>       <C>       <C>
                                     (in thousands except per share data)
Revenues........................  $51,464 $75,363 $ 76,529  $ 79,476  $134,612
Gross profit....................   33,070  50,065   48,411    47,956    78,798
Operating income (loss).........    3,065   7,319  (10,057)  (17,869)  (35,555)
Income (loss) before income tax-
 es.............................    4,273   8,517   (8,993)  (17,688)  (26,871)
Income tax expense (benefit)....    2,643   4,758   (2,868)    1,000       780
                                  ------- ------- --------  --------  --------
Net income (loss)...............    1,630   3,759   (6,125)  (18,688)  (27,651)
                                  ======= ======= ========  ========  ========
Net income (loss) per share:
  Basic.........................  $  0.09 $  0.18 $  (0.28) $  (0.81) $  (0.83)
                                  ======= ======= ========  ========  ========
  Diluted.......................  $  0.08 $  0.17 $  (0.28) $  (0.81) $  (0.83)
                                  ======= ======= ========  ========  ========
Weighted average common shares
 used in computing net income
 (loss) per share:
  Basic.........................   18,740  20,962   21,847    22,965    33,147
  Diluted.......................   19,350  22,358   21,847    22,965    33,147
<CAPTION>
                                                 December 31,
                                  --------------------------------------------
                                   1996    1997     1998      1999      2000
                                  ------- ------- --------  --------  --------
<S>                               <C>     <C>     <C>       <C>       <C>
Total assets....................  $62,662 $81,693 $ 78,950  $ 70,709  $498,778
Long-term debt,
  less current portion..........      392     243      260       306   175,000
</TABLE>

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

Overview

  We provide enabling technologies to the world's leading suppliers of
networking and communications equipment. Our customers incorporate our
software and hardware products and technologies into their solutions in order
to enable communication service providers and enterprises to rapidly and cost-
effectively deploy data, voice and fax applications and enhanced services in
converged networks. These converged networks integrate packets of data, voice
and fax from several sources on a single physical network link and allow for
interoperability between the Internet, a packet-based network, and the public
switched telephone network (PSTN), which is circuit based.

  Over the past three years, we have been strategically repositioning our
business to address new, high growth markets resulting from the growth in the
converged network build out. To support this repositioning, we made
significant investments in our sales force, built a service organization,
expanded our research and development, acquired complementary products and new
capabilities for network infrastructure and services, and strengthened our
management team. As a result, we achieved sequential increases in revenue over
the prior quarter of 15% in the third quarter and 23% in the fourth quarter of
1999, and 11% in the first quarter, 16% in the second quarter, and 26% in the
third quarter of 2000. In the quarter ended September 30, 2000, we achieved
record revenues of $40.5 million representing a 100% increase over the same
period in the prior year. Revenues of $34.2 million for the fourth quarter of
2000 decreased sequentially over the prior quarter by 16% but still
represented an increase of 37% over the same period in the prior year. As we
are now in the midst of a broad-based economic slowdown

                                      24
<PAGE>

affecting most technology sectors and communications in particular, the levels
of revenue we will be able to achieve going forward will depend to a great
extent upon how long this slowdown will continue.

  In March 2000, we had an additional stock offering of 6.9 million shares
available to the public for $26.75 per share. This offering yielded an
additional $175 million in capital for general corporate purposes, including
working capital, capital expenditures and potential acquisitions.

  In July 2000, we acquired IML, a privately-held company headquartered in
Canada. IML is a leading provider of enabling technology used in voice over
digital subscriber line (VoDSL) gateways and other network access solutions.
In connection with the acquisition, we issued or reserved for issuance an
aggregate of 2,635,300 shares of our common stock, paid net aggregate cash
consideration of $65.8 million, and assumed the obligation to issue up to an
additional 318,672 shares of our common stock upon exercise of outstanding
stock options for the purchase of the common stock of IML. We have accounted
for the acquisition as a purchase.

  In October 2000, we issued $175 million of convertible subordinated notes
(the "notes"). The notes are convertible into shares of our 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 and they mature on October 15, 2005. Under the indenture
related to the notes, we are subject to certain covenants, including a
covenant that prevents a third party from acquiring us without the consent of
the debt holders.

  Our revenues consist primarily of product sales and, to a lesser extent,
services provided to our customers. We sell our products worldwide principally
through direct sales focusing on large original equipment manufacturers and
significant systems supplier customers. We use indirect channels to focus on
all other customers and prospects. This strategy allows us to focus our
resources on customers that offer us the largest revenue opportunities.

  Our 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 we have a future obligation to obtain
customer acceptance, revenues are deferred until this obligation has been met.
Our systems are generally a bundled hardware and software solution that are
shipped together. We have no obligations to customers after the date products
are shipped other than pursuant to warranty obligations. We provide for the
estimated costs to fulfill customer warranty and other contractual obligations
upon the recognition of the related revenue. We do not offer rights of return
to our customers. Shipping and handling fees, if any, billed to customers are
recognized as revenue. The related costs are recognized in cost of revenues.

  We do not provide maintenance service or rights to upgrades or enhancements.
Services are not sold with products. Services currently represent less than
10% of revenues and therefore are not presented separately. Services sold
separately include on-site support, telephone support, system hosting and
training. These services are recognized ratably over the contractual period or
as provided based on the nature of the service.

  Our cost of revenues consist primarily of product cost, cost of services
provided to our customers and the overhead associated with testing and
fulfillment operations.

  Sales, 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 and other general corporate expenses. As we add
personnel, launch new products and incur additional costs related to the
growth of our business, we expect these expenses to increase.

  Research and development expenses consist primarily of salaries, personnel
expenses and prototype fees related to the design, development, testing and
enhancement of our products. As of December 31, 2000, all

                                      25
<PAGE>

research and development costs have been expensed as incurred. We believe that
continued investment in research and development is critical to attaining our
strategic product and cost reduction objectives, and that these expenses will
increase in the future.

Results of Operations

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

<TABLE>
<CAPTION>
                                                            Year Ended
                                                           December 31,
                                                         ---------------------
                                                         1998    1999    2000
                                                         -----   -----   -----
<S>                                                      <C>     <C>     <C>
Revenues................................................ 100.0%  100.0%  100.0%
Cost of revenues........................................  36.7    39.7    41.5
                                                         -----   -----   -----
  Gross profit..........................................  63.3    60.3    58.5
                                                         -----   -----   -----
Operating expenses
  Selling, general and administrative...................  44.4    50.3    59.3
  Research and development..............................  28.0    31.0    23.2
  Purchased in-process research and development.........   --      --      2.4
  Merger costs..........................................   --      1.6     --
  Restructuring and other special charges...............   4.0    (0.1)    --
                                                         -----   -----   -----
    Total operating expenses............................  76.4    82.8    84.9
                                                         -----   -----   -----
Operating loss.......................................... (13.1)  (22.5)  (26.4)
  Other income, net.....................................   1.4     0.2     6.5
                                                         -----   -----   -----
Loss before income taxes................................ (11.7)  (22.3)  (19.9)
  Income tax expense (benefit)..........................  (3.7)    1.2     0.6
                                                         -----   -----   -----
Net loss................................................  (8.0)% (23.5)% (20.5)%
                                                         =====   =====   =====
</TABLE>

Year Ended December 31, 2000 Compared to Year Ended December 31, 1999

Revenues

  Revenues increased to $134.6 million for the year ended December 31, 2000
from $79.5 million for the year ended December 31, 1999, representing an
increase of 69.4%. The increase is attributable to increased volume of product
sales in North America, Asia and Europe, the 50.1% growth of our services
sector and $4.7 million of revenue from IML. Revenues from sales to customers
located outside North America were 28.3%, or $38.1 million, and 27.4%, or
$21.8 million, in 2000 and 1999, respectively. No single customer accounted
for more than 10% of revenues in 2000 or 1999.

Gross Profit

  Gross profit increased to $78.8 million for 2000 from $48.0 million for
1999, representing an increase of 64.3%. The increase in gross profit is
directly related to the additional revenue growth. Gross profit as a
percentage of revenue was 58.5% in 2000, compared to 60.3% in 1999,
representing a decrease of 3.0%. This decrease was due to a $3.7 million
increase in cost of revenues related to the purchase accounting write-up of
IML inventory to fair value at the date of acquisition, a $1.3 million
increase in cost of revenues related to the establishment of a reserve to
write-down IML inventory to the lower of cost or market value at December 31,
2000 and a $741,000 increase in cost of revenues related to the amortization
of the current technology acquired in the IML transaction.

                                      26
<PAGE>

Selling, General and Administrative

  Selling, general and administrative expense increased to $79.8 million for
2000 from $40.0 million for 1999, representing an increase of 99.7%. The
increase in expenses was primarily due to $12.8 million of amortization of
goodwill and other intangibles and $13.4 million of compensation expense
related to the acquisition of IML, which occurred in 2000. The additional
increase was due to costs associated with increased selling activity.

Research and Development

  Research and development expense increased to $34.5 million for 2000 from
$24.7 million for 1999, representing an increase of 39.7%. The increase in
expense was due to the write-off of $3.3 million of in-process research and
development expense related to the IML acquisition, $1.0 million expense
related to the execution of a funded research and development agreement
acquired in the IML transaction, and increased personnel and project
development costs associated with the CG6000, PowerBlade, PowerAccess, HearSay
and PacketMedia product lines and development of PolicyPoint. We expect that
our research and development expense will remain fairly consistent as a
percentage of revenue.

Purchased In-process Research and Development

  In-process research and development charge for the year ended December 31,
2000 is the result of the immediate expensing of the value allocated to the
in-process research and development efforts associated with IML's interface
technology. We assigned a value of $3.3 million to in-process research and
development based upon the utilization of a modified discounted cash flow
model.

  The in-process research and development is comprised of a category of
products that provide interface technology consisting of high capacity line
interfaces that convert telephony signals into computer data. These products
are used in media access gateway products to interface aggregate DSL or
wireless traffic to the PSTN or IP based data networks. At the date of
acquisition, these products were estimated to be 58% complete.

  A significant amount of uncertainty existed surrounding the successful
development and completion of the research and development acquired.
Significant risks exist because we are unsure of the obstacles we will
encounter in the form of time and cost necessary to produce technologically
feasible products. Should these products fail to become viable, it is unlikely
that we would be able to realize any value from the sale of the technology to
another party. The work performed as of the acquisition date on these in-
process products is very specific to the tasks and markets for which it is
intended. There are no alternative uses for the in-process work in the event
that the products are not feasible.

  We based the cash flow projections for revenue on the projected incremental
increase in revenue that we expected to receive from the completed acquired
in-process research and development. IML expected revenue to commence with
each product's release date, which occur on various dates in the fourth
quarter of 2000 and the first half of 2001, and continue throughout each
product's economic life, which range from three to six years. We deducted
estimated operating expenses from estimated revenue to arrive at estimated
pre-tax cash flows. Projected operating expenses included cost of goods sold,
selling, general and administrative expense, and research and development
expense. We estimated operating expenses as a percent of revenue based on
IML's historical results for the years ended March 31, 1999 to 2000. Projected
results for the fiscal years ended March 31, 2001 to 2005 were also used in
combination with past operating results and industry averages. We also
deducted capital charges, or cash flow attributable to other assets such as
working capital, customer list and assembled workforce, from pre-tax operating
income to isolate the cash flow solely attributable to the in-process research
and development. Income taxes were then deducted to arrive at after-tax cash
flows. We discounted the after-tax cash flow projections using a risk-adjusted
rate of return of 23%. In using the discounted model, we excluded the costs to
complete the in-process technology from the research and development expense
for 2000, and we reflected the percentage completion of the in-process
research and development in each year's projected cash flow.

                                      27
<PAGE>

Other Income, Net

  Other income and expense, reflecting net interest income, one time gains or
losses and foreign exchange gains and losses, increased to $8.7 million for
2000 from $181,000 for 1999. The increase is primarily due to gains of $2.2
million realized on the sale of minority investments and interest income on
cash received from the common stock offering completed in March 2000 and the
debt offering completed in October 2000. This was off-set by a $2.3 million
foreign currency translation loss generated on the intercompany debt related
to the IML transaction and interest expense related to the notes.

