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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-K

(Mark One)

|ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------

For the fiscal year ended December 31, 2001

|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission file number 0-23282

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

|DELAWARE(State or other jurisdiction of incorporation or organization) | 04-2814586(IRS Employer Identification No.)
|---------------------------------------------------------------------- | -------------------------------------------

100 CROSSING BOULEVARD, FRAMINGHAM, MASSACHUSETTS 01702(Address of principal executive offices)

508-271-1000(Registrant's telephone number, including area code)

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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Title of class

Name of each exchange on which registeredCommon stock, $.01 per share

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, 2002, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $125.9 million, based on the
closing price on such date of the registrant's Common Stock on the NASDAQ National Market. As of February 28, 2002, 35,959,983 shares of Common Stock, $.01 par value per share were outstanding.

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Documents Incorporated by Reference

Portions of the registrant's Proxy Statement relating to the 2002 Annual Meeting of Stockholders of the registrant are incorporated by reference into
Part III of this Form 10-K. Some of the exhibits listed in the accompanying Exhibit Index beginning on page 75 are incorporated by reference.

EXHIBIT INDEX ON PAGE 75

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

NMS Communications Corporation, NMS, CT Access, Natural Access, Natural Call Control, Convergence Generation, Mercury, Sonata III, Symphony,
Cadenza II, PacketMedia, HearSay, PowerBlade and PowerAccess are trademarks; Studio Sound and Alliance Generation are registered trademarks; and NMS is a trade name of the registrant. All other
brand names or trademarks appearing in this Form 10-K are the property of their respective holders.

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

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

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PART I

Item 1.    Business.

OVERVIEW

NMS Communications Corporation ("NMS") designs, delivers and supports technology-leading systems and system building blocks for innovative voice, video and data
services on wireless and wireline networks. NMS products and services are built on open technologies and strategic relationships with application and technology suppliers, and leverage
best-in-class supply chain and integration partnerships. Because of this, NMS customers, all of the world's top communications equipment suppliers, and many of the world's top
solution developers and service providers, are able to enhance their competitive position and bring their applications and services to market faster and at lower cost.

Our
products consist of complete systems for voice enhancement and voice applications and services, and system building blocks for customer relationship management and contact centers,
interactive voice response, unified messaging, enhanced services, media servers, voice over Internet protocol gateways and conferencing. The voice enhancement offering, recently acquired from Lucent
Technologies, Inc. ("Lucent"), consists of a comprehensive portfolio of open, ready-to-install products and services that are deployed in large switching systems to facilitate
the achievement of consistently clear audio qualityand through which all voice traffic on wireless networks must pass. These systems have been installed in central offices and mobile
switching centers worldwide with over 10 million channels deployed.

Voice
application systems provide wireless and wireline operators with the capability for rapid and cost-effective deployment of customized, innovative voice-driven services.
Our voice application systems include call and media processing, speech technology from all of the leading suppliers, operations, administration, management, provisioning, and billing interfaces,
application servers with open, standard programming interfaces, and a validated group of well-known, third-party applications including voice-
activated dialing and unified messaging. NMS system building blocks, consistent leaders in price performance, scalability and flexibility, provide basic hardware and software functions that enable
network equipment manufacturers and solutions developers to rapidly develop and deploy new voice communications services, applications and infrastructure. Our system building blocks are deployed in
over 90 countries in enhanced services, network infrastructure, and voice-based enterprise applications.

Demand
for our solutions arises from:



Our
products and services 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
2001, we took important steps to focus our company on markets for wireless systems and solutions, where healthy competition among operators, rapidly evolving technologies, and new
service

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requirements are expected to drive sustained growth and profitable opportunities. We significantly reduced our cost structure during the past six months by exiting certain activities, including our
IP Services Management initiative, and by reducing our yearly expense rate by approximately $25 million. We established new initiatives in the areas of voice-driven applications and services
and packet infrastructure. These directly address critical wireless operator requirements such as increased revenue per subscriber, reduced customer turnover and cost effective migration to next
generation networks.

In
November 2001, NMS completed the acquisition of the voice enhancement and echo cancellation business of Lucent. This acquisition provides NMS with a family of complete,
ready-to-install systems, an experienced carrier-facing sales force, a top-notch development group, significant intellectual property, including patents, and access
to a set of customers, through Lucent, that includes some of the world's largest wireless operators. Additionally, NMS has a multi-year agreement to serve as the exclusive supplier of
stand-alone voice enhancement and echo cancellation systems for Lucent, as Lucent continues to supply these systems to its global service provider customers. At the same time, the agreement allows NMS
to expand its market reach by establishing new alliances with other communications equipment suppliers and service providers.

In
April 2001, NMS acquired privately held Mobilee, Inc. ("Mobilee"), a Boston and Israel based wireless Internet infrastructure provider. With this acquisition, NMS added
VoiceXML, audio streaming technologies, and considerable applications integration experience to its portfolio of capabilities.

Strong
partnerships with companies around the world enhance our ability to deliver essential technologies to service providers and network equipment suppliers and reduce
time-to-market for these customers. Beginning in early 2002, we added new technology partners including Oracle and Sun Microsystems in conjunction with the introduction of NMS'
Hearsay product. NMS works with Oracle to enable operators to take advantage of the wireless capabilities of Oracle9 Application Server and give their customers access to advanced voice services.
Because wireless operators around the world know and trust Sun's Netra systems, NMS works closely with Sun's Network Equipment Provider Group to deliver carrier-grade, NEBS-certified
reliability and uptime.

NMS
has also broadened and strengthened relationships with speech technology suppliers, such as InfoTalk, Nuance, Philips and SpeechWorks, to ensure that NMS platforms for developing new
enhanced services and applications support a wide range of speech processing technologies. New speech application partners, announced in early 2002, include Oracle and Ureach Technologies, Inc.

We
broadened our reach and expanded our market coverage by adding new distribution partners, including AVNET/ACS in Europe, the S.A.S. Group in Hong Kong and Taiwan, and other
distributors in Asia.

NMS
has made and continues to make significant investments in its supply chain capabilities, improving our ability to rapidly fulfill product at competitive costs. This is increasingly
required by our customers as they seek to make their operations more efficient and responsive. For example, we extended our
contract manufacturing relationships, which now include the globally distributed capabilities of SMTC Manufacturing Corporation, Celestica Inc., and Via Systems, Inc.

INDUSTRY BACKGROUND

The communications sector is a diverse, multi-billion dollar market that ranges from wireless applications and infrastructure, to Web services and voice portals,
to equipment that delivers voice, video and data over packet and broadband networks. Participants in this industry succeed by maintaining a clear focus on business fundamentals, particularly
developing and selling revenue-generating applications and services, maximizing the value of existing network infrastructure, and reducing the time to market, cost and risk of developing solutions.

The
communications industry has experienced dynamic change over the past few years, including reduced capital expenditures by service providers, limited availability of capital in the
capital markets,

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reduced valuations, consolidation of service providers and equipment manufacturers, and workforce reductions. In addition, we are in a broad-based economic slowdown affecting most technology sectors.
There are indications of stabilization that suggest the restructuring of the industry may be nearing completion, yet carrier capital expenditure concerns continue, as evidenced by the delay in the
buildout of the 3G wireless network. Upon recovery of the economy, we expect the resumption of rapid growth in the telecommunications industry and the purchase of communications equipment, including
our products, driven by the primary factors described below.

MARKET NEEDS

The most advanced markets for wireless services are Japan and Western Europe. International Data Corporation ("IDC") estimates that 69.4% of the European
population and 57% of the Japanese population were mobile subscribers at the end of 2001. The market for wireless services in the United States is on the threshold of enormous change and opportunity.
IDC estimates the total number of wireless subscribers in the United States will increase from 125.5 million at the end of 2001 to 200.6 million subscribers in 2006, growing at a
compound annual growth rate (CAGR) of 9.8%. IDC further estimates that business subscribers will account for the strongest growth (12.4% CAGR).

There
are major opportunities for growth in the consumer market in the coming years. We believe, beginning as early as 2003, new wireless terminals optimized to enhance wireless data
services, such as access to Internet content, will emerge in the marketplace. This trend paves the way for carriers to provide richer media experiences by offering premium services such as
high-quality multimedia beginning in 2004. Wireless carriers are now aggressively upgrading their networks to 2.5G, which adds data (internet access and text messaging) to the current
wireless infrastructure, and rolling out services expansively in their markets as part of their gradual migration paths to full 3G, a completely new
wireless infrastructure with high performance and greater packet orientation, expected to be commercially deployed and operational in 2004 with widespread deployment thereafter.

As
wireless carriers begin their 2.5G/3G deployments in the next 18 to 24 months, they are expected to offer enhanced functionality to existing services while introducing more
robust wireless data applications to consumers and businesses. These advanced networks will support higher data speeds and provide always-on functionality, global roaming, location
services and support for high-quality multimedia. Consumers can expect to see some of the following applications and functionality based on 2.5G and 3G wireless network deployments:



Declining
subscriber growth and the resulting need to increase the average revenue per user will compel carriers to migrate their existing customer base from analog and 2G to 2.5G and 3G
networks to provide new revenue streams from these services. Additionally, the efficiencies in the use of the radio spectra that allow for significant increases in subscribers and services afforded by
2.5G and 3G networks will further necessitate carriers migrating their customers to next generation networks. 3G operators will seek to differentiate their high-value services in the
marketplace, while new opportunities

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will arise for infrastructure suppliers, content providers, advertisers and application service providers to thrive in the evolving 3G ecosystem.

In
the near term, however, the growth of wireless data services will be gated by a number of hurdles. These include customer awareness, uncertain or confusing pricing strategies, lack of
interoperability among different carrier networks, carrier control of content and customer security concerns. Consumers will initially be unaware of the burgeoning array of new services offered.
Carriers will need to focus on educating consumers about wireless services other than voice and will have to step up targeted marketing campaigns to reflect this new concept. Initially, pricing of
wireless data services is likely to be confusing and frustrating to consumers as carriers experiment with connection-based and usage-based pricing structures, both of which are neither familiar nor
amenable to consumers. This confusion may delay or prevent consumer adoption of one or more services. Currently, widespread adoption of wireless messaging services, including short message service and
instant messaging is inhibited by the lack of network interoperability among all carriers. Additionally, based on their respective affiliations, carriers still control wireless content, quite unlike
the way traditional Internet content is provided. This limits the Internet content choices for subscribers and thus the widespread adoption of wireless Internet content services. Additionally,
consumer perception about wireless security will need to be addressed to allay any consumer concerns related to wireless messaging applications, Internet access, and ultimately mobile commerce.