Income Tax Expense

  Income tax expense was $780,000 and $1.0 million for 2000 and 1999,
respectively. Our effective tax rate decreased in 2000 to 2.9% from 5.7% in
1999. In 2000, the primary components of the effect tax rate are the non-
deductible amortization of intangible assets and the maintenance of the full
valuation allowance on the deferred tax asset. In 1999, the primary component
of the effective tax rate was the establishment of a full valuation allowance
against the deferred tax asset as we concluded that a full valuation allowance
against our net deferred tax asset was required, under applicable accounting
standards, due to uncertainties surrounding its realization. This was
partially offset by 1999 operating loss carrybacks and a reduction in the
income tax reserve for probable loss contingencies.

Year Ended December 31, 1999 Compared to Year Ended December 31, 1998

Revenues

  Revenues increased to $79.5 million for the year ended December 31, 1999
from $76.5 million for the year ended December 31, 1998, representing an
increase of 3.9%. The increases is attributable to the growth of our services
sector, increased revenues in Europe and increased revenues from our strategic
accounts, partially offset by lower revenues in Latin America. Revenues from
sales to customers located outside North America were 27.4%, or $21.8 million,
and 26.9%, or $20.6 million, in 1999 and 1998, respectively. No single
customer accounted for more than 10% of revenues in 1999 or 1998.

Gross Profit

  Gross profit decreased to $48.0 million for 1999 from $48.4 million for
1998, representing a decrease of 0.9%. The decrease in gross profit was
related to increased expenses incurred for investment in the services and
manufacturing departments.

Selling, General and Administrative

  Selling, general and administrative expense increased to $40.0 million for
1999 from $34.0 million for 1998, representing an increase of 17.6%. The
increase in expenses was due to costs associated with increased selling
activity and increased expenditures for marketing, international expansion and
customer support. In 1999, we added a sales office in Italy. These increased
expenditures were in anticipation of increased revenues and aided in our
repositioning.

Research and Development

  Research and development expense increased to $24.7 million for 1999 from
$21.5 million for 1998, representing an increase of 15.1%. The increase in
expense was primarily due to increased personnel and project development costs
associated with the Convergence Generation and Alliance Generation product
lines and associated software, and development of PolicyPoint. We expect that
our research and development expense will continue to increase.

                                      28
<PAGE>

Merger-Related Expenses

  We incurred a charge of $1.2 million in the fourth quarter of 1999
consisting of investment banking, accounting and legal fees connected with
closing the QWES acquisition.

Restructuring and Other Special Charges

  In the fourth quarter of 1998, in response to changes in our business
environment we took several actions to create efficiency, to decrease cash
outflows and to manage our business more effectively that resulted in
restructuring and other special charges. To eliminate payroll and other
related expenditures, we reduced our head count by three senior international
managers. The accrued cost to implement this reduction was approximately
$951,000 (of which approximately $65,000 was paid in 1998). We also committed
to reduce future lease commitments for a new corporate office and engineering
space, neither of which will be occupied, which resulted in an estimated
charge of $2.1 million

  In 1999, we were able to buy out the lease commitment at one of the
locations and sublease the other location at an aggregate cost of
approximately $958,000, resulting in a saving of approximately $1.1 million
from our original estimate. There is no remaining balance for the lease
accruals at December 31, 1999.

  In 1999, we completed our management reorganization and terminated two
additional senior managers. The severance costs were approximately $441,000.
In addition, in 1999, we incurred a special charge of approximately $557,000
for payroll-related taxes on an option exercise by one of the terminated
managers. The lease commitment savings of $1.1 million, net of the additional
severance costs of $441,000 and payroll-related taxes of $557,000 resulted in
a $91,000 credit in 1999. At December 31, 2000 there are no remaining balance
for the severance accruals.

Other Income, Net

  Other income and expense, reflecting net interest income and foreign
exchange gains and losses, decreased to $181,000 for 1999 from $1.1 million
(exclusive of merger costs) for 1998, representing a decrease of 83.0%. The
decrease is primarily due to lower average cash balances for the period,
foreign exchange losses and an increase in interest expense associated with
the debt assumed in the QWES acquisition.

Income Tax Expense (Benefit)

  Income tax expense (benefit) was $1.0 million and ($2.9 million) for 1999
and 1998, respectively. During the quarter ended December 31, 1999, we
concluded that a full valuation allowance against our net deferred tax asset
was required, under applicable accounting standards, due to uncertainties
surrounding its realization. Accordingly, we established a full valuation
allowance for the net deferred tax asset of $4.8 million as of the beginning
of the year. This was partially offset by 1999 operating loss carrybacks and a
reduction in the income tax reserve for probable loss contingencies.

Liquidity and Capital Resources

  Cash provided by (used by) operations for the years ended December 31, 2000,
1999 and 1998 was $14.6 million, $7.6 million and ($4.1 million),
respectively. The net loss for the year ended December 31, 2000 included non-
cash charges for depreciation and amortization of $30.8 million, a $4.7
million accrual related to additional consideration that will be paid to the
former shareholders of IML in the form of NMS stock based on the achievement
of certain financial results and acquired in-process research and development
costs of $3.3 million. The increase in accrued expenses and other liabilities
is primarily due to the accrual of interest to be paid on the convertible
notes. Additionally, cash was provided by operations from the change in
inventory and income tax receivable. This was offset by the increase in
accounts receivable, which was due to the increase in sales in the fourth
quarter of 2000 versus the fourth quarter of 1999, the increase in prepaid and
other assets, and the decrease in accounts payable. Cash was provided by
operations in 1999 from our decreases in accounts

                                      29
<PAGE>

receivable, inventory and prepaid assets and increases in accrued expenses,
partially offset by the net loss. Cash was used in operations in 1998 from the
net loss, and increases in inventory, prepaid expenses and a restructuring and
special charge accrual partially offset by decrease in accounts receivable.

  Cash provided by (used in) investing activities in 2000, 1999 and 1998 was
($99.1 million), ($7.7 million) and $7.2 million, respectively. Cash of $672.8
million, $17.3 million and $6.5 million was used to purchase marketable
securities, with cash of $650.6 million, $16.4 million and $27.6 million
provided from maturities of marketable securities for 2000, 1999 and 1998,
respectively. Capital expenditures were $10.5 million, $6.2 million and $8.6
million for 2000, 1999 and 1998, respectively. Increased capital expenditures
in 2000 were primarily due to the acquisition of IML and the minority
investments in two privately held companies. Increased capital expenditures in
1998 were primarily due to increased in personnel-related and capital
improvement costs. We expect capital expenditures in 2001 will approximate
$14.2 million, principally for testing equipment, development equipment and
computer hardware and software.

  Cash provided by financing activities in 2000, 1999 and 1998 was $349.2
million, $4.2 million and $3.2 million, respectively. The financing in 2000
was provided primarily from the offerings of our common stock and notes. The
financing in 1999 was provided primarily by the exercise of stock options and
issuance of debt used to fund QWES operations. This was partially offset by
our purchase for $1.1 million of 100,000 shares of common stock through our
repurchase plan, which our board of directors authorized in July 1999 and
subsequently rescinded. The financing in 1998 was provided primarily from the
exercise of stock options and issuance of debt used to fund QWES operations.

  We established a $7.5 million bank line of credit for working capital
purposes effective May 1999 and amended on September 15, 2000. Borrowings
under our line of credit bear interest at the bank's floating rate of prime
plus one percent. This interest rate will be reduced to the bank's floating
rate of prime upon completion of a common stock offering by us. We are subject
to covenants requiring maintenance of certain profitability, equity and
liquidity ratios. As of December 31, 2000 we were in compliance with all of
those covenants, and there were no amounts outstanding. This credit agreement
is subject to renewal on May 13, 2001.

  We believe that our current cash and marketable securities will be
sufficient to meet our cash requirement to fund operations and expected
expenditures for the foreseeable future.

Recent Accounting Pronouncements

  In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"),
"Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133
was amended in July 1999 by the issuance of Statement of Financial Accounting
Standards No. 137 ("SFAS No. 137"), "Accounting for Derivative Instruments and
Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133--
An Amendment of FASB No. 133." SFAS No. 137 defers the implementation of SFAS
No. 133 by one year. SFAS No. 133 was further amended in June 2000 by the
issuance of Statement of Financial Accounting Standards No. 138 ("SFAS No.
138"), "Accounting for Certain Derivative Instruments and Certain Hedging
Activities--An Amendment of FASB Statement No. 133." SFAS No. 138 further
clarifies the provisions of SFAS No. 133. SFAS No. 133, as amended, is
effective for fiscal quarters beginning after January 1, 2001 for us and its
adoption is not expected to have a material impact on our financial position
or results of operations.
  In December 1999, the Securities and Exchange Commission ("SEC") released
Staff Accounting Bulletin No. 101, ("SAB 101"), "Revenue Recognition in
Financial Statements," as amended by SAB 101B, which is effective no later
than the year ended December 31, 2000. The bulletin clarifies the SEC's views
regarding recognition of revenue. We adopted SAB 101 in the fourth quarter of
2000. The application of the guidance in SAB 101 did not have a material
impact on our results of operations.

  In September 2000, the FASB issued SFAS No. 140 "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities--a
replacement of FASB Statement No. 125". SFAS No. 140 revises

                                      30
<PAGE>

the standards for accounting for securitizations and other transfers of
financial assets and collateral and requires certain disclosures, but it
carries over most of SFAS No. 125's provisions without reconsideration. This
Statement is effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after March 31, 2001. This Statement
is effective for recognition and reclassification of collateral and for
disclosures relating to securitization transactions and collateral for fiscal
years ending after December 15, 2000. We do not expect the adoption of SFAS
No. 140 to have a material impact on our financial position or results of
operations.

Quarterly Results

  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 (consisting only of normal
recurring adjustments) necessary for a fair presentation of such information.
This information has not been audited or reviewed by the Company's 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.

  In 1999 we began to realize the results of repositioning our business as we
achieved sequential increases in revenue over the prior quarter of 6% in the
second quarter, 15% in the third quarter and 23% in the fourth quarter of
1999, and 11% in the first quarter, 16% in the second quarter, and 26% in the
third quarter of 2000. In the quarter ended September 30, 2000, we achieved
record revenues of $40.5 million representing a 100% increase over the same
period in the prior year. Revenues of $34.2 million for the fourth quarter of
2000 decreased sequentially over the prior quarter by 16% but still
represented an increase of 37% over the same period in the prior year.

  Operating income (loss) during the eight quarters steadily increased as a
percent of revenues from quarter to quarter for 1999 and the first two
quarters of 2000. The significant decrease in operating income (loss) in the
third and fourth quarter of 2000 is primarily due to the increase in our
operating expenses that resulted from our acquisition of IML. The cost of
revenues increased in 1999 and the first two quarters of 2000 in-line with the
increase in revenues, as our profit margin remained consistent. During the
third and fourth quarter of 2000, our margins declined due to the increase in
cost of revenues, which was primarily the result of our acquisition of IML.
During 1999 and the first two quarters of 2000, selling, general and
administrative expenses and research and development expenses remained
relatively constant, even decreasing as a percentage of revenues. In the third
and fourth quarters of 2000, these costs increased, primarily due to our
acquisition of IML.

  The Company's quarterly operating results may fluctuate as a result of a
number of other factors, including timing of customer orders, adjustments of
delivery schedules to accommodate customer or regulatory requirements,
availability of components from suppliers, timing and level of international
sales, mix of products sold, and timing and level of expenditures for sales,
marketing and new product development.

  We operate on a relatively small backlog. Quarterly sales and operating
results therefore generally depend on the volume and timing of orders received
during or just before the start of the quarter. Our expense levels are based
in part on our forecasts of future revenues and, if such revenues were to fall
below expectations, our operating results could be adversely affected.
Accordingly, we cannot be sure that we will be profitable in any particular
quarter. All figures set out in the table below are in thousands.

                                      31
<PAGE>

<TABLE>
<CAPTION>
                                                           Quarter Ended
                          -------------------------------------------------------------------------------------
                          31-Mar-99  30-Jun-99  30-Sep-99  31-Dec-99  31-Mar-00 30-Jun-00 30-Sep-00   31-Dec-00
                          ---------  ---------  ---------  ---------  --------- --------- ---------   ---------
                                               (In thousands except per share data)
<S>                       <C>        <C>        <C>        <C>        <C>       <C>       <C>         <C>
Revenues................   $16,621    $17,565    $20,276    $25,014    $27,722   $32,125  $ 40,536    $ 34,229
Cost of revenues........     6,625      6,953      8,080      9,862     10,589    11,991    17,450      15,784
                           -------    -------    -------    -------    -------   -------  --------    --------
 Gross profit...........     9,996     10,612     12,196     15,152     17,133    20,134    23,086      18,445
Operating expenses:
 Selling, general and
  administrative........     9,743      9,775      9,966     10,492     11,011    11,806    28,840      28,191
 Research and
  development...........     5,925      6,258      6,278      6,244      6,984     6,940     8,434       8,847
 Purchased in-process
  research and
  development...........       --         --         --         --         --        --      3,300         --
 Merger related
  expenses..............       --         --         --       1,235        --        --        --          --
 Restructuring and other
  special charges.......       --         --         --         (91)       --        --        --          --
                           -------    -------    -------    -------    -------   -------  --------    --------
 Total operating
  expenses..............    15,668     16,033     16,244     17,880     17,995    18,746    40,574      37,038
                           -------    -------    -------    -------    -------   -------  --------    --------
Operating income
 (loss).................    (5,672)    (5,421)    (4,048)    (2,728)      (862)    1,388   (17,488)    (18,593)
Other income (loss)
 net....................      (208)       191         50        148      1,976     3,989     2,571         148
                           -------    -------    -------    -------    -------   -------  --------    --------
Income (loss) before
 income taxes...........    (5,880)    (5,230)    (3,998)    (2,580)     1,114     5,377   (14,917)    (18,445)
Income tax expense
 (benefit)..............    (1,858)    (1,580)    (1,156)     5,594         78       376       312          14
                           -------    -------    -------    -------    -------   -------  --------    --------
Net income (loss).......   $(4,022)   $(3,650)   $(2,842)   $(8,174)   $ 1,036   $ 5,001  $(15,229)   $(18,459)
                           =======    =======    =======    =======    =======   =======  ========    ========
<CAPTION>
                                                           Quarter Ended
                          -------------------------------------------------------------------------------------
                          31-Mar-99  30-Jun-99  30-Sep-99  31-Dec-99  31-Mar-00 30-Jun-00 30-Sep-00   31-Dec-00
                          ---------  ---------  ---------  ---------  --------- --------- ---------   ---------
                                                       (Percent of revenues)
<S>                       <C>        <C>        <C>        <C>        <C>       <C>       <C>         <C>
Revenues................     100.0%     100.0%     100.0%     100.0%     100.0%    100.0%    100.0%      100.0%
Cost of revenues........      39.9       39.6       39.8       39.4       38.2      37.3      43.0        46.1
                           -------    -------    -------    -------    -------   -------  --------    --------
 Gross profit...........      60.1       60.4       60.2       60.6       61.8      62.7      57.0        53.9
Operating expenses:
 Selling, general and
  administrative........      58.6       55.7       49.2       41.9       39.7      36.8      71.1        82.4
 Research and
  development...........      35.7       35.6       31.0       25.0       25.2      21.6      20.8        25.8
 Purchased in-process
  research and
  development...........       --         --         --         --         --        --        8.2         --
 Merger related
  expenses..............       --         --         --         4.9        --        --        --          --
 Restructuring and other
  special charges.......       --         --         --        (0.3)       --        --        --          --
                           -------    -------    -------    -------    -------   -------  --------    --------
 Total operating
  expenses..............      94.3       91.3       80.2       71.5       64.9      58.4     100.1       108.2
                           -------    -------    -------    -------    -------   -------  --------    --------
Operating income
 (loss).................     (34.2)     (30.9)     (20.0)     (10.9)      (3.1)      4.3     (43.1)      (54.3)
Other income, net.......      (1.2)       1.1        0.3        0.6        7.1      12.4       6.3         0.4
                           -------    -------    -------    -------    -------   -------  --------    --------
Income (loss) before
 income taxes...........     (35.4)     (29.8)     (19.7)     (10.3)       4.0      16.7     (36.8)      (53.9)
Income taxes expense
 (benefit)..............     (11.2)      (9.0)      (5.7)      22.4        0.3       1.2       0.8         0.0
                           -------    -------    -------    -------    -------   -------  --------    --------
Net income (loss).......     (24.2)%    (20.8)%    (14.0)%    (32.7)%      3.7%     15.5%    (37.6)%     (53.9)%
                           =======    =======    =======    =======    =======   =======  ========    ========
</TABLE>

European Union Currency Conversion

  On January 1, 1999, eleven member nations of the European Economic and
Monetary Union began using a common currency, the euro. For a three-year
transition period ending June 30, 2002, both the euro and each of the
currencies for such member nations will remain in circulation. After June 30,
2002, the euro will be the sole legal tender for those countries. We have
subsidiary operations in three of the eleven countries currently using the
euro, France, Germany and Italy, and we have branch operations in a fourth
country, Spain. We have assessed the potential impact of the euro conversion
in a number of areas, particularly the potential impact on pricing and other
marketing strategies, and on product development.

                                      32
<PAGE>

Other

  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 a non-marketable security is subject to
interest rate fluctuations, but we believe this risk is immaterial due to the
short-term nature of these investments. At December 31, 2000, we had $175.0
million of long-term debt outstanding. A hypothetical 10% decrease in our
weighted-average borrowing rate at December 31, 2000 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
operations of our international subsidiaries are primarily conducted in their
respective local currencies. 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 is denominated in U.S. dollars and will be settled during
the ordinary course of business. In 2000, as a result of remeasuring the debt
at each reporting period, we incurred a foreign exchange loss of approximately
$2.3 million. 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.

   For U.S. federal income tax purposes we have net operating loss
carryforwards available to reduce taxable income of approximately $33.8
million at December 31, 2000, a portion of which may be subject to Internal
Revenue Code Section 382. These carryforwards will begin to expire in 2019. We
also have a foreign net operating loss carryforward of approximately $6.0
million. Utilization of a portion of the net operating loss carryforwards is
subject to an annual limitation of approximately $772,000 under Internal
Revenue Code Section 382. We have $3.5 million of tax credits which are
composed of federal research and development credits and state and local
credits. These credits expire beginning in 2004.

  We believe that our revenues and results of operations have not been
significantly impacted by inflation during the past three fiscal years.

Item 8. Financial Statements and Supplementary Data

                       Report of Independent Accountants

To the Board of Directors and Stockholders of Natural MicroSystems
Corporation:

  In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) present fairly, in all material respects, the
financial position of Natural MicroSystems Corporation and its subsidiaries
(the "Company") at December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 2000 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 index appearing under Item 14(a)(2)
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.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP
Boston, Massachusetts
January 19, 2001

                                      33
<PAGE>

                        NATURAL MICROSYSTEMS CORPORATION

                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                              December 31,
                                                            ------------------
                                                              1999      2000
                                                            --------  --------
<S>                                                         <C>       <C>
                                                              (In thousands
                                                            except share and
                                                             per share data)
                          ASSETS
Current assets:
  Cash and cash equivalents................................ $ 16,617  $280,152
  Marketable securities....................................    6,837    29,002
  Accounts receivable, net of allowance for doubtful
   accounts of $1,408 and $1,260, respectively.............   11,604    18,840
  Inventories..............................................    5,393     7,781
  Prepaid expenses and other assets........................    3,030     5,189
  Income tax receivable....................................    2,014     2,278
                                                            --------  --------
    Total current assets...................................   45,495   343,242
                                                            --------  --------
Property and equipment, net................................   14,871    19,768
Other assets...............................................    6,538    16,340
Goodwill and other intangibles, net........................    3,805   119,428
                                                            --------  --------
    Total assets........................................... $ 70,709  $498,778
                                                            ========  ========
           LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable.........................................    7,211     6,576
  Accrued expenses and other liabilities...................    9,772    25,218
  Current portion of long-term debt........................    2,907       --
                                                            --------  --------
    Total current liabilities..............................   19,890    31,794
                                                            --------  --------
Long-term debt less current portion........................      306   175,000
Commitments and contingencies (see note 15)
Stockholders' equity:
  Common stock, $.01 par value; 90,000,000 shares
   authorized at December 31, 1999 and 2000, 25,532,522 and
   36,494,753 shares issued at December 31, 1999 and 2000,
   respectively, and 25,519,614 and 36,401,236 shares
   outstanding at December 31, 1999 and 2000,
   respectively............................................      255       364
Additional paid-in capital.................................   72,796   375,663
Accumulated deficit........................................  (21,980)  (49,631)
Accumulated other comprehensive loss.......................     (391)   (1,065)
Deferred compensation......................................      --    (31,028)
Notes receivable from common stockholders..................      (99)      (96)
Treasury stock, at cost, 12,908 and 93,517 shares in 1999
 and 2000, respectively....................................      (68)   (2,223)
                                                            --------  --------
Total stockholders' equity.................................   50,513   291,984
                                                            --------  --------
  Total liabilities and stockholders' equity............... $ 70,709  $498,778
                                                            ========  ========
</TABLE>

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

                                       34
<PAGE>

                        NATURAL MICROSYSTEMS CORPORATION

                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                    Year Ended December 31,
                                                   ----------------------------
                                                     1998      1999      2000
                                                   --------  --------  --------
                                                    (In thousands except for
                                                        per share data)
<S>                                                <C>       <C>       <C>
Revenues.......................................... $ 76,529  $ 79,476  $134,612
Cost of revenues..................................   28,118    31,520    55,814
                                                   --------  --------  --------
Gross profit......................................   48,411    47,956    78,798
Operating expenses:
  Selling, general and administrative.............   33,979    39,976    79,848
  Research and development........................   21,464    24,705    31,205
  Purchased in-process research and development...      --        --      3,300
  Merger related expenses.........................      --      1,235       --
  Restructuring and other special charges.........    3,025       (91)      --
                                                   --------  --------  --------
    Total operating expenses......................   58,468    65,825   114,353
                                                   --------  --------  --------
Operating loss....................................  (10,057)  (17,869)  (35,555)
  Interest income.................................    1,389       849    11,947
  Interest expense................................     (119)     (239)   (2,640)
  Other...........................................     (206)     (429)     (623)
                                                   --------  --------  --------
    Other income, net.............................    1,064       181     8,684
                                                   --------  --------  --------
Loss before income taxes..........................   (8,993)  (17,688)  (26,871)
  Income tax expense (benefit)....................   (2,868)    1,000       780
                                                   --------  --------  --------
Net loss.......................................... $ (6,125) $(18,688) $(27,651)
                                                   ========  ========  ========
Basic:
  Net loss per common share....................... $  (0.28) $  (0.81) $  (0.83)
                                                   ========  ========  ========
  Weighted average shares outstanding.............   21,847    22,965    33,147
                                                   ========  ========  ========
Diluted:
  Net loss per common share....................... $  (0.28) $  (0.81) $  (0.83)
                                                   ========  ========  ========
  Weighted average shares outstanding.............   21,847    22,965    33,147
                                                   ========  ========  ========
</TABLE>


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

                                       35
<PAGE>

                       NATURAL MICROSYSTEMS CORPORATION
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