THE NMS COMMUNICATIONS SOLUTION

We provide complete, open systems to the world's leading wireless and wireline network operators and network equipment providers. These systems enable
communications service providers to rapidly create new services, including voice quality enhancements and voice application systems. We provide system building blocks that enable network equipment
manufacturers and solutions developers to rapidly develop and deploy new voice communications services in wireless, wireline and enterprise networks.

NMS
services include product evaluation support, systems architecture and engineering design and development, trial and deployment support, and post deployment lifecycle management
services. Our Services and Solutions group has expertise in a broad range of communications technologies and specialization in the areas of wireless video, speech applications infrastructure, and
specialized hardware including hardware for data services.

These
systems, system building blocks and services facilitate the rapid creation and deployment of enhanced services and applications, including voice, video and data services, 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 servers, microprocessors, digital signal processors and operating system software.

STRATEGY

Our objective is to be the leading provider of systems to the top telecommunications service providers around the world and the leading supplier of systems and
system building blocks to the major network equipment providers and solutions developers.

Growth
areas that NMS addresses include:



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The
following are key elements of our strategy:

Focus on wireless.The business challenges for wireless network operators include competition for
subscribers, retention of subscribers, and the need to increase average revenues per user. As a result, these operators provide innovative new services. We believe that our technologies, products and
services are uniquely suited to these business challenges.

Provide a complete solution.To insure the commercial success of our products and services, we invest
in development of a complete set of capabilities and services required by the end customer. Examples of capabilities which NMS coordinates in its offering to customers include systems, speech,
database, network operations, systems integration, supply chain, and other technology and services suppliers. Our investment makes NMS accountable to the end customer for the complete solution.

Strengthen and expand strategic partnerships.Our strategic relationships with speech technology,
applications, and technology partners are essential to our complete solutions offering. We work closely
with partners to insure that our customers are provided with the most integrated solution comprised of the latest offerings, and that there is a clear line of support and accountability.

Extend our technology leadership.We have assembled a team of approximately 300 engineers and
technical personnel. Over our 25 years of experience, we have developed significant expertise in voice and media processing, including echo cancellation, background noise suppression, voiceXML
technology, speech based applications, global network interface and protocol technologies, digital signal processing software, and specialized silicon for media processing. We intend to continue to
invest in our technological expertise through in-house development and strategic acquisitions.

Support open architecture and evolving standards.We will continue to support open architectures and
industry standards. We expect that this will in turn further reduce development time for our customers and enable them to take advantage of advances made in complementary technologies. Our products
are open and accessible, allowing our customers to integrate them into their environments. We have a record of developing and promoting open industry standards and intend to continue our leadership
role.

Strengthen and expand relationships with strategic customers.Our strategy is to establish and
maintain long term working relationships with, and to sell our products and services to, leading network operators and network equipment providers. We dedicate over 100 sales and technical services
personnel to approximately 100 network operators and 40 network equipment providers worldwide. By focusing on leading network operators and network equipment providers, we believe we can reach the
largest portion of our market opportunity while minimizing the cost and complexity of our marketing efforts. These customer relationships also provide us with multiple sales opportunities across
product lines. We work closely with our customers to design our software and hardware solutions into their offerings 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.

Expand reach and improve coverage through channel partners.We use indirect channel partners to reach
the broader market, including network equipment providers, solutions developers, and additional geographies. These channel partners provide sales, marketing, pre- and
post-sales support, fulfillment, and credit services to additional customers. We plan to migrate more of our system building blocks sales through these indirect channels as we focus on the
systems business.

Leverage our corporate infrastructure.NMS' sales and services organization comprises over 100 people
and represents our company's product line to service providers, network operators, major telecommunication equipment providers and solution developers around the world. Our customers require rapid
availability of our products at a cost effective price. We have made significant investments in systems, supplier relationships, customer relationships, systems integration partnerships, and people

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to develop a responsive, cost-effective supply chain that is a strategic asset. NMS' consulting and support services extend from initial product conception and design through
implementation, field trial, marketing, and deployment. These service relationships increase our visibility to our customers and provide us with insight into future market requirements.

PRODUCTS AND SERVICES

Our broad range of products include voice quality enhancement and echo cancellation systems, voice applications systems, systems building blocks that provide
connectivity to communications networks, call processing, and real-time media processing. Our emerging products will address packet network infrastructure. NMS' consulting and support
services extend from initial product conception and design through implementation, field trial, marketing, and deployment.

Our
products are developed for global markets and allow customers to integrate their applications and systems into existing and future network architectures. Our products are compatible
with signaling protocols and are in use in over 90 countries.

Systems Products

Studio Sound®. is a comprehensive software product that runs in conjunction with NMS Echo
Cancellation systems to create an optimal listening environment for both parties in a wireless voice call. It consists of five major components: acoustic echo control, dynamic speech restoration,
noise compensation, noise reduction, and automatic gain control, minimizing distractions due to outside noise, such as traffic. Independent studies have shown that consumers are more likely to make
calls in noisy environments if they know they will still be able to hear clearly, and they will stay on the phone longer if it is a more pleasant experience.

Mercury.The Mercury Broadband Echo Cancellation System removes electrical and acoustic echo and
supports DS3, STS-1, OC3, or STM-1 interfaces in a single package. Introduced in 2001, Mercury provides the highest density at the lowest acquisition and operational costs.

Sonata III.The Sonata III Echo Cancellation system offers a cost-effective, high
capacity, and low-power-consumption solution for E1 echo cancellation and voice enhancement. Designed to improve the voice quality of digital cellular and long distance international
calls, it also offers a design option for the A-Interface in GSM networks.

Symphony.The Symphony T1 Echo Cancellation System offers a high per-shelf channel
capacity, low power consumption, unmatched performance and unique Studio Sound® features, supporting North American networks.

Cadenza II.The Cadenza II Echo Cancellation system provides the benefits of cost effectiveness, high
capacity, and low power consumption with exceptional voice quality for long distance communications in North America.

HearSay.Introduced in January 2002, HearSay is a complete reliable, scalable,
cost-effective solution that enables wireless operators worldwide to voice-empower communication services. This solution is the first open and comprehensive offering that merges telecom
mobility with the content-rich Internet and integrates applications and technology from leading suppliers. This gives wireless operators new and essential capabilities for rapidly and
cost-effectively deploying customized, innovative voice-driven services such as: voice-activated dialing (VAD), personalized voice portals, short message service, conferencing
applications, and unified communications, all of which can be deployed in today's networks, and operate in the packet-based networks of the future.

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System Building Blocks

Convergence Generation.The Convergence Generation product family consists of software and hardware
components configured specifically for convergence-centric systems and applications. This product family's design includes 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 Internet protocol network and public switch
telephone network 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. In 2001, NMS introduced several new versions, including the CG 6100, high density T1/E1 network interface and resource hardware.

PowerAccess.Introduced in 2001, this high density access gateway hardware and software is used for
VoDSL, VoATM, voice over wireless local loop (WLL) deployments, and gateways for emerging network infrastructure. This product family includes the PA HYPER T3 DS3/STS-1 Network Adapter,
the M100 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.

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.

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 services multimedia 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.

Natural Access Software.The Natural Access Software suite consists of CT Access with Natural Call
Control, NaturalFax, 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.

Services

To complement our hardware and software products, we also offer a broad range of services with practices specializing in wireless video, speech application
infrastructure, and specialized hardware, including hardware for wireless data services. Services offered include:

Product Evaluation.The first phase of our customer relationships consist of product evaluation. We
supply a set of services including training, documentation, telephone, and on-site consultation, to assist the customer in evaluation of our product prior to selection for development or
deployment.

Design and Development.We provide telephone and on-site consultation, as well as custom
design and engineering services.

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Trial.We supply telephone and on-site consultation, as well as on-site
operations and integration assistance during the field trail phase of our customers' go to market initiatives.

Deployment.Our services range from on-site installation and systems integration services
to 24x7 on-call support.

CORE PRODUCT ATTRIBUTES

All of our products contain Network Operator standards and features including the following competencies:

High availability technology.Our voice enhancement and echo cancellation systems feature 1:1
protected network interfaces and system controller, 1:N redundant EC boards, dual -48V power supplies, extensive system monitoring and alarms, built-in self test and
diagnostics and a Remote Operations Support System (OSS). These have been developed over years of proven operation in the central offices and mobile switching centers of 100 operators worldwide. We
also 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.

Network Operator environment integration.We understand the operations, administration, maintenance,
and provisioning environments of service providers and our software and services facilitate systems integration into those environments.

Highly scalable systems.Our offerings can address the needs ranging from a handful of users to
millions of subscribers.

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 any development efforts.

Cost of acquisition and ownership.Our systems and system building blocks leverage
mass-market components and custom silicon, with the objective of price performance leadership. Because of this, we believe our products have the lowest acquisition costs and consume less
space and power, and generate less heat than competitive offerings, resulting in the lowest cost of ownership.

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 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.

Speech and media processing.We have extensive knowledge and experience with voice recognition, text
to speech processing, and Voice XML (VXML). These capabilities are embedded in our HearSay applications server, shielding the application developer from the complexities of call management and speech
engines. We have extensive knowledge and capabilities for media processing, including voice encoding and decoding on DSPs, including g.729, g.723.1, GSM, g.711, T.38 fax, AMR, and others.

Leverage Open Systems and Industry Standards.Our products are built from merchant silicon (Intel,
Texas Instruments); utilize standard processors (Sun, Windows Servers), and standard operating

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systems (SPARC Solaris, Windows 2000, Linux). We participate in the development of industry standards (PCIMIG, IEEE, ITEF) and we readily adopt appropriate standards (H.323, SIP, GSM, VXML, SALT).
Our offerings are accessible to software developers, and are extended by them.

Embedded computing.NMS' systems building blocks function as embedded computers that provide systems
level service, leaving host processors available for other purposes. Our embedded computing hardware includes:



CUSTOMERS AND MARKET AREAS

Our customers are network operators, network equipment providers, and solutions developers. Through Lucent, our network operator and service provider customers
include ATT, ATT Wireless, Cable and Wireless, France Telecom, Hutchison Telecom, NTT, NTT DoCoMo, Telefonica, and Verizon Wireless. Our network equipment provider customers include ADC Telecom,
Alcatel, Avaya, Cisco, Comverse, Ericsson, Fujitsu, Lucent, Motorola, NEC, Nortel, and Siemens. Our solution developer customers include Aspect, Edify and Jetstream.

NMS
is pursuing four market areas: wireless network operators for voice enhancement systems, voice driven applications, and the next generation of voice infrastructure, as well as
platforms and services for network equipment providers and solutions developers.