<TABLE>
<CAPTION>
                                Preferred                                          Accumulated                  Notes
                                  stock     Common stock   Additional Accumulated     other                   receivable
                              ------------- --------------  paid-In    earnings   comprehensive   Deferred   from common
                              Shares Amount Shares  Amount  capital    (deficit)      loss      compensation stockholders
                              ------ ------ ------  ------ ---------- ----------- ------------- ------------ ------------
                                                                                      (in thousands)
<S>                           <C>    <C>    <C>     <C>    <C>        <C>         <C>           <C>          <C>
Balance, December 31, 1997..   --    $ --   21,576   $216   $ 65,095   $  2,833      $   (2)           --         --
                               ---   -----  ------   ----   --------   --------      -------      --------      -----
 Exercise of common
 stock options..                               327      3      1,460
 Issuance of
 common stock
 under employee
 purchase plan..                               133      1        920
 Issuance of
 common stock...                             1,867     19        859                                             (102)
 Reduction of
 notes
 receivable
 related to
 expenses of the
 Company paid by
 certain
 stockholders...                                                                                                    3
 Issuance of
 perferred
 stock..........                38     --                         35
 Deferred
 compensation...                                                 154                                  (154)
 Amortization of
 deferred
 compensation...                                                                                        44
 Foreign
 currency
 translation
 adjustment.....                                                                        (46)
 Net loss.......                                                         (6,125)
                               ---   -----  ------   ----   --------   --------      -------      --------      -----
Balance, December 31, 1998..    38   $ --   23,903   $239   $ 68,523   $ (3,292)     $   (48)     $   (110)     $ (99)
                               ---   -----  ------   ----   --------   --------      -------      --------      -----
 Exercise of common
 stock options
 and warrants...                               737      7      2,285
 Conversion of
 preferred into
 common.........               (38)            784      8        140
 Amortization of
 deferred
 compensation                                                                                          110
 Issuance of
 common stock
 under employee
 purchase plan..                               109      1        235
 Stock
 repurchase.....                              (200)    (2)
 Tax Benefit
 related to
 stock options..                                               2,165
 Treasury Stock
 used in ESPP
 Plan...........                               187      2       (552)
 Change in
 market value of
 securities
 available for
 sale...........                                                                          93
 Foreign
 currency
 translation
 adjustment.....                                                                        (436)
 Net loss.......                                                        (18,688)
                               ---   -----  ------   ----   --------   --------      -------      --------      -----
Balance, December 31, 1999..   --    $ --   25,520   $255   $ 72,796   $(21,980)     $  (391)     $    --       $ (99)
                               ---   -----  ------   ----   --------   --------      -------      --------      -----
 Exercise of common
 stock options
 and warrants...                             1,295     13      5,911
 Stock issued in
 follow-on
 offering, net
 of offering
 costs of
 $9,644.........                             6,900     69    174,862
 Stock issued in
 acquisition of
 IML............                             2,635     26    118,324
 Issuance of
 common stock
 under employee
 purchase plan..                               144      1      2,170
 Settlement of
 QWES.com
 escrow.........                               (73)            1,600
 Deferred
 compensation...                                                                                   (39,696)
 Amortization of
 deferred
 compensation...                                                                                     8,668
 Stock
 repurchase.....                               (20)
 Debt repayment
 by common
 stockholders...                                                                                                    3
 Foreign
 currency
 translation
 adjustment                                                                            (674)
 Net loss.......                                                        (27,651)
                               ---   -----  ------   ----   --------   --------      -------      --------      -----
Balance, December 31, 2000..   --    $ --   36,401   $364   $375,663   $(49,631)     $(1,065)     $(31,028)     $ (96)
                               ===   =====  ======   ====   ========   ========      =======      ========      =====
<CAPTION>
                                            Total
                              Treasury  stockholder's Comprehensive
                               stock       equity     income (loss)
                              --------- ------------- ------------- --- --- --- --- --- --- --- ---
<S>                           <C>       <C>           <C>           <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997..      --      $ 68,142      $  3,671
                              --------- ------------- =============
 Exercise of common
 stock options..                             1,463
 Issuance of
 common stock
 under employee
 purchase plan..                               921
 Issuance of
 common stock...                               776
 Reduction of
 notes
 receivable
 related to
 expenses of the
 Company paid by
 certain
 stockholders...                                 3
 Issuance of
 perferred
 stock..........                                35
 Deferred
 compensation...                               --
 Amortization of
 deferred
 compensation...                                44
 Foreign
 currency
 translation
 adjustment.....                               (46)          (46)
 Net loss.......                  --        (6,125)       (6,125)
                              --------- ------------- -------------
Balance, December 31, 1998..  $   --      $ 65,213      $ (6,171)
                              --------- ------------- =============
 Exercise of common
 stock options
 and warrants...                             2,292
 Conversion of
 preferred into
 common.........                               148
 Amortization of
 deferred
 compensation                                  110
 Issuance of
 common stock
 under employee
 purchase plan..                               236
 Stock
 repurchase.....               (1,058)      (1,060)
 Tax Benefit
 related to
 stock options..                             2,165
 Treasury Stock
 used in ESPP
 Plan...........                  990          440
 Change in
 market value of
 securities
 available for
 sale...........                                93            93
 Foreign
 currency
 translation
 adjustment.....                              (436)         (436)
 Net loss.......                           (18,688)      (18,688)
                              --------- ------------- -------------
Balance, December 31, 1999..  $   (68)    $ 50,513      $(19,031)
                              --------- ------------- =============
 Exercise of common
 stock options
 and warrants...                             5,924
 Stock issued in
 follow-on
 offering, net
 of offering
 costs of
 $9,644.........                           174,931
 Stock issued in
 acquisition of
 IML............                           118,350
 Issuance of
 common stock
 under employee
 purchase plan..                   68        2,239
 Settlement of
 QWES.com
 escrow.........               (1,600)         --
 Deferred
 compensation...                           (39,696)
 Amortization of
 deferred
 compensation...                             8,668
 Stock
 repurchase.....                 (623)        (623)
 Debt repayment
 by common
 stockholders...                                 3
 Foreign
 currency
 translation
 adjustment                                   (674)         (674)
 Net loss.......                           (27,651)      (27,651)
                              --------- ------------- -------------
Balance, December 31, 2000..  $(2,223)    $291,984      $(28,325)
                              ========= ============= =============
</TABLE>

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

                                       36
<PAGE>

                        NATURAL MICROSYSTEMS CORPORATION

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                    Years Ended December 31,
                                                    ---------------------------
                                                     1998      1999      2000
                                                    -------  --------  --------
                                                         (In thousands)
<S>                                                 <C>      <C>       <C>
Cash flow from operating activities:
Net loss..........................................  $(6,125) $(18,688) $(27,651)
Adjustments to reconcile net loss to cash provided
 by (used) in operating activities:
 Depreciation and amortization of fixed assets....    3,761     5,317     6,762
 Amortization of goodwill and other intangibles...    1,874     1,264    15,358
 Foreign exchange translation loss on intercompany
  debt............................................      --        --      2,291
 Gain on sale of investments......................      --        --     (2,228)
 Amortization of bond issuance costs..............      --        --        237
 Deferred stock compensation expense amortized or
  accrued.........................................       44       110    13,356
 Purchased in-process research and development....      --        --      3,300
 Deferred income taxes............................      --      4,820       --
 Receipt of previously written-off note
  receivable......................................      --        --       (484)
 Tax benefit from stock option exercises..........      --      2,165       --
 Other operating activities.......................      (26)      163      (121)
 Changes in operating assets and liabilities, net
  of effects of acquisition:
 Accounts receivable..............................    2,535     5,132    (3,035)
 Inventories......................................   (1,053)    4,195     3,202
 Prepaid expenses and other assets................   (2,216)      529    (1,725)
 Income tax receivable............................      139    (2,002)    1,385
 Accounts payable.................................      298     1,619    (1,480)
 Accrued expenses and other liabilities...........   (3,328)    2,975     5,399
                                                    -------  --------  --------
  Cash provided by (used in) operating
   activities.....................................   (4,097)    7,599    14,566
                                                    -------  --------  --------
Cash flow from investing activities:
 Additions to property and equipment..............   (8,618)   (6,194)  (10,479)
 Purchases of marketable securities...............   (6,470)  (17,326) (672,777)
 Proceeds from the sale of marketable securities..   27,578    16,393   650,570
 Acquisition of IML business, net of cash
  acquired........................................      --        --    (65,836)
 Proceeds from sale of investments................      --        --      5,728
 Purchase of investments..........................   (3,000)      --     (7,410)
 Proceeds from the sale of property & equipment...      100        61       194
 Additions to other assets and intangibles........     (505)     (159)      (64)
 Additions to goodwill for contingent payments....   (1,923)     (515)      --
 Receipts on notes receivable.....................      --        --        984
                                                    -------  --------  --------
  Cash provided by (used in) investing
   activities.....................................    7,162    (7,740)  (99,090)
                                                    -------  --------  --------
Cash flow from financing activities:
 Proceeds from the issuance of preferred stock,
  net.............................................      812       --        --
 Proceeds from the issuance of notes payable......      100     2,256       --
 Payments of notes payable........................      --        --     (2,588)
 Proceeds from issuance of common stock...........    2,381     2,125     8,111
 Issuance of common stock, net of issuance costs
  of $9,642.......................................      --        --    174,931
 Issuance of convertible notes....................      --        --    175,000
 Payment of issuance costs on convertible notes...      --        --     (5,698)
 Repurchase of common stock.......................      --     (1,058)     (623)
 Issuance of repurchased treasury common stock....      --        990        68
 Other financing activities.......................     (123)     (105)      (24)
                                                    -------  --------  --------
  Cash provided by financing activities...........    3,170     4,208   349,177
                                                    -------  --------  --------
Effect of exchange rate changes on cash...........     (381)      378    (1,118)
                                                    -------  --------  --------
Net increase in cash and cash equivalents.........    5,854     4,445   263,535
                                                    -------  --------  --------
Cash and cash equivalents, beginning of year......    6,318    12,172    16,617
                                                    -------  --------  --------
Cash and cash equivalents, end of year............  $12,172  $ 16,617  $280,152
                                                    =======  ========  ========
Supplemental cash flow information:
 Interest paid....................................  $   134  $    239  $    674
 Taxes paid.......................................    1,551       197       242
Noncash transactions:
 Acquisition of assets under capital lease........       13       --        --
 Issuance of common stock in exchange for notes
  receivable......................................      102       --        --
 Issuance of warrants.............................      --        147       --
 Acquisition of treasury stock through settlement
  of QWES.com escrow..............................      --        --      1,600
 Acquisition of business:
 Fair value of assets acquired, net of cash
  acquired........................................                      189,448
 Fair value of liabilities assumed................                        5,262
 Fair value of stock issued and common stock
  options exchanged...............................                      118,350
                                                                       --------
 Acquisition of business, net of cash acquired....                       65,836
</TABLE>

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

                                       37
<PAGE>

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1--Summary of Significant Accounting Policies

Business Description

  Natural MicroSystems Corporation (the "Company") provides enabling
technologies to the world's leading suppliers of networking and communications
equipment. The Company's customers incorporate its software and hardware
products and technologies into their solutions in order to enable service
providers and enterprises to rapidly and cost-effectively deploy data, voice
and fax applications and enhanced services in converged networks.

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.

Reclassifications

  Certain prior year amounts have been reclassified to conform to the current
year's presentation.

Use of Estimates

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

Foreign Currency Translation

  Assets and liabilities of the Company's subsidiaries operating outside the
United States which account 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
shareholders' equity. Gains and losses resulting from foreign currency
transactions are included in other income (expense), net and were immaterial
for 1998 and 1999. 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 will be settled during
the ordinary course of business. In 2000, as a result of remeasuring the debt
at each reporting period, the Company incurred a foreign exchange loss of
approximately $2.3 million. 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.

Revenue Recognition

  Revenue from product sales is generally recognized upon shipment providing
that persuasive evidence of an arrangement exists, the sales price is fixed or
determinable, collectibility is reasonably assured and title and risk of loss
have passed to the customer. If the Company has a future obligation to obtain
customer acceptance, revenues are deferred until this obligation has been met.
The Company's systems are generally a bundled hardware and software solution
that are shipped together. The Company has no obligations to customers after
the date products are shipped other than pursuant to warranty obligations. The
Company provides for the estimated costs to fulfill customer warranty and
other contractual obligations upon the recognition of the related revenue. The
Company does not offer rights of return to its customers. Shipping and
handling fees, if any, billed to customers are recognized as revenue. The
related costs are recognized in cost of revenues.


                                      38
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  The Company does not provide maintenance services or rights to upgrades or
enhancements. Services are not sold with products. Services currently
represent less than 10% of revenues and therefore are not presented
separately. Services sold separately include on-site support, telephone
support, system hosting and training. These services are recognized ratably
over the contractual period or as 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.

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 as other comprehensive income
(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 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.

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:

<TABLE>
   <S>                              <C>
   Machinery and equipment......... 3 years
   Computer equipment.............. 3-5 years
   Furniture and fixtures.......... 5 years
   Telecommunications computer
    equipment...................... 5 years
   Leasehold improvements.......... Shorter of the lease term or economic life
</TABLE>

  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 depreciated are removed from the accounts and any
resulting gain or loss is included in the results of operations.

Goodwill and Other Intangibles

  Goodwill, which is being amortized on a straight-line basis over its
estimated useful life of five years, was $2.4 million and $106.7 million, net,
at December 31, 1999 and 2000, respectively. Accumulated amortization was $1.7
million and $14.7 million as of December 31, 1999 and 2000, respectively.
Other intangible assets were $1.4 million and $12.7 million, net, at December
31, 1999 and 2000, respectively. These amounts include patents,

                                      39
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

trademarks, customer lists and other items, which are being amortized on a
straight-line basis over lives ranging from 4 to 17 years. Other intangibles
also include license agreements which are stated at cost. Amortization of
licenses is computed on the shorter of a per unit sold basis or over the
estimated useful lives of these licenses. At December 31, 1999 and 2000,
accumulated amortization amounted to $1.3 million and $3.4 million,
respectively. At January 1, 2000, the Company revised its estimate of the
useful life of existing goodwill from seven to five years. The net effect of
such change was a charge of $260,000 for the year ended December 31, 2000,
which is included in the statement of operations classification, "Amortization
of goodwill and other intangibles". Amortization expense for the years ended
December 31, 1998, 1999 and 2000 was $1.9 million, $1.3 million and $15.4
million, respectively.

Impairment of Long-Lived Assets

  The Company reviews long-lived assets, including goodwill, for impairment
whenever events or changes in business circumstances indicate that the
carrying amount of the assets may not be fully recoverable or that the useful
lives of these assets are no longer appropriate. Each impairment test is based
on a comparison of the undiscounted cash flows to the recorded value of the
asset. If an impairment is indicated, the asset is written down to its
estimated fair value on a discounted cash flow basis.

Research and Development

  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

  Financial instruments, primarily cash and cash equivalents, marketable
securities and accounts receivable are carried at amounts which approximate
their fair value. Fair value of long-term debt at December 31, 2000 is
approximately $77.2 million.

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 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.

Basic and Diluted Net Income (Loss) Per Common Share

  Basic net income (loss) per common share is computed by dividing net income
(loss) by the weighted-average number of common shares outstanding during the
period. Diluted net income (loss) per common share is computed by dividing the
net income (loss) by the sum of the weighted-average number of common shares

                                      40
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

outstanding plus all additional common shares that would have been outstanding
if potentially dilutive common stock equivalents had been issued.

Stock Split

  Per share amounts and share data have been retroactively restated to give
effect to the two-for-one stock split distributed on August 7, 2000, effected
in the form of a stock dividend.

Recent Accounting Pronouncements

  In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"),
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
was amended in July 1999 by the issuance of Statement of Financial Accounting
Standards No. 137 ("SFAS No. 137"), "Accounting for Derivative Instruments and
Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133--
An Amendment of FASB No. 133." SFAS No. 137 defers the implementation of SFAS
No. 133 by one year. SFAS No. 133 was further amended in June 2000 by the
issuance of Statement of Financial Accounting Standards No. 138 ("SFAS No.
138"), "Accounting for Certain Derivative Instruments and Certain Hedging
Activities--An Amendment of FASB Statement No. 133." SFAS No. 138 further
clarifies the provisions of SFAS No. 133. SFAS No. 133, as amended, is
effective for fiscal quarters beginning after January 1, 2001 for the Company
and its adoption is not expected to have a material impact on its financial
position or results of operations.

  In December 1999, the Securities and Exchange Commission ("SEC") released
Staff Accounting Bulletin No. 101, ("SAB 101"), "Revenue Recognition in
Financial Statements," as amended by SAB 101B, which is effective no later
than the year ended December 31, 2000. The bulletin clarifies the SEC's views
regarding recognition of revenue. The Company adopted SAB 101 in the fourth
quarter of 2000. The application of the guidance in SAB 101 did not have a
material impact on the Company's results of operations.

  In September 2000, the FASB issued SFAS No. 140 "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities--a
replacement of FASB Statement No. 125". SFAS No. 140 revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures, but it carries over most of SFAS
No. 125's provisions without reconsideration. This Statement is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001. This Statement is effective for recognition
and reclassification of collateral and for disclosures relating to
securitization transactions and collateral for fiscal years ending after
December 15, 2000. The Company does not expect the adoption of SFAS No. 140 to
have a material impact on its financial position 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,
historically 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, a lessening demand in the
telecommunications market and stock price volatility. It is reasonably
possible that the Company may incur impairment charges for intangible assets,
including goodwill, or investments in future reporting periods.


                                      41
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

3--Mergers and Acquisitions

IML

  Effective July 7, 2000, the Company acquired InnoMediaLogic Inc. ("IML"), a
privately held company headquartered in Canada. IML is a leading provider of
enabling technology used in voice over digital subscriber line (VoDSL)
gateways and other network access solutions. In connection with the
acquisition, the Company issued or reserved for issuance 2,635,300 shares of
NMS common stock valued at an average price of $39.66 per share, paid net
aggregate cash consideration of $65.8 million, and assumed the obligation to
issue up to an additional 318,672 shares of NMS common stock upon exercise of
outstanding stock options for the purchase of the common stock of IML. The
Company valued the IML options that were exchanged for NMS option using the
Black-Scholes option pricing model.

  The total cost of the acquisition, including transaction costs of $2.4
million, was approximately $189.9 million. For each of the years ended March
31, 2001 and 2002, certain employees of IML are entitled to additional
consideration based on the financial results of IML for the years then ended.
The maximum potential total additional consideration is $12.5 million and is
payable in the common stock of the Company. During the year ended December 31,
2000, the Company has accrued $4.7 million related to this additional
consideration as compensation expense, which is included in the statement of
operations classification, "Selling, general and administrative expense".

  The acquisition has been accounted for as a purchase business combination.
Accordingly, the results of operations of IML have been 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):

<TABLE>
<CAPTION>
                                                                     Estimated
                                                             Amount    Life
                                                            -------- ---------
   <S>                                                      <C>      <C>
   In-process research and development..................... $  3,300    --
   Acquired technology.....................................    6,000      4
   Customer list...........................................    6,300      4
   Workforce...............................................    1,600      4
   Deferred compensation...................................   39,696    2-3
   Net fair value of tangible assets acquired and
    liabilities assumed....................................    7,356    --
   Goodwill................................................  125,691      5
                                                            --------
   Total purchase price allocation......................... $189,943
                                                            ========
</TABLE>

  During the fourth quarter of 2000, the Company finalized its business plan
related to the acquisition and integration of IML. As a result, the company
recorded an increase to goodwill of $137,400 in order to account for the
severance of six former IML employees. Additionally, the Company reduced
goodwill by $1.1 million in the fourth quarter of 2000 to adjust for an
unsubstantiated liability on the opening balance sheet of IML.

  The in-process research and development is comprised of a category of
products that provide interface technology consisting of high capacity line
interfaces that convert telephony signals into computer data. These products
are used in media access gateway products to interface aggregate DSL or
wireless traffic to the PSTN (Public Switched Telephone Network) or IP based
data networks. At the date of acquisition, these products were estimated to be
58% complete.

  A significant amount of uncertainty existed surrounding the successful
development and completion of the research and development acquired.
Significant risks exist because the Company is unsure of the obstacles it will
encounter in the form of time and cost necessary to produce technologically
feasible products. Should these products fail to become viable, it is unlikely
that the Company would be able to realize any value from the sale

                                      42
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

of the technology to another party. The work performed as of the acquisition
date on these in-process products is very specific to the tasks and markets
for which it is intended. There are no alternative uses for the in-process
work in the event that the products are not feasible.

  The Company assigned values of $3.3 million to in-process research and
development and $6.0 million to existing core technology based upon an
independent appraisal that utilized a modified discounted cash flow model. The
in-process research and development amount of $3.3 million was immediately
expensed under applicable accounting standards. The Company based the cash
flow projections for revenue on the projected incremental increase in revenue
that the Company expected to receive from the completed acquired in-process
research and development. IML expected revenue to commence with each product's
release date, which occur on various dates in the fourth quarter of 2000 and
the first half of 2001, and continue throughout each product's economic life,
which range from three to six years. The Company deducted estimated operating
expenses from estimated revenue to arrive at estimated pre-tax cash flows.
Projected operating expenses included cost of goods sold, selling general and
administrative expense, and research and development expense. The Company
estimated operating expenses as a percent of revenue based on IML's historical
results for the years ended March 31, 1999 to 2000. Projected results for the
fiscal years ended March 31, 2001 to 2005 were also used in combination with
past operating results and industry averages. The Company also deducted
capital charges, or cash flow attributable to other assets such as working
capital, customer list and assembled workforce, from pre-tax operating income
to isolate the cash flow solely attributable to the in-process research and
development. Income taxes were then deducted to arrive at after-tax cash
flows. The Company discounted the after-tax cash flow projections using a
risk-adjusted rate of return of 23%. In using the discounted model, the
Company excluded the costs to complete the in-process technology from the
research and development expense for 2000, and the Company reflected the
percentage completion of the in-process research and development in each
year's projected cash flow.

  The amounts allocated to acquired technology, customer list and workforce
are being amortized over a four-year period. Goodwill is being amortized over
a five-year period. The amortization of acquired technology is included in the
statement of operations classification, "Cost of revenues," and the
amortization of customer list, workforce and goodwill is included in the
statement of operations classification, "Selling, general and administrative
expense."

  The following unaudited pro forma data summarize the combined results of
operations of NMS and IML for the twelve months ended December 31, 1999 and
2000 as if the acquisition had been completed as of the beginning of the
periods presented. The pro forma data give effect to actual operating results
prior to the acquisition and adjustments to interest expense, goodwill and
other intangibles amortization and income taxes. These pro forma amounts do
not purport to be indicative of the results that would have actually been
obtained if the acquisition had occurred at the beginning of the periods
presented or that may be obtained in the future.

<TABLE>
<CAPTION>
                                                              Twelve months
                                                             ended December
                                                                   31,
                                                            ------------------
                                                              1999      2000
                                                            --------  --------
                                                             (in thousands,
                                                            except per share
                                                                  data)
   <S>                                                      <C>       <C>
   Revenue................................................. $ 85,696  $142,948
   Operating loss.......................................... $(65,980) $(52,174)
   Net loss................................................ $(61,328) $(47,862)
   Basic and diluted net loss per share.................... $  (2.40) $  (1.38)
</TABLE>

QWES

  In December 1999, the Company acquired QWES.com, Inc. ("QWES") in a
transaction accounted for as a pooling of interests. QWES is a business in the
differentiated IP service provisioning and application traffic

                                      43
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

shaping markets. In connection with the acquisition, the Company exchanged or
reserved 3,000,000 shares of its common stock for the outstanding shares,
options and warrants of QWES, at an exchange ratio of 0.1372 shares for each
QWES common equivalent. Upon effectiveness of the merger, the Company issued
an aggregate of 2,899,570 shares of common stock in exchange for the
outstanding shares of capital stock of QWES, and it reserved 60,628 shares and
39,802 shares, respectively, for issuance upon exercise of the options and
warrants that it assumed from QWES. Of the issued shares, 289,922 shares were
placed in escrow as a reserve for general management representation and
warranties of QWES that were unknown as of the date of the merger. On December
20, 2000, this escrow was settled and 216,779 of the escrow shares were
distributed to the former QWES shareholders and 73,143 shares were retained by
the Company and are included in treasury stock at December 31, 2000.

  The consolidated financial statements of the Company for 1998 have been
restated to include the financial position, results of operations and cash
flows of QWES since its incorporation in April 1998. The Company incurred a
charge of $1.2 million in the fourth quarter of 1999 consisting of investment
banking, accounting and legal fees connected with closing the QWES
acquisition.