SALES AND MARKETING

We focus our sales and marketing efforts on approximately 100 leading network operators and service providers, and 40 leading suppliers of networking and
communications systems. We utilize channel partnerships to address network operator and equipment customers and prospects.

By
the end of 2001, our sales and marketing organization consists of 117 employees in 16 offices worldwide, of which 73 are in North America, 28 are in Europe, and 16 are in Asia. During
2001, 37% of our revenues were from sales and services to customers based outside North America.

RESEARCH AND DEVELOPMENT

We believe that the extension and enhancement of existing products, the development of new products and the development of NMS-proprietary
technologies in support of future products are critical to our future success. Therefore, we undertake direct research and development, we do joint product development with selected partners and we
participate in the development of industry standards where appropriate. During 2001, we spent $37.2 million, or 45.9% of our revenues, on research and development.

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Our current research and development is conducted by 281 employees located at our headquarters in Framingham, Massachusetts, and at our offices in Red Bank, New Jersey, Schaumburg,
Illinois, Saint Hubert, Quebec, Chaville, France and Bet Shamesh, Israel. Significant research and development activities include, but are not limited to, packetization engines for ATM and IP
transport, digital signal processing engines for speech coding, echo cancellation and voice quality enhancement, SS7 signaling, conferencing, efficient and feature rich VoiceXML middleware,
integration of speech technologies from partner companies, high density cost optimized platforms, highly available platforms and OAMP interfaces. Our product development investment is focused on
bringing these technologies to market both in the form of highly scalable platforms and as complete systems ready for deployment by service providers.

MANUFACTURING

We outsource the manufacturing and order fulfillment of all printed circuit board products, subassemblies and wired frame equipment to ISO 9000 certified
electronic manufacturing service providers.

We
monitor quality control and ensure final test verification from our Framingham, Massachusetts facility, for which we originally received ISO 9002 certification in 1996. Since then, we
have participated in all processes and audits required to maintain this certification, successfully completing an ISO Quality Systems re-certification in October 2000. The British
Approvals Board for Telecommunications conducted its most recent audit on NMS 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. Additionally, we maintain a formal product specific structure for all required international regulatory and compliance
testing.

We
seek to use industry standard components for our products. Many of these components are generally available from multiple suppliers. However, we also use certain custom integrated
circuits and other devices in our products that are sourced from a single supplier. Although we believe we could develop other sources for each of these custom devices, the process could take several
months.

COMPETITION

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. Competition in many of our markets is highly fragmented.

Our
current voice enhancement competitors include Ditech Communications Corporation and Tellabs, Inc. Current voice application systems competitors include Comverse
Technology, Inc., Unisys Corporation, Hewlett-Packard Company, IBM, and Intervoice-Brite, Inc. These competitors have established themselves as systems suppliers to wireless operators,
our target customers.

Our
current system building blocks competitors include AudioCodes Ltd., RadiSys Corporation, Brooktrout, Inc., Dialogic Corp., a wholly owned subsidiary of Intel
Corporation, and the Blue Wave division of Motorola, Inc. Others may enter our markets in the future.

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 ten patents issued, we have received a notice of allowance on four additional patents which we expect to issue shortly, and we have
applications pending on 49 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.

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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.

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, 2001, we had 607 full-time employees, including 74 in sales, 55 in marketing and business development, 281 in research and
development, 59 in services, 49 in operations and 89 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 are "forward-looking
statements" within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking
statements by our use of the words "believes," "anticipates," "plans," "expects," "may," "will," "would," "intends," "estimates," "predicts," "potential," "continue" and similar expressions, whether
in the negative or affirmative. We cannot guarantee that we actually will achieve these plans, intentions and expectations disclosed in the forward-looking statements we make. Factors that could cause
or contribute to such differences include, but are not limited to, those discussed in "Factors That May Affect Future Operating Results" below, as well as other risks and uncertainties referenced in
this Form 10-K. We do not assume any obligations to update any of the forward-looking statements after the date of this Form 10-K to conform these statements to
actual results.

Factors That May Affect Future Operating Results

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

We experienced operating losses in all four quarters of 2001 and in the first, third and fourth quarters of 2000. As a result, for the years ended
December 31, 2000 and 2001, we reported operating losses of approximately $35.6 million and $151.6 million, respectively. We expect to continue to maintain 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.

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

We are in a broad-based economic slowdown affecting most technology sectors and communications in particular. As a result, many of our customers have aggressively
increased efficiency in their supply chains and reduced inventory levels. This is evident as our customers continue to order low quantities and, in some cases, to defer 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.

During 2001 we initiated a major reorganization and repositioning of our business to offer systems as well as system building blocks, the success of
which is dependent upon, among other things, our ability to effect major changes in our prior sales, marketing and sourcing strategies.

To accomplish our repositioning, we are in the process of the following initiatives, the effectiveness of which will affect our future operating results.

We
are increasing our dependency on a direct sales force to penetrate new customers for our systems offerings, including the creation of a sales force to penetrate wireless service
providers. We must be successful in selling to our customers' laboratories for evaluation and field trial, to their purchasing decision-makers, and to the appropriate network operations staff in order
to achieve customer acceptance of our systems products. Repeated customer acceptance is required to achieve market acceptance of our systems offerings.

In
concert with our greater emphasis on systems offerings, we are shifting the primary sales method of our historical system building blocks to indirect channels and original equipment
manufacturers. In the past, we have sold the vast majority of these products directly with our own sales force. If we are successful in this repositioning, indirect channels will be the primary outlet
for the majority of our system building blocks. We will be increasingly reliant on the effectiveness of our indirect channel partners' sales, marketing, and distribution capabilities to generate and
fulfill demand for our products.

We
have begun to leverage our existing supplier relationships and to develop a broader network of suppliers and strategic partners to support our systems level product offerings. We must
be successful in developing strategic relationships with major hardware and software companies, in securing the breadth and depth of application partners, and in identifying and completing supply
relationships with various providers of outsourced services.

There
can be no assurance that we will be successful at implementing these changes and the failure to achieve successfully one or more of these initiatives could result in reduced
revenues and/or increased expenses. In addition, there can be no assurance that our repositioning, even if fully implemented, will have a positive effect on our financial results, our operations or
our market share.

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:



14

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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.

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

We may be unable to integrate successfully with our business the echo cancellation business acquired from Lucent Technologies and our financial
performance may suffer.

The process of integrating our acquisition of the assets, technology and business comprising Lucent's echo cancellation business 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 and repositioning. The integration
and exploitation of this acquired business is important to our future financial performance and failure to achieve a successful integration will likely cause our results to suffer.

We expect that nearly all of our revenue for our voice enhancement systems in the next one to two years will come from Lucent Technologies, Inc.
through Lucent's purchases under a three year supply agreement signed with Lucent at the time of our acquisition of this business from Lucent.

As part of our acquisition of Lucent's echo cancellation business, now comprising most of our voice enhancement systems business, we entered into a three year
supply agreement with Lucent in which Lucent agreed to purchase from us, on an exclusive basis, any of our products that Lucent requires which incorporate the recently purchased voice enhancement
products. We expect such sales to Lucent to generate most of our near term revenue for such products. Accordingly, any delays, reductions or other disruptions of Lucent's purchasing volume would have
a significant and material adverse effect on our revenues.

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. Competition in many of our markets is highly fragmented.

Our
current voice enhancement competitors include Ditech Communications Corporation and Tellabs, Inc. Current voice application systems competitors include Comverse
Technology, Inc., Unisys Corporation, Hewlett-Packard Company, IBM, and Intervoice-Brite, Inc. These competitors have established themselves as systems suppliers to wireless operators,
our target customers.

Our
current system building blocks competitors include AudioCodes Ltd., RadiSys Corporation, Brooktrout, Inc., Dialogic Corp., a wholly owned subsidiary of Intel
Corporation, and the Blue Wave division of Motorola, Inc. Others may enter our markets in the future.

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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, and in certain cases, to ship, distribute and install our products.

We do not have in-house manufacturing capabilities and currently rely on several third-party contract manufacturer partners to assemble our printed
circuit boards and other product offerings. Our manufacturing capabilities are concentrated on these manufacturers, some of which are the sole source for the products such partner manufactures for us.
In addition, some of these manufacturers ship our products directly from their fabrication facility, and provide distribution and installation services. This reliance could subject us to product
shortages or quality assurance problems, which, in turn, could lead to an increase in the cost of manufacturing or assembling our products. Any problems that occur and persist in connection with the
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, Texas Instruments is our sole source for the digital signal processors used in many of our products and customarily requires order lead times
of 12 to 14 weeks or more to insure
delivery in desired quantities. In addition, Agere Systems, Inc. is our sole source supplier for integrated circuit components used in many of our products and customarily requires order lead
times of 13 weeks or more. An interruption in supply from either Texas Instruments or Agere 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 volume purchase agreements with network equipment providers and our supply agreements with service providers are not supported by purchase obligations.
Therefore, there can be no assurance that these agreements will result in purchase orders for our products. After we begin receiving initial orders for a product from a customer, we rely heavily on
the customer's projections as to future needs for our product, without having any binding commitment from the customer as to future orders. Because our 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.

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Our products typically have long sales cycles, causing us to expend significant resources before achieving agreements or "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 their operating environment or product offering. This evaluation period is often prolonged due to delays
associated with approval processes that typically accompany the design and testing of new communications equipment by our customers. In addition, the rapidly emerging and evolving nature of the
markets in which 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 an agreement or "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 network equipment providers and service providers 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 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. We are continuing to invest significant research and development resources into new product categories, including voice applications and packet infrastructure, and supporting
technologies, the market acceptance and commercial viability of which has not been proven. Failure to successfully update and enhance current products and to develop and launch new products would harm
our business.

We
have experienced, and may in the future experience, delays in developing and releasing new products and product enhancements. These delays have led to, and may in the future lead to,
delayed sales, increased expenses and lower quarterly 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.

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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 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.

Internal development efforts by our customers may adversely affect demand for our system building blocks.

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.

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

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agreement under the intellectual property rights of those parties claiming 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

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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 37% of our revenues in 2001, and we believe a material portion of our domestic sales results
in the use of our products outside North America. 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 markets we target may not develop as rapidly as we anticipate.

We currently operate in four areas of the communications market: echo cancellation systems, voice application systems including speech access to network content,
network infrastructure and system building blocks. Although we expect growth in these areas, each of these market areas is characterized by emerging product categories and rapid technological change,
and we may fail to generate demand for our products at the levels we anticipate, which could limit our future revenues and harm our business.