  Net revenue for the combined companies in 1998 was $76.5 million which was
totally related to Natural MicroSystems, as QWES had no revenues in 1998.
Operating income (loss) for the combined companies in 1998 was ($10.1) million
of which ($9.3) million related to Natural Microsystems and ($0.8) million
related to QWES. Net income (loss) for the combined companies in 1998 was
($6.1) million of which ($5.3) million related to Natural Microsystems and
($0.8) million related to QWES.

  Net revenue for the combined companies in 1999 was $79.5 million which was
totally related to Natural MicroSystems, as QWES had no revenues in 1999.
Operating income (loss) for the combined companies in 1999 was ($16.6) million
of which ($14.2) million related to Natural Microsystems and ($2.4) million
related to QWES. Net income (loss) for the combined companies in 1999 was
($18.7) million of which ($15.9) million related to Natural Microsystems and
($2.8) million related to QWES.

Teknique

  In June 1996, the Company acquired the outstanding shares of Teknique, Inc.
and an affiliate. The final purchase price totaled $8.3 million, including
contingent performance payments. During the years ended December 31, 1997 and
1998, $1.9 million and $515,000 of contingent consideration was earned and was
added to goodwill when it was paid in January 1998 and 1999, respectively.
There are no possible further contingent payments.

4--Restructuring and Other Special Charges

  In the fourth quarter of 1998, in response to changes in the Company's
business environment, several actions were taken to create efficiency, to
decrease cash outflows and to manage the business more effectively, that
resulted in restructuring and other special charges. To eliminate payroll and
other related expenditures, the Company reduced headcount by three senior
international managers. The accrued cost to implement this reduction was
approximately $951,000 (of which approximately $65,000 was paid in 1998). The
Company also committed to reduce future lease commitments for a new corporate
office and engineering space, neither of which will be occupied, which
resulted in an estimated charge of $2.1 million.

  In 1999, the Company was able to buy out the lease commitment at one of the
locations and sublease the other location at an aggregate cost of
approximately $958,000, resulting in a savings of approximately $1.1 million
from the original estimate. There is no remaining balance for the lease
accruals at December 31, 1999.

  In 1999, the Company completed the management reorganization and terminated
two additional senior managers. The severance costs were approximately
$441,000. In addition, in 1999, the Company incurred a

                                      44
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

special charge of approximately $557,000 for payroll-related taxes on an
option exercise by one of the terminated managers. The lease commitment
savings of $1.1 million, net of the additional severance costs of $441,000 and
payroll-related taxes of $557,000 resulted in a $91,000 credit in 1999. At
December 31, 2000 there are no remaining balance for the severance accruals.

5--Business and Credit Concentration

  No customer accounted for 10% or more of the Company's revenues for the
years ended December 31, 1998, 1999 and 2000, respectively. The Company did
have two customers that had ending accounts receivable balances that were
greater than 10% of the Company's balance at the end of 1999 and 2000. The
Company does not require collateral on accounts receivable or letters of
credit on foreign export sales. The Company evaluates its customer's
creditworthiness before extending credit and performs periodic credit reviews
on customers with existing credit. Additions to the allowance for doubtful
accounts were $775,000, $1,235,000 and $433,000 in 1998, 1999 and 2000,
respectively.

6--Investments

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

<TABLE>
<CAPTION>
                                                                 December 31,
                                                               ----------------
                                                                1999     2000
                                                               ------- --------
                                                                (in thousands)
   <S>                                                         <C>     <C>
   Money market mutual funds.................................. $ 1,136 $ 36,425
   Corporate securities.......................................  11,789  246,451
                                                               ------- --------
                                                               $12,925 $282,876
   Included in cash and cash equivalents......................   6,088  253,874
                                                               ------- --------
   Marketable securities...................................... $ 6,837 $ 29,002
                                                               ======= ========

  Since it is the Company's intent to maintain a liquid portfolio, at December
31, 2000, all marketable securities are due to mature within one year and the
unrealized gain (loss) is immaterial for all periods presented. Proceeds and
gross realized gains (losses) from sale of securities for the years ended
December 31, 1998, 1999 and 2000, were, $27.6 million, $16.4 million and
$650.6 million and $22,000, ($43,000) and $344,000 respectively.

  Investments for which there is not a readily determinable market value were
$3.8 million and $7.6 million at December 31, 1999 and 2000, respectively.
These investments are included in the consolidated balance sheet caption
"Other assets". For the year ended December 31, 2000, gross realized gains
from the sale of these investments was $2.2 million. The Company did not
realize any gains or losses related to these investments for either of the
years ended December 31, 1998 and 1999.

7--Inventories

  Inventories consist of the following:

<CAPTION>
                                                                 December 31,
                                                               ----------------
                                                                1999     2000
                                                               ------- --------
                                                                (in thousands)
   <S>                                                         <C>     <C>
   Raw materials.............................................. $   517 $  3,489
   Work in process............................................   2,611      713
   Finished goods.............................................   2,265    3,579
                                                               ------- --------
                                                               $ 5,393 $  7,781
                                                               ======= ========
</TABLE>


                                      45
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

8--Property and Equipment

  Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                               December 31,
                                                             ------------------
                                                               1999      2000
                                                             --------  --------
                                                              (in thousands)
<S>                                                          <C>       <C>
Computer equipment.......................................... $ 14,015  $ 18,912
Computer software...........................................    4,495     7,882
Furniture and fixtures......................................    2,331     3,143
Machinery and equipment.....................................    1,670     2,637
Leasehold improvements......................................    4,744     6,053
                                                             --------  --------
                                                               27,255    38,627
                                                             --------  --------
Less accumulated depreciation...............................  (12,384)  (18,859)
                                                             --------  --------
                                                             $ 14,871  $ 19,768
                                                             ========  ========
</TABLE>

  Depreciation and amortization expense was $3.8 million, $5.3 million and $6.8
million for the years ended December 31, 1998, 1999 and 2000, respectively.

9--Income Taxes

  The components of income tax expense consist of the following:

<TABLE>
<CAPTION>
                                                   Year Ended December 31,
                                                  ---------------------------
                                                   1998      1999      2000
                                                  -------  --------  --------
                                                       (in thousands)
<S>                                               <C>      <C>       <C>
Current income tax expense (benefit):
  Federal........................................ $  (311) $ (3,927) $    185
  State..........................................      40        25       100
  Foreign........................................     158        89       495
                                                  -------  --------  --------
                                                     (113)   (3,813)      780
Deferred income tax expense (benefit):
  Federal........................................  (2,184)    3,340       --
  State..........................................    (636)      613       --
  Foreign........................................      65       860       --
                                                  -------  --------  --------
                                                   (2,755)    4,813       --
                                                  -------  --------  --------
                                                  $(2,868) $  1,000  $    780
                                                  =======  ========  ========
Deferred tax assets (liabilities) consist of the
 following:
  Net operating loss carryforwards............... $ 2,040  $  7,211  $ 16,636
  Tax credit carryforwards.......................     370     1,547     3,538
  Inventories....................................     314       682       277
  Receivable allowances..........................     302       637       --
  Accrued expenses...............................   1,168      (516)      832
  Other..........................................   1,291     1,495     6,539
                                                  -------  --------  --------
                                                  $ 5,485  $ 11,056  $ 27,822
                                                  -------  --------  --------
Fixed assets.....................................    (313)   (1,048)   (1,633)
                                                  -------  --------  --------
Valuation allowance:                                 (359)  (10,008)  (26,189)
                                                  -------  --------  --------
Net deferred taxes............................... $ 4,813  $    --   $    --
                                                  =======  ========  ========
</TABLE>

                                       46
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  For U.S. federal income tax purposes, the Company has net operating loss
carryforwards available to reduce taxable income of approximately $33.8
million at December 31, 2000, 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 $6.0 million. The Company has $3.5 million of tax credits which
are composed of federal research and development credits and state and local
credits. These credits expire beginning in 2004. Under applicable accounting
standards, management believed that the realization of certain deferred tax
assets were more unlikely than not and, accordingly, established a full
valuation. During fiscal 2000, the deferred tax asset valuation allowance
increased by $16.2 million, primarily as the result of additional net
operating loss carryforwards and tax credit carry forwards. 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 $18.8
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.

  The difference between the total expected income tax expense computed by
applying the federal income tax rate of 34.0% to income before income taxes
and the reported income tax expense is as follows:

<TABLE>
<CAPTION>
                                                Year Ended December 31,
                                               -----------------------------
                                                1998       1999       2000
                                               -------   --------   --------
<S>                                            <C>       <C>        <C>
Computed 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......................................    (5.3)      (4.9)       0.4
Rate differential of foreign operations.......     --         1.9       (0.5)
State tax credits.............................     --        (3.4)       --
U.S. federal research and development
 credits......................................     --        (3.2)      (7.6)
Change in valuation allowance.................     3.1       43.3       19.2
Exempt interest...............................    (1.8)       --         --
Purchased in-process research and
 development..................................     --         --         4.3
Amortization of nondeductible intangibles.....     3.6        1.9       22.2
Acquisition expense...........................     --         2.2        --
Other.........................................     2.5        1.9       (1.1)
                                               -------   --------   --------
Effective tax rate............................   (31.9)%      5.7%       2.9%
                                               =======   ========   ========

  The domestic and foreign components of earnings before income tax were:

<CAPTION>
                                                Year Ended December 31,
                                               -----------------------------
                                                1998       1999       2000
                                               -------   --------   --------
                                                     in thousands
<S>                                            <C>       <C>        <C>
Domestic...................................... $  (441)  $(15,435)  $ 18,628
Foreign.......................................  (8,552)    (2,253)   (45,499)
                                               =======   ========   ========
                                               $(8,993)  $(17,688)  $(26,871)
                                               =======   ========   ========
</TABLE>

                                      47
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


10--Accrued Expenses and Other Liabilities

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

<TABLE>
<CAPTION>
                                                                  December 31,
                                                                 --------------
                                                                  1999   2000
                                                                 ------ -------
                                                                 (in thousands)
<S>                                                              <C>    <C>
Accrued compensation and related expenses....................... $6,314 $14,877
Accrued interest expense........................................    --    2,288
Income taxes payable............................................    114   2,359
Accrued restructuring and other special charges.................    450     --
Other liabilities...............................................  2,894   5,694
                                                                 ------ -------
                                                                 $9,772 $25,218
                                                                 ====== =======
</TABLE>

11--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, 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 most restrictive of which
prohibits the Company from paying cash dividends. The Company incurred debt
issuance costs aggregating $5.7 million, which have been deferred and will be
amortized as a component of interest expense over the term of the notes. The
unamortized issuance costs, $5.5 million at December 31, 2000, are included in
the consolidated balance sheet caption "Other assets."

Bank Line of Credit

  The Company established a $7.5 million bank line of credit for working
capital purposes effective May 14, 1999 and amended September 15, 2000.
Borrowings under the line of credit bear interest at the bank's floating rate
of prime plus one percent. This interest rate will be reduced to the bank's
floating rate of prime upon completion of a common stock offering by the
Company. The Company is subject to covenants requiring maintenance of certain
profitability, equity and liquidity ratios. The Company is currently compliant
with all covenants under the line, the most restrictive of which relates to
the Company's profitability, and there are no amounts currently outstanding.
This credit agreement as amended is subject to renewal on May 13, 2001.

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. The total amount of
this debt that was outstanding at December 31, 1999 was $2.5 million with
interest rates ranging from 8.0% to 10.0% per annum. During 2000, this debt
was paid in full by the Company and at December 31, 2000, there are no amounts
outstanding relating to this debt. In

                                      48
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 $.04 per share for 141,084 shares and $3.94 per share for the remaining
28,586 shares. The warrants are exercisable in whole or in part at any time
from the date of the grant and expire four years from the date of grant. At
December 31, 2000, warrants to purchase 19,062 shares were outstanding. The
estimated fair value of the warrants aggregating approximately $147,000, was
reflected as original issue discount reducing the carrying value of the notes
on the accompanying balance sheet at December 31, 1999 and has been fully
amortized to interest expense over the respective lives of the notes.

  Included in debt is a government advance of $31,000 at December 31, 1999.
This represents an interest free loan from the French government repayable
from the proceeds of export sales from France. At December 31, 2000, there are
no amounts outstanding related to this government loan.

12--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 employer contribution for the years ended December 31, 1998,
1999 and 2000 was $416,000, $452,000 and $588,000, respectively.

  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 $10,000 per calendar year.

13--Earnings Per Share

  The following is a reconciliation of basic and diluted EPS computations for
net loss, pursuant of SFAS 128:

<TABLE>
<CAPTION>
                                                                        Per
                                                Loss        Shares     Share
                                             (Numerator) (Denominator) Amount
                                             ----------- ------------- ------
<S>                                          <C>         <C>           <C>
Year Ended December 31, 2000
Basic net loss per common share.............  $(27,651)   33,147,471   $(0.83)
Effect of dilutive securities (stock
 options)...................................       --            --       --
                                              --------    ----------   ------
Diluted net loss per common share...........  $(27,651)   33,147,471   $(0.83)
                                              ========    ==========   ======
Year Ended December 31, 1999
Basic net loss per common share.............  $(18,688)   22,964,684   $(0.81)
Effect of dilutive securities (stock
 options)...................................       --            --       --
                                              --------    ----------   ------
Diluted net loss per common share...........  $(18,688)   22,964,684   $(0.81)
                                              ========    ==========   ======
Year Ended December 31, 1998
Basic net loss per common share.............  $ (6,125)   21,846,522   $(0.28)
Effect of dilutive securities (stock
 options)...................................       --            --       --
                                              --------    ----------   ------
Diluted net loss per common share...........  $ (6,125)   21,846,522   $(0.28)
                                              ========    ==========   ======
</TABLE>

  The effect of dilutive options excludes those stock options for which the
impact would have been anti-dilutive based on the exercise price of the
options. The number of options that were anti-dilutive at December 31, 1998,
1999, and 2000 were 6,699,402, 5,496,976 and 1,580,055, respectively.

                                      49
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


14--Stock Option and Stock Purchase Plans

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 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-employees 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. As of December 31, 2000, 280,000 shares
had been granted at prices ranging from $2.44 to $24.63 per share. 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. 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. In April 1998, the Board of Directors amended the
plan to increase the number of shares available for purchases to 2,600,000
shares of common stock, and in March 1999, the Board of Directors amended the
plan to increase the number of shares available for purchases to 3,600,000
shares of common stock. 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

                                      50
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 2,500,000 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 100% and 50%, respectively, of
the fair market value of the company's common stock on the date of grant.

<TABLE>
<CAPTION>
                              Year Ended           Year Ended          Year Ended
                           December 31, 1998   December 31, 1999    December 31, 2000
                          -------------------- ------------------- --------------------
                                      Weighted            Weighted             Weighted
                                      Average             Average              Average
                                      Exercise            Exercise             Exercise
                           Options     Price    Options    Price    Options     Price
                          ----------  -------- ---------  -------- ----------  --------
<S>                       <C>         <C>      <C>        <C>      <C>         <C>
Outstanding at beginning
 of period..............   3,532,502   $ 7.84  4,729,016   $5.70    5,496,700   $ 5.74
Granted.................   3,864,070     8.20  2,060,894    4.94    3,871,627    36.38
Exercised...............    (342,618)    4.60   (607,122)   3.68   (1,274,287)    4.57
Forfeited or expired....  (2,324,938)   13.32   (686,088)   4.79     (320,156)   13.27
                          ----------           ---------           ----------
Outstanding at end of
 period.................   4,729,016     5.70  5,496,700    5.74    7,773,884    20.84
                          ----------           ---------           ----------
Exerciseable at end of
 period.................   1,648,458     5.47  2,352,920    5.75    2,680,062     5.80
                          ==========           =========           ==========
</TABLE>

  The following table summarizes information concerning currently outstanding
and exercisable options as of December 31, 2000:

<TABLE>
<CAPTION>
                             Weighted    Weighted   Weighted
                              Average    Remaining  Average              Average
                              Number    Contractual Exercise   Number    Exercise
 Range of Exercise Prices   Outstanding    Life      Price   Exercisable  Price
 ------------------------   ----------- ----------- -------- ----------- --------
 <S>                        <C>         <C>         <C>      <C>         <C>
 $0.17-$10.00.............   3,773,215      6.3      $4.50    2,374,771   $ 4.46
 $10.01-$20.00............     377,198      6.8      15.27      226,290    13.95
 $20.01-$30.00............     291,356      8.5      23.53       79,001    22.85
 $30.01-$40.00............   1,756,060      4.4      32.70          --       --
 $40.01-$50.00............   1,440,705      4.6      45.86          --       --
 $50.01-$60.00............      43,900      4.8      56.17          --       --
 $60.01-$70.00............      14,200      4.7      65.26          --       --
 $70.01-$80.00............      77,250      4.7      71.95          --       --
                             ---------                        ---------
                             7,773,884               20.84    2,680,062     5.80
                             =========                        =========
</TABLE>

Other Stock Option Information

  On July 9, 1998, the Company gave certain holders of stock options,
including executive officers, the opportunity to exchange options for new
options with a lower exercise price and with a new vesting schedule beginning
on the grant date of the new options. The Company believes the repricing
restores the long-term incentive element of its stock option programs. The
options were valued at $5.10, which reflects the market closing price on the
date of the repricing. There were 2,081,278 options that were exchanged at
exercise prices ranging from $6.16 to $24.31. Prior to this event, the Company
had never engaged in a repricing of common stock options.

  All options granted under the various plans administered by the Company have
a vesting life not to exceed four years. These options have an expiration date
of ten years from the date of grant, with the exception of all repriced
options, which have an expiration date of seven years from the date of grant.


                                      51
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

  The Company applies Accounting Principles Board Option No. 25 "Accounting
for Stock Issued to Employees" and related interpretations in accounting for
its stock option and employee stock purchase plan.

  The weighted average fair value at date of grant for stock options granted
during the years ended December 31, 1998, 1999 and 2000 was $1.67, $3.42 and
$30.83, respectively. Had compensation cost for the Company's stock option
grants been determined based on the fair value at the grant dates, as
calculated in accordance with SFAS No.123, the Company's net loss, and net
loss per diluted common share for the years ended December 31, 1998, 1999 and
2000, would have been $8.2 million, $23.6 million and $51.1 million and $0.38,
$1.03 and $1.54, respectively. The fair value of each option granted during
the years ended December 31, 1998, 1999 and 2000 is estimated on the date of
grant using the Black-Scholes option pricing model with the following
assumptions; an expected life of five years, no dividend yield, 50.0% expected
volatility in 1998, 80.0% in 1999 and 100.0% in 2000, and a risk free interest
rate of 5.6% for 1998, 6.4% for 1999 and 6.1% for 2000.

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. As of December 31, 2000, 706,948 shares have been issued
under the Purchase Plan at prices ranging from $2.18 to $34.11 per share.

Restricted Stock Awards

  On April 3, 1998, QWES.com, Inc. issued 1,867,524 shares of restricted
common stock at a fair value of $0.06 per share to its founders. The stock was
scheduled to vest over a three-year period, but vested in full, in accordance
with its original terms, when the Company acquired QWES in December 1999.

15--Commitments and Contingencies

  The Company leases its current manufacturing and office facilities under
non-cancelable leases extending to May 31, 2012. The Company occupies other
facilities under leases, which expire within one year. Rental expenses under
all operating lease agreements in effect during December 31, 1998, 1999 and
2000 amount to approximately $1.3 million, $1.8 million and $2.7 million,
respectively.

  The Company currently has a sublease on one of its facilities located in
Schaumburg, Illinois. The lease, which commenced in November 1999, calls for
future payments to the Company of $4.9 million from January 2001 through
October 2008, the end of the original lease term. These payments over time
would reduce the overall lease burden of the Company at December 31, 2000 to
$35.2 million.

  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 our current needs and
that suitable space will be available to meet future needs.

                                      52
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


  At December 31, 2000, commitments under operating leases for minimum future
payments consist of the following:

<TABLE>
<CAPTION>
                                                                 (in thousands)
                                                                 --------------
<S>                                                              <C>
Year ending December 31,
2001............................................................    $ 4,085
2002............................................................      4,151
2003............................................................      3,995
2004............................................................      3,954
2005............................................................      3,561
Thereafter......................................................     20,392
                                                                    -------
                                                                    $40,138
                                                                    =======
</TABLE>

  The Company is the defendant in an action filed by Connectel, LLC 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 a United States patent owned by it and seeks
injunctive relief and damages in an unspecified amount. The patent relates to
a specific routing protocol. The action is in the early stages of discovery
phase. The Company has reviewed the allegations with its patent counsel and
believes that none of its products infringe upon the patent. Accordingly, the
Company has not recorded any liability in the financial statements. The
Company intends to deny the allegation of infringement and defend against the
claim vigorously.

                                      53
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


16--Segment and Geographic Information

  The Company manages and reports its business internally on the basis of
geographic area. See Note 1 for a description of the Company's business. All
intercompany revenues and expenses are eliminated in computing revenues and
operating income. As of December 31, 2000 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 exchange rates. Net sales by
geographic region are presented by attributing revenues from external
customers on the basis of where products are sold. "Other" includes the
regions of Asia and Latin America.

<TABLE>
<CAPTION>
                                 North
                                America   Europe    Other   Corporate  Total
                                --------  -------  -------  --------- --------
                                              (in thousands)
<S>                             <C>       <C>      <C>      <C>       <C>
Net Sales to unaffiliated
 customers:
  2000........................  $ 96,471  $18,376  $19,765            $134,612
  1999........................    57,664   14,329    7,483              79,476
  1998........................    55,906   11,772    8,851              76,529
Income (loss) from operations:
  2000........................  $(46,540) $ 2,070  $ 8,915            $(35,555)
  1999........................   (16,780)    (608)    (481)            (17,869)
  1998........................    (1,283)  (4,208)  (4,566)            (10,057)
Segment assets:
  2000........................  $200,257  $13,773  $ 1,879  $282,869  $498,778
  1999........................    47,287    9,764    1,355    12,303    70,709
  1998........................    51,655    9,540    1,086    16,669    78,950
Long-lived assets:
  2000........................  $137,386  $ 1,458  $   282            $139,126
  1999........................    17,197    1,153      248              18,598
  1998........................    16,876    1,383      367              18,626
Capital expenditures:
  2000........................  $  9,286  $ 1,050  $   143            $ 10,479
  1999........................     5,668      423      103               6,194
  1998........................     7,354      909      355               8,618
Depreciation and amortization
 expense:
  2000........................  $ 21,488  $   524  $   108            $ 22,120
  1999........................     6,028      497       56               6,581
  1998........................     5,074      459      102               5,635
</TABLE>

  Included in North America are the United States and Canada. Net sales to
unaffiliated customers from the United States were $55.9 million, $57.7
million and $96.5 million for the years ended December 31, 1998, 1999 and
2000, respectively. Long-lived assets in the United States were $16.9 million,
$17.2 million and $17.9 million at December 31, 1998, 1999 and 2000,
respectively. Additionally, Canada had long-lived assets of $119.5 million at
December 31, 2000. There are no other countries that had material net sales to
unaffiliated customers or long-lived assets.

                                      54
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)


Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

  None.

Valuation and Qualifying Accounts

 Schedule VIII

<TABLE>
<CAPTION>
                                                                      Column E
    Column A            Column B         Column C      Column D      Balance at
  Allowance for        Balance at                                      end of
doubtful accounts   beginning of year   Additions    Deduction (1)      year
-----------------   -----------------   ---------    -------------   ----------
<S>                 <C>                 <C>          <C>             <C>
12/31/98               $  641,918       $  755,448     $618,369      $  778,997
12/31/99               $  778,997       $1,235,480     $605,993      $1,408,484
12/31/00               $1,408,484       $  433,073     $581,195      $1,260,362
</TABLE>
--------
(1) Amounts include write-offs of accounts receivable deemed to be
    uncollectable.