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

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

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

Provisions of Delaware law and our corporate documents may make it difficult and expensive for a third party to 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 two facilities totaling approximately 145,000 square feet for our corporate headquarters in Framingham, Massachusetts. The leases on these facilities
expire in May 2012.

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We
also lease facilities in Red Bank, New Jersey, Schaumburg, Illinois, Saint-Hubert, Quebec, Chaville, France and Bet Shamesh, Israel, in which we conduct design and engineering
operations. The Chaville office also serves as our European sales and service headquarters.

In
addition, we have short-term leases for 15 sales offices throughout North America, Europe and Asia. We believe our facilities are adequate for our current needs and
that we will be able to secure suitable space as needed in the future.

Item 3.    Legal Proceedings

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

We
are the defendant in an action by Connectel, LLC initially filed in August 2000 in the U.S. District Court for the Eastern District of Virginia. This action has been
transferred by court order to the U.S. District Court for the District of Massachusetts. The plaintiff alleges that one or more of our products infringe upon 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 discovery
phase. We have reviewed the allegations with our patent counsel and believe that none of our products infringe upon the patent. We are defending the claim vigorously.

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

None during the fourth quarter of 2001.

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PART II

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

PRICE RANGE OF COMMON STOCK

Our common stock is quoted on the Nasdaq National Market under the symbol "NMSS." The table below shows the high and low 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.

Year Ended December 31, 2000

High

LowFirst Quarter

$
42.88

$
16.13Second Quarter


56.22


22.50Third Quarter


76.88


45.31Fourth Quarter


57.25


6.03


Year Ended December 31, 2001First Quarter

$
11.94

$7.56Second Quarter


8.13

4.94Third Quarter


6.59

1.56Fourth Quarter


5.18

1.56


As
of December 31, 2001, we had approximately 243 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, 2001, 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.

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Item 6.    Selected Financial Data.

Components of selected financial information consist of the following:

SELECTED FINANCIAL INFORMATION

|                                                                              |         | Year Ended December 31, |       
|----------------------------------------------------------------------------- | ------- | ----------------------- | ------
|
|
|Revenues                                                                      |         | $                       | 75,363
|Gross profit                                                                  |         |                         | 50,065
|Operating income (loss)                                                       |         |                         | 7,319 
|Income (loss) before income taxes and extraordinary item                      |         |                         | 8,517 
|Income tax expense (benefit)                                                  |         |                         | 4,758 
|Gain on early extinguishment of debt, net of tax                              |         |                         |      
|Net income (loss)                                                             |         |                         | 3,759 
|Net income (loss) per share:                                                  |         |                         |       
|                                                                              | Basic   |                         | $     
|                                                                              | Diluted |                         | $     
|Weighted average common shares used in computing net income (loss) per share: |         |                         |       
|                                                                              | Basic   |                         |       
|                                                                              | Diluted |                         |       

|                |                      | December 31,
|--------------- | -------------------- | ------------
|
|Total assets    |                      | $           
|Long-term debt, |                      |             
|                | less current portion |             

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

OVERVIEW

We design, deliver and support technology-leading systems and system building blocks for innovative voice, video and data services on wireless and wireline
networks. Our products and services are built on open technologies and strategic relationships with application and technology suppliers and leverage best-in-class supply chain
and integration partnerships. Because of this, our customers, all of the world's top communications equipment suppliers, and many of the world's top solution developers and service providers, are able
to enhance their competitive position and bring their applications and services to market faster and at lower costs.

During
2001 we initiated a major reorganization and repositioning of our business to offer systems as well as system building blocks to our customers. The success of this reorganization
and repositioning is dependent upon, among other things, our ability to effect major changes in our prior sales, marketing and sourcing strategies. To accomplish our repositioning, we are in the
process of several initiatives, the effectiveness of which will affect our future operating results. We are increasing our dependence on a direct sales force to penetrate new customers for our systems
offerings, including the creation of a sales force to penetrate wireless service providers. In concert with our greater emphasis on systems offerings, we are shifting the primary sales method of our
historical system building blocks to indirect channels and original equipment manufacturers. We have also begun to leverage our existing supplier

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relationships and to develop a broader network of suppliers and strategic partners to support our systems level product offerings. There can be no assurance that we will be successful at implementing
these changes and the failure to achieve successfully one or more of these initiatives could result in reduced revenues and/or increased expenses. In addition, there can be no assurance that our
repositioning, even if fully implemented, will have a positive effect on our financial results or operations.

We
achieved sequential increases in revenue over the prior quarter of 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% as we began to experience the effects of the broad-based, worldwide economic slowdown affecting most technology sectors and communications in particular.
Revenue continued to decline sequentially over prior quarters in the first, second and third quarters of 2001 by 22%, 37% and 4%, respectively. In the fourth quarter of 2001 we achieved a sequential
increase over prior quarter revenue of 35%, primarily due to the revenue generated by the voice enhancement and echo cancellation business acquired from Lucent. As we continue to be in a broad-based
economic slowdown 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.

Effective
April 10, 2001, we acquired Mobilee, Inc. ("Mobilee"), a privately held Massachusetts company, for a total cost of $13.3 million, including transaction
costs of approximately $150,000. In connection with the acquisition, we paid net aggregate cash consideration of $11.2 million to the founders and shareholders of Mobilee. An additional
$1.0 million was placed in escrow and will be released to the founders of Mobilee on April 10, 2002, less any potential losses we incur that are allowed to be off-set against
the escrow per the escrow agreement. This amount was recorded as deferred compensation and is being amortized as compensation expense ratably over the one-year escrow period. We also will
issue stock valued at approximately $300,000 to a founder of Mobilee in four equal quarterly installments beginning July 31, 2001, provided that this individual is still employed by us at the
time each respective stock issuance is to be made. This amount was recorded as deferred compensation and is being amortized as compensation expense ratably over the one-year period. We
have accounted for the acquisition as a purchase business combination.

On
November 30, 2001, we acquired the voice enhancement and echo cancellation business ("VES") of Lucent. Under the terms of the agreement, we paid cash totaling
$60 million for all assets of VES. We also entered into a multi-year agreement to serve as the exclusive supplier of stand-alone voice enhancement and echo cancellation systems for
Lucent, as Lucent continues to supply these systems to its global service provider customers. This agreement allows us to expand our market reach by establishing new alliances with other
communications equipment suppliers and service providers. We also received a perpetual license from Lucent for a substantial portfolio of complementary intellectual property to support the development
efforts and growth of the acquired business. We have accounted for the acquisition as a purchase business combination.

During
2001, we recorded restructuring and other special charges of approximately $11.5 million. These charges consist of approximately $2.3 million for the closing of the
IP Services Management operation in Tustin, California, approximately $2.6 million related to a long-term lease obligation, and approximately $6.6 million related to our
strategic repositioning of the Company. The details of these charges are explained further in management's discussion and analysis of 2001 compared to 2000.

During
2001, we wrote down approximately $56.0 million of impaired long-lived assets related to the goodwill associated with the IML acquisition and the goodwill and
acquired technology associated with the ViaDSP acquisition. Based on the declining historical and forecasted operating results of IML as they related to earlier estimates and the economic condition of
the telecommunications industry as a

24

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whole, the estimated value of IML's and ViaDSP's goodwill had decreased. Furthermore, based on the uncertain future utilization of the acquired technology, the estimated value of
ViaDSP's acquired technology had decreased. As a result, these assets were written-down to their fair value.

During
2001, we paid $27.1 million to extinguish $46.6 million face value of convertible debt. As a result, we recorded a related extraordinary gain of
$11.3 million, net of tax expense of $7.6 million. It is reasonably possible that we will record further extraordinary gains or losses related to early debt extinguishment in future
reporting periods.

In
October 2001, the Board of Directors approved a stock repurchase program authorizing us to repurchase up to 2,500,000 shares of our outstanding common stock for an aggregate
purchase price not to exceed $5.0 million. As of December 31, 2001, we have repurchased 400,000 shares for an aggregate purchase price of $1.9 million.

CRITICAL ACCOUNTING POLICIES

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

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



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26

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27

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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.

|                                   |                                                          | Year Ended December 31,  |     
|---------------------------------- | -------------------------------------------------------- | ------------------------ | ----
|
|Revenues                           |                                                          | 100.0                    | %   
|Cost of revenues                   |                                                          | 39.7                     |     
|                                   |                                                          |                          |     
|                                   | Gross profit                                             |                          | 60.3
|                                   |                                                          |                          |     
|Operating expenses                 |                                                          |                          |     
|                                   | Selling, general and administrative                      |                          | 50.3
|                                   | Research and development                                 |                          | 31.0
|                                   | Purchased in-process research and development            |                          |    
|                                   | Impairment charges                                       |                          |    
|                                   | Merger related expenses                                  |                          | 1.6 
|                                   | Restructuring and other special charges                  |                          | (0.1
|                                   |                                                          |                          |     
|                                   |                                                          | Total operating expenses |     
|                                   |                                                          |                          |     
|Operating loss                     |                                                          | (22.5                    | )   
|                                   | Other income (loss), net                                 |                          | 0.2 
|                                   |                                                          |                          |     
|Loss before income taxes           |                                                          | (22.3                    | )   
|                                   | Income tax expense (benefit)                             |                          | 1.2 
|                                   |                                                          |                          |     
|Net loss before extraordinary item |                                                          | (23.5                    | )   
|                                   | Gain on early extinguishment of debt, net of tax expense |                          |    
|                                   |                                                          |                          |     
|Net loss                           |                                                          | (23.5                    | )%  
|                                   |                                                          |                          |     

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

REVENUES

Our revenues consist primarily of product sales and, to a lesser extent, services provided to our customers. Revenues decreased to $81.0 million for the
year ended December 31, 2001 from $134.6 million for the year ended December 31, 2000, representing a decrease of 39.8%. The decrease from 2000 to 2001 is attributable to the
broad-based, worldwide economic slowdown affecting most technology sectors, and communications in particular, which has had a negative impact across all of our product families. This decrease was
partially offset by the revenue generated by VES, which we
acquired on November 30, 2001. The levels of revenue we will be able to achieve in the future will depend to a great extent upon how long this slowdown will continue. Future revenues will also
depend on the success of our reorganization and repositioning.

Revenues
from sales to customers located outside North America were 36.9% of sales, or $29.9 million, and 28.3% of sales, or $38.1 million, in 2001 and 2000, respectively.
The dollar decrease from 2000 to 2001 is due to the broad-based economic slowdown affecting most technology sectors reaching beyond North America.

No
single customer accounted for more than 10% of revenues in 2001 or 2000.

GROSS PROFIT

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. Gross profit decreased 49.7% to

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$39.6 million in 2001 from $78.8 million in 2000, and represented 48.9% and 58.5% of revenues for 2001 and 2000, respectively. The decrease in gross profit is primarily due to an
increase in per unit allocated overhead costs that resulted from lower sales volume and increased spending intended to create efficiencies, such as out-sourced manufacturing and order
fulfillment, in our supply chain operation. Included in cost of revenues for 2001 are $2.1 million of completed technology amortization related to the VES, Mobilee, IML and ViaDSP acquisitions,
a $1.5 million inventory fair value adjustment related to the VES acquisition, $388,000 for the impairment of completed technology from the ViaDSP acquisition, and a $516,000 restructuring
charge related to the write-down of IP Services Management inventory. Excluding these costs from cost of revenues would yield a gross profit percentage of 54.5% for the year ended
December 31, 2001. Included in cost of revenues for 2000 are $1.1 million of completed technology amortization related to the IML and ViaDSP acquisitions, as well as a
$5.1 million inventory fair value adjustment related to the IML acquisition. Excluding these costs from cost of revenues would yield a gross profit percentage of 63.1% for the year ended
December 31, 2000.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses consist primarily of salaries, commissions and related personnel expenses for those engaged in our sales, marketing,
promotional, public relations, executive, accounting and administrative activities and other general corporate expenses. Selling, general and administrative expense increased to $87.4 million
for 2001 from $79.8 million for 2000, representing an increase of 9.5%. Included in selling, general and administrative expense for 2001 are $21.3 million of amortization of goodwill and
other intangibles related to the VES, Mobilee, IML, ViaDSP and Teknique acquisitions, $14.8 million of non-cash compensation expense related to the Mobilee and IML acquisitions,
$1.1 million of amortization of debt issuance costs and the reversal of a $4.7 million accrual
related to additional compensation that would not be paid to the employees of IML. This accrual was originally established during the third and fourth quarters of 2000 when it appeared probable that
IML would achieve the financial results outlined in the merger agreement that would entitle certain individuals to additional compensation. During the first quarter of 2001, when it became known that
these financial results would not be met, the accrual was reversed. Included in selling, general and administrative expense for 2000 are $14.1 million of amortization of goodwill and other
intangibles related to the IML, ViaDSP and Teknique acquisitions, $8.7 million of non-cash compensation expense related to the IML acquisition and a $4.7 million accrual for
additional compensation related to the IML merger agreement. As we continue to reposition our business and integrate VES, we expect selling, general and administrative expenses to remain relatively
flat as cost savings realized as a result of the restructuring and repositioning will be offset by VES expenses.

RESEARCH AND DEVELOPMENT

Research and development expenses consist primarily of salaries, personnel expenses and prototype fees related to the design, development, testing and enhancement
of our products. These costs are expensed as incurred. Research and development expense increased to $37.2 million for 2001 from $31.2 million for 2000, representing an increase of
19.1%. The increase in expense was due to increased development project related costs associated with the CG6100, PowerAccess, HearSay and PacketMedia product lines. As we continue to reposition our
business and integrate VES, we expect research and development expenses to remain relatively flat as cost savings realized as a result of the restructuring and repositioning will be offset by VES
expenses.

RESTRUCTURING AND OTHER SPECIAL CHARGES

During 2001, we recorded restructuring and other special charges of approximately $11.5 million. These charges consist of approximately $2.3 million
for the closing of the IP Services Management

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operation in Tustin, California, approximately $2.6 million related to a long-term lease obligation, and approximately $6.6 million related to our strategic repositioning of
our Company. For this total charge of $11.5 million, approximately $516,000 related to the write-down of IP Services Management inventory and is included in the statement of
operations classification, "cost of revenues." The remaining $11.0 million is included in the statement of operations classification, "restructuring and other special charges." The details of
each of these items are outlined below.



During 2001, we announced a plan to close our IP Services Management operation, which resulted in restructuring and other special charges of $2.3 million.
As part of this plan, all 30 employees of the IP
Services Management operation were terminated. The charge consisted of approximately $616,000 of involuntary severance related costs, approximately $650,000 of fixed asset write-downs, approximately
$516,000 of inventory write-downs, approximately $406,000 of lease termination costs and approximately $139,000 of other administrative closing costs. At December 31, 2001, the remaining
accrued balance for this charge was approximately $536,000 and is included in the consolidated balance sheet classification, "accrued expenses and other liabilities." We expect to utilize the majority
of the remaining accrued balance during 2002.



We lease a facility in Schaumburg, Illinois that is not currently being occupied by us and will not be occupied by us in the future. This facility was
sub-leased by us to a third party tenant for a sub-lease term equivalent to the original lease term, which ends on September 30, 2008. In April 2001, we were
notified that the tenant had filed for bankruptcy protection and we would be required to resume primary responsibility for the lease payments on this facility. We are currently working with a real
estate agent to find another sub-lease tenant for this facility. We have estimated that the difference between the committed lease payments over the life of the lease and the
sub-lease rental income will approximate $2.6 million, and this amount is included as restructuring and other special charges in 2001. At December 31, 2001, the remaining
accrued balance for this charge was approximately $2.2 million and is included in the consolidated balance sheet classification, "accrued expenses and other liabilities." Due to the
long-term nature of this liability, we expect to utilize the remaining accrued balance over the next five years.



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

Due
to this strategic repositioning, certain facilities and fixed assets were no longer being utilized by us and will not be utilized by us in the future. We are currently working with
real estate agents in an attempt to sub-lease the idle facilities that are located in the United States, Canada and throughout Europe. We have estimated that the difference between the
committed lease payments over the lives of the leases and the sub-lease rental income will approximate $702,000, and this amount is included as restructuring and other special charges in
2001. At December 31, 2001, the remaining accrued balance for this charge was approximately $702,000 and is included in the consolidated balance sheet classification, "accrued expenses and
other liabilities." We expect to utilize the majority of the

30

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remaining accrued balance during 2002. We are also in the process of disposing of the fixed assets that are no longer being utilized. These fixed assets consist primarily of leasehold improvements on
the idle leased facilities and computer equipment, furniture and fixtures and machinery and equipment that were used in connection with activities that have been discontinued. The total charge for the
fixed assets that is included as restructuring and other special charges in 2001 is $2.4 million. At December 31, 2001, there is no accrual balance related to this charge.

Additional
costs of approximately $670,000 related to the strategic repositioning have been charged to restructuring and other special charges. These costs consist primarily of contract
termination charges and legal fees. At December 31, 2001, the remaining accrued balance for this charge was approximately $520,000 and is included in the consolidated balance sheet
classification, "accrued expenses and other liabilities." We expect to utilize the remaining accrued balance during 2002.

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IMPAIRMENT CHARGE

We review 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. If an impairment is indicated, the asset is written down to its estimated fair value.
During 2001, we wrote down approximately $56.0 million of impaired long-lived assets which consisted of approximately $55.3 million related to the goodwill associated with
the IML acquisition and approximately $638,000 related to the goodwill and acquired technology associated with the ViaDSP acquisition. Based on the declining historical and forecasted operating
results of IML as they related to earlier estimates and the economic condition of the telecommunications industry as a whole, the estimated value of IML's and ViaDSP's goodwill had
decreased. Furthermore, based on the uncertain future utilization of the acquired technology, the estimated value of ViaDSP's acquired technology had decreased. As a result, these assets were
written-down to their fair value. The charge of approximately $55.6 million related to the write-down of goodwill is included in the statement of operations
classification "impairment charges" while the charge of approximately $388,000 related to acquired technology is included in the statement of operations classification "cost of revenues."

It
is reasonably possible that we may incur additional impairment charges for long-lived assets, including goodwill, in future reporting periods.

OTHER INCOME (LOSS), NET

Other income and expense, reflecting net interest income, one time gains or losses and foreign exchange gains and losses, decreased to ($8.5 million) for
2001 from $8.7 million for 2000. Included in other income and expense for 2001 is a $4.7 million foreign currency translation loss generated on the intercompany debt related to the IML
transaction, a $7.0 million write-down to fair market value of a minority investment, $8.3 million of interest expense related to the convertible notes and a $174,000 gain on
the sale of a minority investment. Included in other income and expense for 2000 is a $2.3 million foreign currency translation loss generated on the intercompany debt related to the IML
transaction, $2.0 million of interest expense related to the convertible notes and a $2.2 million gain on the sale of minority investments.

INCOME TAX (BENEFIT) EXPENSE

Income tax (benefit) expense was ($6.2 million) and $780,000 for 2001 and 2000, respectively. Our effective tax rate decreased in 2001 to (3.8%) from 2.9%
in 2000. In 2001, the primary component of the effective tax rate is the maintenance of the full valuation allowance on the deferred tax asset. In 2000, the primary components of the effective tax
rate are the non-deductible amortization of intangible assets and the maintenance of the full valuation allowance on the deferred tax asset.

EXTRAORDINARY GAIN

During 2001, we paid $27.1 million to extinguish $46.6 million face value of convertible debt. As a result, we recorded a related extraordinary gain
of $11.3 million, net of tax expense of $7.6 million. It is reasonably possible that we will record further extraordinary gains or losses related to early debt extinguishment in future
reporting periods.

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

REVENUES

Our revenues consist primarily of product sales and, to a lesser extent, services provided to our customers. Revenues increased to $134.6 million for the
year ended December 31, 2000 from

32

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$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

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. 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.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses consist primarily of salaries, commissions and related personnel expenses for those engaged in our sales, marketing,
promotional, public relations, executive, accounting and administrative activities and other general corporate expenses. 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 expenses consist primarily of salaries, personnel expenses and prototype fees related to the design, development, testing and enhancement
of our products. These costs are expensed as incurred. 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.

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

33

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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.

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.