                                       55
<PAGE>

                                   PART III

Item 10. Directors and Executive Officers of the Registrant

  The following table lists our executive officers and directors as of
December 31, 2000:

<TABLE>
<CAPTION>
Name                       Age                      Position
----                       --- --------------------------------------------------
<S>                        <C> <C>
Robert P. Schechter......   52 Chairman of the Board, President and Chief
                                Executive Officer

Robert E. Hult...........   53 Senior Vice President of Finance and Operations,
                                Chief Financial Officer and Treasurer

George D. Kontopidis, Ph.   47 Senior Vice President of Engineering
 D.......................

Dorothy A. Terrell.......   55 Senior Vice President of Worldwide Sales and
                                Services and President of the Services Group

R. Brough Turner.........   54 Senior Vice President of Technology

Alex N. Braverman........   41 Vice President and Corporate Controller

Allen P. Carney..........   50 Vice President of Marketing

William E. Foster........   56 Director

Ofer Gneezy..............   48 Director

Zenas W. Hutcheson, III..   47 Director

W. Frank King, Ph. D.....   61 Director

Pamela D. A. Reeve.......   51 Director

Ronald W. White..........   60 Director
</TABLE>

  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.

  Mr. Schechter has served as a member of the Board, President and Chief
Executive Officer of Natural MicroSystems since April 1995 and as Chairman of
the Board since March 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 Infinium Software, Inc., a developer of enterprise-level business
software applications and Moldflow Corporation, a leader in process-wide
solutions for optimizing the design and manufacture of plastic products.

  Mr. Hult joined Natural MicroSystems as Vice President of Finance, Chief
Financial Officer and Treasurer in October 1998 and became Senior Vice
President of Finance and Operations in April 1999. From 1996 to 1998 he held
numerous positions at AltaVista Search Service (a division of Digital
Equipment Corporation), most recently serving as Chief Operating Officer,
Chief Financial Officer and General Manager. He served Digital Equipment
Corporation in a variety of financial executive positions from 1972 to 1995.
Mr. Hult is also a director of Centra Software.

  Dr. Kontopidis has served as our Vice President of Engineering since January
1989 and became Senior Vice President of Engineering in April 1999. From 1984
until 1989, he was director of engineering of the Sea Data Division of Pacer
Systems, Inc., a maker of oceanographic instruments.

  Ms. Terrell joined Natural MicroSystems as our Senior Vice President of
Corporate Operations and President of the Services Group in February 1998 and
became Senior Vice President of Worldwide Sales and President of the Services
Group in April 1999. From 1991 until 1997, she was President of SunExpress,
Inc., the

                                      56
<PAGE>

after-marketing and online services company of Sun Microsystems, Inc. Ms.
Terrell is also a director of Sears Roebuck and Company, General Mills, Inc.
and Herman Miller, Inc.

  Mr. Turner, a co-founder of Natural MicroSystems, has served as our Senior
Vice President of Technology since 1994. He served as Vice President of
Operations from 1983 to 1994.

  Mr. Braverman has 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.

  Mr. Carney has served as our Vice President of Marketing since April 1996.
From 1992 to 1996, Mr. Carney held various marketing positions including Vice
President, Applications Marketing and Vice President of International
Marketing at Lotus Development Corporation. From 1982 to 1992, Mr. Carney held
various marketing positions including Vice President, European Operations,
with Atex, Inc., a turnkey supplier of pre-press automation systems.

  Mr. Foster began serving as a director of Natural MicroSystems in July 2000.
He is a private investor serving on the boards of several private high-
technology companies. In 1980, Mr. Foster co-founded Stratus Computer, Inc., a
supplier 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. Gneezy began serving as a director of Natural MicroSystems in July 2000.
He is co-founder, director, President and Chief Executive Officer 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.

  Mr. Hutcheson has served as a director of Natural MicroSystems since 1989.
He has been, since September 1997, a general partner of St. Paul Venture
Capital, a venture capital firm. From 1996 to 1998, Mr. Hutcheson was Chief
Executive Officer of Vivo Software, Inc., a developer of web-based video and
audio streaming applications. From 1981 to 1996, Mr. Hutcheson was President
of Hutcheson & Co., Inc., a management consulting firm.

  Dr. King has served as a director of Natural MicroSystems 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. (formerly a
division of Pencom, 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 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; Excaliber Technologies Corporation, a developer of document
management software; Concero, formerly known as PSW Technologies, Inc.;
Perficient, Inc., a provider of virtual professional services organizations to
Internet software companies; and Allaire Corporation, a provider of Internet
infrastructure software.

  Ms. Reeve has served as a director of Natural MicroSystems since 1997. She
has served, since September 1993, as Chief Executive Officer and a director
and, from 1989 to September 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 WebLink
Wireless, Inc., formerly known as PageMart Wireless, Inc., a provider of
wireless messaging services.

                                      57
<PAGE>

  Mr. White has served as a director of Natural MicroSystems since 1988. Since
October 1997, he has been a partner of Argo Global Capital, formerly known as
GSM Capital, a venture capital fund focused on wireless technology. Since
1983, Mr. White has been a partner of Advanced Technology Development Fund, a
venture capital firm. Mr. White is a director of Preferred Networks, Inc., a
provider of paging services.

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 the Company's Proxy Statement for its Annual Meeting
of Stockholders to be held May 4, 2001 is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management

  The information appearing under the caption "Stock Ownership of Directors,
Executive Officers and Principal Stockholders" of the Company's Proxy
Statement for its Annual Meeting of Stockholders to be held May 4, 2001 is
incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

  The information appearing under the caption "Certain Relationships and
Related Transactions" of the Company's Proxy Statement for its Annual Meeting
of Stockholders to be held May 4, 2001 is incorporated herein by reference.

                                      58
<PAGE>

                                    PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on FORM 8K

(A) (1) Financial Statements

  The following are included in Part II of this report:

Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1999 and 2000.
Consolidated Statements of Operations for the Years Ended December 31, 1998,
1999 and 2000.
Consolidated Statements of Stockholders' Equity for the Years Ended December
31, 1998, 1999 and 2000. Consolidated Statements of Cash Flow for the Years
Ended December 31, 1998, 1999 and 2000.
Notes to the Consolidated Financial Statements.

(A) (2) Financial Statement Schedules

  The following are included on the indicated pages of this report:

<TABLE>
<CAPTION>
                                                                        Page No.
                                                                        --------
<S>                                                                     <C>
Report of Independent Accountants on Schedule..........................    33
Schedule VIII Valuation and Qualifying Accounts........................    55
</TABLE>

  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 61, is incorporated herein by reference.

(A) (4) Reports on Form 8K

  The Registrant filed a current report on Form 8-K on October 12, 2000
regarding the issuance of $175 million of convertible subordinated notes,
which was consummated on October 5, 2000.

                                      59
<PAGE>

                                  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.

                                          Natural Microsystems Corporation

                                                /s/ Robert P. Schechter
                                          By: _________________________________
                                                    Robert P. Schechter
                                                 President, Chief Executive
                                             Officer and Chairman of the Board

  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.

<TABLE>
<CAPTION>
              Signature                            Title                    Date
              ---------                            -----                    ----

<S>                                    <C>                           <C>
     /s/ Robert P. Schechter           President, Chief Executive      March 14, 2001
______________________________________  Officer and Chairman of the
         Robert P. Schechter            Board of Directors
                                        (Principal Executive
                                        Officer)

        /s/ Robert E. Hult             Senior Vice President of        March 14, 2001
______________________________________  Finance and Operations,
            Robert E. Hult              Chief Financial Officer and
                                        Treasurer (Principal
                                        Financial Officer)

      /s/ Alex N. Braverman            Vice President and Corporate    March 14, 2001
______________________________________  Controller (Chief
          Alex N. Braverman             Accounting Officer)

      /s/ William E. Foster            Director                        March 14, 2001
______________________________________
          William E. Foster

         /s/ Ofer Gneezy               Director                        March 14, 2001
______________________________________
             Ofer Gneezy

    /s/ Zenas W. Hutcheson III         Director                        March 14, 2001
______________________________________
        Zenas W. Hutcheson III

    /s/ W. Frank King, Ph. D.          Director                        March 14, 2001
______________________________________
        W. Frank King, Ph. D.

      /s/ Pamela D. A. Reeve           Director                        March 14, 2001
______________________________________
          Pamela D. A. Reeve

       /s/ Ronald W. White             Director                        March 14, 2001
______________________________________
           Ronald W. White
</TABLE>

                                      60
<PAGE>

                                 EXHIBIT INDEX

  The Company 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 the Company may require payment of a reasonable fee not
to exceed its cost of furnishing such exhibit.

<TABLE>
<CAPTION>
 No.                                      Title
 ---                                      -----
 <C>     <S>
  1.1*   Convertible Debt Underwriting Agreement dated as of October 5, 2000 by
          and among the Registrant and each of Deutsche Bank Securities Inc.,
          U.S. Bancorp Piper Jaffray Inc. and Dain Rauscher Incorporated (filed
          with the Registrant's Form 8-K dated October 12, 2000).

  2.4*   Agreement and Plan of Merger and Reorganization dated as of November
          30, 1999 by and among the Registrant, NMS California Acquisition
          Corp. and QWES.com, Inc. (filed with the Registrant's Form 8-K dated
          January 13, 2000).

  2.5*   Amendment to Agreement and Plan of Merger and Reorganization dated as
          of December 15, 1999 by and among the Registrant, NMS California
          Acquisition Corp., QWES.com, Inc. and NMS Delaware Acquisition Corp.
          (filed with the Registrant's Form 8-K dated January 13, 2000).

  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).

  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 Registrant's
          registration statement on Form S-1 (#33-72596)).

  3.3*   Certificate of Amendment to Fourth Restated Certificate of
          Incorporation of the Registrant (filed with the Registrant's Form 10-
          Q for the quarter ended June 30, 2000).

  4.1*   Specimen Certificate for the Common Stock (filed with 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).

 10.3*   Agreement dated as of February 28, 1992 between Registrant and Eltron
          Associates (filed with the Registrant's registration statement on
          Form S-1 (#33-72596)).

 10.11#* 1989 Stock Option and Stock Purchase Plan, as amended (filed with the
          Registrant's registration statement on Form S-1 (#33-72596)).

 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#* 1993 Employee Stock Purchase Plan, as amended and restated (filed with
          the Registrant's registration statement on Form S-8 (333-40940)).

 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)).

 10.18*  Lease Amendment between Registrant and Lillian Greene dated April 4,
          1995 (filed with the Registrant's Form 10-Q for the quarter ended
          June 30, 1995).

 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)).
</TABLE>
<PAGE>

<TABLE>
<CAPTION>
 No.                                      Title
 ---                                      -----
 <C>     <S>
 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).

 10.21*  Loan Modification Agreement dated May 17, 1996 between Registrant and
          Silicon Valley Bank (filed with the Registrant's Form 10-Q for the
          quarter ended June 30, 1996).

 10.22*  Turnkey Manufacturing Agreement dated June 1, 1996 between the
          Registrant and Sanmina Corporation.

 10.23#* 2000 Equity Incentive Plan (filed with Registrant's registration
          statement on Form S-8 (333-40940)).

 10.24*  Loan and Security Agreement dated May 14, 1999 between the Registrant
          and Silicon Valley Bank (filed with the Registrant's Form 10-Q for
          the quarter ended September 30, 2000).

 10.25*  First Loan Modification Agreement dated March 8, 2000 between the
          Registrant and Silicon Valley Bank (filed with the Registrant's Form
          10-Q for the quarter ended September 30, 2000).

 10.26*  Second Loan Modification Agreement dated September 15, 2000 between
          the Registrant and Silicon Valley Bank (filed with the Registrant's
          Form 10-Q for the quarter ended September 30, 2000).

 21.1    Subsidiaries of the Company.

 23.1    Consent of PricewaterhouseCoopers LLP.

 25.1*   Form T-1 Statement of Eligibility of State Street Bank and Trust
          Company to act as trustee under the Indenture (filed with the
          Registrant's Form 8-K dated October 12, 2000).
</TABLE>

--------
*  Previously filed with the registration statement or report indicated.
#  Management contract or compensatory plan or arrangement.