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Liquidity and Capital Resources

As of December 31, 2001, our principal sources of liquidity included cash and cash equivalents of $84.0 million and marketable securities of
$77.2 million. We also have access to a $7.5 million bank line of credit for working capital purposes that was established in May 1999 and amended on August 30, 2001.
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 certain covenants under the agreement. The most significant of these covenants require the maintenance of equity and liquidity ratios, timely financial
reporting to the bank and the maintenance of depository and operating accounts with the bank. As of December 31, 2001 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, 2002. We do not have any off-balance sheet financing arrangements, other than property operating leases
that are disclosed in the contractual obligations table below and in our consolidated financial statements, nor do we have any transactions, arrangements or other relationships with any special
purpose entities

Cash
provided by (used in) operations for the years ended December 31, 2001, 2000 and 1999 was ($35.4 million), $14.6 million and $7.6 million, respectively.
The following table provides a reconciliation of our net loss to cash provided by (used in) operations for the years ended December 31, 2001, 2000 and 1999:

|                                                |                                                        | 2001                       |          | 2000    |         | 1999    |       
|----------------------------------------------- | ------------------------------------------------------ | -------------------------- | -------- | ------- | ------- | ------- | ------
|Net loss                                        |                                                        | $                          | (142,658 | )       | $       | (27,651 | )     
|                                                |                                                        |                            |          |         |         |         |       
|Non-cash adjustments:                           |                                                        |                            |          |         |         |         |       
|                                                | Depreciation and amortization (1)                      |                            |          | 47,172  |         |         | 35,476
|                                                | Loss on impairment of fixed assets                     |                            |          | 3,069   |         |         |      
|                                                | Loss on impairment of goodwill and other intangibles   |                            |          | 55,985  |         |         |      
|                                                | Foreign exchange translation loss on intercompany debt |                            |          | 4,688   |         |         | 2,291 
|                                                | Loss on minority investment                            |                            |          | 7,000   |         |         |      
|                                                | Purchased in-process research and development          |                            |          |        |         |         | 3,300 
|                                                | Write off of debt issuance costs                       |                            |          | 1,222   |         |         |      
|                                                | Amortization of bond issuance costs                    |                            |          | 1,074   |         |         | 237   
|                                                | Deferred taxes                                         |                            |          |        |         |         |      
|                                                | Tax benefit from stock option exercises                |                            |          |        |         |         |      
|                                                |                                                        |                            |          |         |         |         |       
|                                                |                                                        | Total non-cash adjustments |          | $       | 120,210 |         | $     
|                                                |                                                        |                            |          |         |         |         |       
|Cash adjustments:                               |                                                        |                            |          |         |         |         |       
|                                                | Gain on minority investment                            |                            |          |        |         |         | (2,228
|                                                | Gain on repurchase of convertible notes                |                            |          | (18,878 | )       |         |      
|                                                | Change in working capital                              |                            |          | 5,807   |         |         | 3,746 
|                                                | Other                                                  |                            |          | 101     |         |         | (605  
|                                                |                                                        |                            |          |         |         |         |       
|                                                |                                                        | Total cash adjustments     |          | $       | (12,970 | )       | $     
|                                                |                                                        |                            |          |         |         |         |       
|Cash provided by (used in) operating activities |                                                        | $                          | (35,418  | )       | $       | 14,566  |       
|                                                |                                                        |                            |          |         |         |         |       

---

The
change in working capital in 2001 was primarily due to the changes in accounts receivable, inventory and accrued expenses and other liabilities. Accounts receivable decreased from
$18.8 million in 2000 to $12.5 million in 2001. This decrease was the result of the decrease in revenue for 2001 compared to 2000. Inventory increased from $7.8 million in 2000 to
$11.1 million in 2001. The increase

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in inventory resulted from the acquisition of $8.2 million of inventory in connection with the VES acquisition, offset by a decrease in inventory that resulted from a declined demand for our
products in 2001 as compared to 2000. Accrued expenses and other liabilities decreased from $25.2 million to $21.2 million due to the reversal of a $4.7 million accrual related to
additional consideration that was to be paid to the former shareholders of IML. This accrual was established in 2000 when it appeared that IML would achieve the financial targets needed to earn the
additional consideration. We reversed this accrual in 2001 when it became known that these financial targets would not be met by IML.

The
change in working capital in 2000 was primarily due to the changes in accounts receivable and accrued expenses and other liabilities. Accounts receivable increased from
$11.6 million in 1999 to $18.8 million in 2000. This increase was the result of the increase in revenue for 2000 compared to 1999. Accrued expenses increased from $9.8 million in
1999 to $25.2 million in 2000. The increase in accrued expenses and other liabilities is primarily due to the accrual of interest to be paid on the convertible notes and the accrual of
$4.7 million of additional consideration to be paid to the former shareholders of IML based on the achievement of certain financial targets.

The
change in working capital in 1999 was primarily due to the changes in accounts receivable and inventory. Accounts receivable decreased from $17.2 million in 1998 to
$11.6 million in 1999. This decrease was the result of more timely cash collections and an increase in the allowance for doubtful accounts. Inventory decreased from $9.8 million in 1998
to $5.4 million in 1999. The decrease in inventory was due to a successful effort by management to reduce inventory levels.

Cash
used in investing activities in 2001, 2000 and 1999 was $133.6 million, $99.1 million and $7.7 million, respectively. Cash of $254.5 million,
$672.8 million and $17.3 million was used to purchase marketable securities, with cash of $206.0 million, $650.6 million and $16.4 million provided from maturities
of marketable securities for 2001, 2000 and 1999, respectively. Capital expenditures were $12.8 million, $10.5 million and $6.2 million for 2001, 2000 and 1999, respectively. In
2001 we spent a total of $73.8 million to acquire VES and Mobilee and in 2000 we spent $65.8 million to acquire IML. We expect capital expenditures in 2002 will approximate
$19.4 million, principally for testing equipment, development equipment and computer hardware and software.

Cash
provided by (used in) financing activities in 2001, 2000 and 1999 was ($27.5 million), $349.2 million and $4.2 million, respectively. In 2001, we used cash of
$27.1 million to extinguish $46.6 million face value of convertible debt and $1.9 million to purchase 400,000 shares of common stock through our repurchase plan, while cash of
$1.7 million was provided by the exercise of stock options and the purchase of stock through our employee stock purchase plan. In 2000, cash of $349.9 million was provided by the
offerings of our common stock and convertible notes. In 1999, cash 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
following table details our future payments due under contractual obligations. We currently do not have any commercial commitments.

|                              |  | Payments Due by Period
|----------------------------- |  | ----------------------
|
|
|Property Leases               |  | $                     
|Convertible Notes             |  |                       
|                              |  |                       
|Total Contractual Obligations |  | $                     
|                              |  |                       

We
believe that our available cash, cash equivalents, marketable securities and bank line of credit will be sufficient to meet our operating expenses, capital requirements and
contractual obligations for

36

---

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

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("FAS No. 141"),
"Business Combinations" and Statement of Financial Accounting Standards No. 142 ("FAS No. 142"), "Goodwill and Other Intangible Assets." FAS No. 141 is effective for all business
combinations for which the date of acquisition is after June 30, 2001 and requires that the purchase method of accounting be used for all business combinations, establishes specific criteria
for the recognition of intangible assets separately from goodwill and requires unallocated negative goodwill to be written off immediately as an extraordinary gain. FAS No. 142 requires that
goodwill and indefinite lived intangible assets will no longer be amortized, goodwill will be tested for impairment at least annually at the reporting unit level, intangible assets deemed to have an
indefinite life will be tested for impairment at least annually and the amortization period of intangible assets with finite lives will no longer be limited to forty years. We adopted FAS
No. 141 and FAS No. 142 on January 1, 2002. The adoption of FAS No. 141 did not have a significant impact on our consolidated financial statements. The adoption of FAS
No. 142 will eliminate the amortization expense of goodwill from our consolidated statement of operations, resulting in a decrease of our operating expenses. However, this decrease will be
offset by the amortization of intangible assets that were acquired during 2001. Additionally, as a result of the required periodic impairment reviews of goodwill, if an impairment is indicated in a
future reporting period, we may be required to record an impairment charge in that future reporting period to reflect the reduction of the carrying value of goodwill to its fair value.

In
October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS
No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and provides a single accounting model for long-lived assets to be disposed of. We are required to
adopt SFAS No. 144 for our fiscal year beginning after December 15, 2001 and we do not believe it will have a significant impact on our consolidated financial statements.

Quarterly Results (Unaudited)

The following tables set forth unaudited selected financial information for the periods indicated, as well as certain information expressed as a percentage of
total revenues for the same periods. This information has been derived from unaudited consolidated financial statements, which, in the opinion of management, include all adjustments (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.

We
achieved sequential increases in revenue over the prior quarter of 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

37

---

by 16% as we began to experience the effects of the broad-based, worldwide economic slowdown affecting most technology sectors and communications in particular. Revenue continued to decline
sequentially over prior quarters in the first, second and third quarters of 2001 by 22%, 37% and 4%, respectively. In the fourth quarter of 2001 we achieved a sequential increase over prior quarter
revenue of 35%, primarily due to the revenue generated by VES.

Our
cost of revenues and operating expenses over the two-year period ended December 31, 2001 have generally increased as a percentage of revenue. For cost of revenues,
this trend is due to increased spending to create future efficiencies in our supply chain operation. For operating expenses, this trend is due to increased acquisition and non-recurring
expenses including, but no limited to, goodwill and other intangibles amortization, deferred compensation amortization, impairment charges and restructuring and other special charges.

We
expect to continue to maintain 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 operating losses.

Our
quarterly operating results may fluctuate as a result of a number of factors, some of which are beyond our control, including, but not limited to: fluctuations in our customers'
businesses; 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 deferrals of orders for our products would cause a shortfall in revenue for the quarter. Accordingly, we cannot be sure that we will be profitable in any particular quarter.

For
U.S. federal income tax purposes we have net operating loss carryforwards available to reduce taxable income of approximately $59.1 million at December 31, 2001, a
portion of which may be limited under Internal Revenue Code Section 382. These carryforwards will begin to expire in 2019. We also have a foreign net operating loss carryforward of
approximately $13.8 million. We have $3.8 million of tax credits that are composed of federal research and development credits and state and local credits. These credits expire beginning
in 2002.

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

38

---

All
figures set out in the table below are in thousands, except per share data, and are unaudited.

|                                                      |                                               | Quarter Ended            |       
|----------------------------------------------------- | --------------------------------------------- | ------------------------ | ------
|
|Revenues                                              |                                               | $                        | 27,722
|Cost of revenues                                      |                                               |                          | 10,589
|                                                      |                                               |                          |       
|                                                      | Gross profit                                  |                          |       
|Operating expenses:                                   |                                               |                          |       
|                                                      | Selling, general and administrative           |                          |       
|                                                      | Research and development                      |                          |       
|                                                      | Purchased in-process research and development |                          |       
|                                                      | Impairment charges                            |                          |       
|                                                      | Restructuring and other special charges       |                          |       
|                                                      |                                               |                          |       
|                                                      |                                               | Total operating expenses |       
|                                                      |                                               |                          |       
|Operating income (loss)                               |                                               |                          | (862  
|Other income (loss) net                               |                                               |                          | 1,976 
|                                                      |                                               |                          |       
|Income (loss) before income taxes                     |                                               |                          | 1,114 
|Income tax expense (benefit)                          |                                               |                          | 78    
|                                                      |                                               |                          |       
|Net income (loss) before extraordinary item           |                                               | $                        | 1,036 
|Extraordinary gain on extinguishment of debt          |                                               |                          |      
|                                                      |                                               |                          |       
|Net income (loss)                                     |                                               | $                        | 1,036 
|                                                      |                                               |                          |       
|Basic loss before extraordinary item per common share |                                               | $                        | 0.04  
|Extraordinary gain on extinguishment of debt          |                                               |                          |      
|                                                      |                                               |                          |       
|Basic net loss per common share                       |                                               | $                        | 0.04  
|                                                      |                                               |                          |       
|Diluted net loss per common share                     |                                               | $                        | 0.03  
|                                                      |                                               |                          |       

|                                             |                                               | Quarter Ended            |     
|-------------------------------------------- | --------------------------------------------- | ------------------------ | ----
|
|
|Revenues                                     |                                               | 100.0                    | %   
|Cost of revenues                             |                                               | 38.2                     |     
|                                             |                                               |                          |     
|                                             | Gross profit                                  |                          | 61.8
|Operating expenses:                          |                                               |                          |     
|                                             | Selling, general and administrative           |                          | 39.7
|                                             | Research and development                      |                          | 25.2
|                                             | Purchased in-process research and development |                          |    
|                                             | Impairment charges                            |                          |    
|                                             | Restructuring and other special charges       |                          |    
|                                             |                                               |                          |     
|                                             |                                               | Total operating expenses |     
|                                             |                                               |                          |     
|Operating income (loss)                      |                                               | (3.1                     | )   
|Other income (loss), net                     |                                               | 7.1                      |     
|                                             |                                               |                          |     
|Income (loss) before income taxes            |                                               | 4.0                      |     
|Income taxes expense (benefit)               |                                               | 0.3                      |     
|                                             |                                               |                          |     
|Net income (loss) before extraordinary item  |                                               | 3.7                      |     
|Extraordinary gain on extinguishment of debt |                                               |                         |     
|                                             |                                               |                          |     
|Net income (loss)                            |                                               | 3.7                      | %   
|                                             |                                               |                          |     

39

---

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

Our primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. Our investment portfolio of cash equivalents,
marketable securities and non-marketable securities are subject to interest rate fluctuations, but we believe this risk is immaterial due to the
short-term nature of these investments. At December 31, 2001, we had $128.4 million of long-term debt outstanding. A hypothetical 10% decrease in our
weighted-average borrowing rate at December 31, 2001 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 2001 and 2000, as a result of remeasuring the debt at each reporting period, we incurred a foreign exchange loss of approximately
$4.7 million and $2.3 million, respectively. 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.

40

---



Item 8.    Financial Statements and Supplementary Data.

Report of Independent Accountants

To
the Board of Directors and Stockholders of NMS Communications 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 NMS Communications
Corporation (formerly, Natural MicroSystems Corporation) and its subsidiaries (the "Company") at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2001 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 16, 2002, except for Note 17
as to which the date is February 13, 2002

41

---



NMS Communications Corporation        Consolidated Balance Sheets

|                                            |                                                                                   | December 31,                                                                                                                                                                                                                                                                 |                                           
|------------------------------------------- | --------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------
|
|
|Assets                                      |                                                                                  
|Current assets:                             |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|                                            |                                                                                   | Cash and cash equivalents                                                                                                                                                                                                                                                    |                                           
|                                            |                                                                                   | Marketable securities                                                                                                                                                                                                                                                        |                                           
|                                            |                                                                                   | Accounts receivable, net of allowance for doubtful accounts of $1,260 and $1,178, respectively                                                                                                                                                                               |                                           
|                                            |                                                                                   | Inventories                                                                                                                                                                                                                                                                  |                                           
|                                            |                                                                                   | Prepaid expenses and other assets                                                                                                                                                                                                                                            |                                           
|                                            |                                                                                   | Income tax receivable                                                                                                                                                                                                                                                        |                                           
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              | Total current assets                      
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|Property and equipment, net                 |                                                                                   |                                                                                                                                                                                                                                                                              | 19,768                                    
|Other assets                                |                                                                                   |                                                                                                                                                                                                                                                                              | 16,340                                    
|Goodwill and other intangibles, net         |                                                                                   |                                                                                                                                                                                                                                                                              | 119,428                                   
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              | Total assets                              
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|Liabilities and Stockholders' Equity        |                                                                                  
|Current liabilities:                        |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|                                            |                                                                                   | Accounts payable                                                                                                                                                                                                                                                             |                                           
|                                            |                                                                                   | Accrued expenses and other liabilities                                                                                                                                                                                                                                       |                                           
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              | Total current liabilities                 
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|Long-term debt less current portion         |                                                                                   |                                                                                                                                                                                                                                                                              | 175,000                                   
|Commitments and contingencies (see note 15) |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|Stockholders' equity:                       |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|                                            |                                                                                   | Common stock, $.01 par value; 125,000,000 shares authorized at December 31, 2000 and 2001, 36,494,753 and 36,728,965 shares issued at December 31, 2000 and 2001, respectively, and 36,401,236 and 36,328,965 shares
outstanding at December 31, 2000 and 2001, respectively |                                           
|                                            | Additional paid-in capital                                                        |                                                                                                                                                                                                                                                                              |                                           
|                                            | Accumulated deficit                                                               |                                                                                                                                                                                                                                                                              |                                           
|                                            | Accumulated other comprehensive loss                                              |                                                                                                                                                                                                                                                                              |                                           
|                                            | Deferred compensation                                                             |                                                                                                                                                                                                                                                                              |                                           
|                                            | Notes receivable from common stockholders                                         |                                                                                                                                                                                                                                                                              |                                           
|                                            | Treasury stock, at cost, 93,517 and 400,000 shares in 2000 and 2001, respectively |                                                                                                                                                                                                                                                                              |                                           
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|                                            | Total stockholders' equity                                                        |                                                                                                                                                                                                                                                                              |                                           
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              |                                           
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              | Total liabilities and stockholders' equity
|                                            |                                                                                   |                                                                                                                                                                                                                                                                              |                                           

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

42

---



NMS Communications Corporation        Consolidated Statements of Operations

|                                                |                                                         | Year Ended December 31,  |        
|----------------------------------------------- | ------------------------------------------------------- | ------------------------ | -------
|
|
|Revenues                                        |                                                         | $                        | 79,476 
|Cost of revenues                                |                                                         |                          | 31,520 
|                                                |                                                         |                          |        
|Gross profit                                    |                                                         |                          | 47,956 
|Operating expenses:                             |                                                         |                          |        
|                                                | Selling, general and administrative                     |                          |        
|                                                | Research and development                                |                          |        
|                                                | Purchased in-process research and development           |                          |        
|                                                | Impairment charges                                      |                          |        
|                                                | Merger related expenses                                 |                          |        
|                                                | Restructuring and other special charges                 |                          |        
|                                                |                                                         |                          |        
|                                                |                                                         | Total operating expenses |        
|                                                |                                                         |                          |        
|Operating loss                                  |                                                         |                          | (17,869
|                                                | Interest income                                         |                          |        
|                                                | Interest expense                                        |                          |        
|                                                | Other                                                   |                          |        
|                                                |                                                         |                          |        
|                                                |                                                         | Other income (loss), net |        
|                                                |                                                         |                          |        
|Loss before income taxes and extraordinary item |                                                         |                          | (17,688
|                                                | Income tax expense (benefit)                            |                          |        
|                                                |                                                         |                          |        
|Net loss before extraordinary item              |                                                         |                          | (18,688
|                                                | Gain on early extinguishment of debt, net of tax        |                          |        
|                                                | expense of $7,551                                       |                          |        
|                                                |                                                         |                          |        
|Net loss                                        |                                                         | $                        | (18,688
|                                                |                                                         |                          |        
|Basic:                                          |                                                         |                          |        
|                                                | Basic loss before extraordinary item per common share   |                          | $      
|                                                | Extraordinary gain on extinguishment of debt            |                          |        
|                                                |                                                         |                          |        
|                                                | Basic net loss per common share                         |                          | $      
|                                                |                                                         |                          |        
|                                                | Weighted average basic shares outstanding               |                          |        
|                                                |                                                         |                          |        
|Diluted:                                        |                                                         |                          |        
|                                                | Diluted loss before extraordinary item per common share |                          | $      
|                                                | Extraordinary gain on extinguishment of debt            |                          |        
|                                                |                                                         |                          |        
|                                                | Diluted net loss per common share                       |                          | $      
|                                                |                                                         |                          |        
|                                                | Weighted average shares outstanding                     |                          |        
|                                                |                                                         |                          |        

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

43

---

NMS Communications Corporation
Consolidated Statements of Stockholders' Equity

|                           |                                                                     | Preferred stock |     | Common stock |   |  |        |       |   | Accumulated
other
comprehensive
loss |    |   |         | Notes
receivable
from common
stockholders |   |          |          |   |        |      |  
|-------------------------- | ------------------------------------------------------------------- | --------------- | --- | ------------ | - |  | ------ | ----- | - | ------------------------------------ | -- | - | ------- | ----------------------------------------- | - | -------- | -------- | - | ------ | ---- | -
|
|
|
|Balance, December 31, 1998 |                                                                     | 38              |     | $            |  |  | 23,903 |       | $ | 239                                  |    | $ | 68,523  |                                           | $ | (3,292   | )        | $ | (48    | )    | $
|                           |                                                                     |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | Exercise of common stock options and warrants                       |                 |     |              |   |  |        | 737   |   |                                      | 7  |   |         | 2,285                                     |   |          |          |   |        |      |  
|                           | Conversion of preferred into common                                 |                 | (38 | )            |   |  |        | 784   |   |                                      | 8  |   |         | 140                                       |   |          |          |   |        |      |  
|                           | Amortization of deferred compensation                               |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | 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   | )    | $
|                           |                                                                     |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | 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                                               |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | Amortization of deferred compensation                               |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | Stock repurchase                                                    |                 |     |              |   |  |        | (20   | ) |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | Debt repayment by common stockholders                               |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | Foreign currency translation adjustment                             |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        | (674 | )
|                           | Net loss                                                            |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          | (27,651  | ) |        |      |  
|                           |                                                                     |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|Balance, December 31, 2000 |                                                                     |                |     | $            |  |  | 36,401 |       | $ | 364                                  |    | $ | 375,663 |                                           | $ | (49,631  | )        | $ | (1,065 | )    | $
|                           |                                                                     |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | Exercise of common stock options and warrants                       |                 |     |              |   |  |        | 149   |   |                                      | 1  |   |         | 464                                       |   |          |          |   |        |      |  
|                           | Issuance of common stock under employee purchase plan               |                 |     |              |   |  |        | 295   |   |                                      | 3  |   |         | (962                                      | ) |          |          |   |        |      |  
|                           | Stock issued under Mobilee merger agreement                         |                 |     |              |   |  |        | 19    |   |                                      |   |   |         |                                          |   |          |          |   |        |      |  
|                           | Stock forfeited under IML merger agreement                          |                 |     |              |   |  |        | (135  | ) |                                      | (1 | ) |         | (9,129                                    | ) |          |          |   |        |      |  
|                           | Deferred compensation                                               |                 |     |              |   |  |        |       |   |                                      |    |   |         | 933                                       |   |          |          |   |        |      |  
|                           | Amortization of deferred compensation                               |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | Stock repurchase                                                    |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | Debt repayment by common stockholders                               |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|                           | Change in market value of securities available for sale             |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        | 113  |  
|                           | Foreign currency translation adjustment                             |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        | 569  |  
|                           | Net loss                                                            |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          | (142,658 | ) |        |      |  
|                           |                                                                     |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  
|Balance, December 31, 2001 |                                                                     |                |     | $            |  |  | 36,729 |       | $ | 367                                  |    | $ | 366,969 |                                           | $ | (192,289 | )        | $ | (383   | )    | $
|                           |                                                                     |                 |     |              |   |  |        |       |   |                                      |    |   |         |                                           |   |          |          |   |        |      |  

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

44

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NMS Communications Corporation    Consolidated Statements of Cash Flows

|                                             |                                                                     | Years Ended December 31,                                      |                                       
|-------------------------------------------- | ------------------------------------------------------------------- | ------------------------------------------------------------- | --------------------------------------
|
|
|Cash flow from operating activities:         |                                                                     |                                                               |                                       
|                                             | Net loss                                                            |                                                               | $                                     
|Adjustments to reconcile net loss to cash    |                                                                     |                                                               |                                       
|provided by (used) in operating activities:  |                                                                     |                                                               |                                       
|                                             | Depreciation and amortization of fixed assets                       |                                                               |                                       
|                                             | Amortization of goodwill and other intangibles                      |                                                               |                                       
|                                             | Foreign exchange translation loss on intercompany debt              |                                                               |                                       
|                                             | Loss on impairment of fixed assets                                  |                                                               |                                       
|                                             | Loss on impairment of goodwill and other intangibles                |                                                               |                                       
|                                             | (Gain) loss on minority investments                                 |                                                               |                                       
|                                             | Gain on repurchase of convertible notes                             |                                                               |                                       
|                                             | Write-off of debt issuance costs                                    |                                                               |                                       
|                                             | Amortization of bond issuance costs                                 |                                                               |                                       
|                                             | Deferred stock compensation expense amortized or accrued            |                                                               |                                       
|                                             | Purchased in-process research and development                       |                                                               |                                       
|                                             | Deferred income taxes                                               |                                                               |                                       
|                                             | Tax benefit from stock option exercises                             |                                                               |                                       
|                                             | Other operating activities                                          |                                                               |                                       
|                                             | Changes in operating assets and liabilities,                        |                                                               |                                       
|                                             |                                                                     | net of effects of acquisition:                                |                                       
|                                             |                                                                     |                                                               | Accounts receivable                   
|                                             |                                                                     |                                                               | Inventories                           
|                                             |                                                                     |                                                               | Prepaid expenses and other assets     
|                                             |                                                                     |                                                               | Income tax receivable                 
|                                             |                                                                     |                                                               | Accounts payable                      
|                                             |                                                                     |                                                               | Accrued expenses and other liabilities
|                                             |                                                                     |                                                               |                                       
|                                             |                                                                     |                                                               |                                       
|                                             |                                                                     |                                                               |                                       
|Cash flow from investing activities:         |                                                                     |                                                               |                                       
|                                             | Additions to property and equipment                                 |                                                               |                                       
|                                             | Purchases of marketable securities                                  |                                                               |                                       
|                                             | Proceeds from the sale of marketable securities                     |                                                               |                                       
|                                             | Acquisition of IML business, net of cash acquired                   |                                                               |                                       
|                                             | Acquisition of Mobilee, net of cash acquired                        |                                                               |                                       
|                                             | Acquisition of VES business                                         |                                                               |                                       
|                                             | Proceeds from sale of investments                                   |                                                               |                                       
|                                             | Purchase of investments                                             |                                                               |                                       
|                                             | Proceeds from the sale of property & equipment                      |                                                               |                                       
|                                             | Additions to other assets and intangibles                           |                                                               |                                       
|                                             | Additions to goodwill for contingent payments                       |                                                               |                                       
|                                             | Receipts on notes receivable                                        |                                                               |                                       
|                                             |                                                                     |                                                               |                                       
|                                             |                                                                     |                                                               |                                       
|                                             |                                                                     |                                                               |                                       
|Cash flow from financing activities:         |                                                                     |                                                               |                                       
|                                             | Repayment of long-term debt                                         |                                                               |                                       
|                                             | Proceeds from the issuance of notes payable                         |                                                               |                                       
|                                             | Payments of notes payable                                           |                                                               |                                       
|                                             | Proceeds from issuance of common stock                              |                                                               |                                       
|                                             | Issuance of common stock, net of issuance costs of $9,642           |                                                               |                                       
|                                             | Issuance of convertible notes                                       |                                                               |                                       
|                                             | Payment of issuance costs on convertible notes                      |                                                               |                                       
|                                             | Repurchase of common stock                                          |                                                               |                                       
|                                             | Issuance of repurchased treasury common stock                       |                                                               |                                       
|                                             | Other financing activities                                          |                                                               |                                       
|                                             |                                                                     |                                                               |                                       
|                                             |                                                                     |                                                               |                                       
|                                             |                                                                     |                                                               |                                       
|Effect of exchange rate changes on cash      |                                                                     |                                                               | 378                                   
|                                             |                                                                     |                                                               |                                       
|Net increase in cash and cash equivalents    |                                                                     |                                                               | 4,445                                 
|                                             |                                                                     |                                                               |                                       
|Cash and cash equivalents, beginning of year |                                                                     |                                                               | 12,172                                
|                                             |                                                                     |                                                               |                                       
|Cash and cash equivalents, end of year       |                                                                     | $                                                             | 16,617                                
|                                             |                                                                     |                                                               |                                       
|Supplemental cash flow information:          |                                                                     |                                                               |                                       
|                                             | Interest paid                                                       |                                                               | $                                     
|                                             | Taxes paid                                                          |                                                               |                                       
|Noncash transactions:                        |                                                                     |                                                               |                                       
|                                             | Issuance of warrants                                                |                                                               |                                       
|                                             | Acquisition of treasury stock through settlement of QWES.com escrow |                                                               |                                       
|                                             | Acquisition of business:                                            |                                                               |                                       
|                                             |                                                                     | Fair value of assets acquired, net of cash acquired           |                                       
|                                             |                                                                     | Fair value of liabilities assumed                             |                                       
|                                             |                                                                     | Fair value of stock issued and common stock options exchanged |                                       
|                                             |                                                                     |                                                               |                                       
|                                             |                                                                     | Acquisition of business, net of cash acquired                 |                                       

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

45

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NMS Communications Corporation        Notes to Consolidated Financial Statements

1Summary of Significant Accounting Policies

Business Description

NMS Communications Corporation (the "Company") provides complete, open systems to the world's leading wireless and wireline network operators and network
equipment providers. These systems enable communications service providers to rapidly create new services, including voice quality enhancements and voice application systems. The Company provides
system building blocks that enable network equipment manufacturers and solutions developers to rapidly develop and deploy new voice communications services in wireless, wireline and enterprise
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 accounting principles generally accepted in the United States of America requires management to make
estimates and judgements that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis,
management evaluates its estimates, including those related to revenue recognition, accounts receivable, inventories, investments, intangible assets, income taxes, restructuring and other special
charges, and accounting for acquisitions. Management bases these estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgements about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

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 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 and 2001, as a result of
remeasuring the debt at each reporting period, the Company incurred a foreign exchange loss of approximately $2.3 million and $4.7 million, respectively. 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.

46

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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, collection is reasonably assured and title and risk of loss have passed to the customer. If a future obligation to install the system or to obtain customer acceptance exists, revenues
are deferred until this obligation has been met. The Company does not offer rights of return on sales made through its direct sales force. The Company does offer quarterly return rights to a limited
number of indirect channel customers that allow the indirect channel customer to rotate a percentage of its inventory based on its prior quarter purchases.
The Company provides for these return rights each quarter by deferring revenue equal to the estimated return amount.

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

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

Service
revenue represents 8.4%, 5.8% and 6.5% of revenue for the years ended December 31, 2001, 2000 and 1999, respectively. Service revenue is primarily comprised of consulting
services and technical support services. Consulting services consist of hardware and/or software customization projects provided to customers through consulting contracts. The Company recognizes
revenue for consulting services based on the percentage-of-completion method for fixed fee contracts and as the services are performed for time and materials contracts.
Technical support services, which are sold separately from products, consist of on-site support, telephone support, system hosting and training. The Company recognizes revenue for
technical support services ratably over the contractual period or as services are provided, based on the nature of the service. The Company does not provide maintenance service or rights to upgrades
or enhancements on any of its products.

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.

47

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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. Reserves related to excess and obsolete inventory are
based primarily on estimated forecast of product demand and production requirements over the next twelve months.

Property and Equipment

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

Machinery and equipment

3 yearsComputer equipment

3-5 yearsFurniture and fixtures

5 yearsTelecommunications computer equipment

5 yearsLeasehold improvements

Shorter of the lease term or economic life


Expenditures
for additions, renewals and betterments of property and equipment are capitalized. Expenditures for repairs and maintenance are charged to expense as incurred. As assets are
retired or sold, the related cost and accumulated 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 $106.7 million and
$69.2 million, net, at December 31, 2000 and 2001, respectively. Accumulated amortization was $14.7 million and $28.5 million as of December 31, 2000 and 2001,
respectively. Other intangible assets were $12.7 million and $31.9 million, net, at December 31, 2000 and 2001, respectively. These amounts include patents, trademarks, customer
lists and other items, which are being amortized on a straight-line basis over lives ranging from 3 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, 2000 and 2001, accumulated
amortization amounted to $3.4 million and $6.1 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, 1999, 2000 and 2001 was $1.3 million, $15.4 million and $23.4 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. If an impairment is indicated, the asset is written down to its estimated
fair value. During 2001, the Company wrote down approximately $56.0 million of impaired long-lived assets which consisted of approximately $55.3 million

48

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related to the goodwill associated with the IML acquisition and approximately $638,000 related to the goodwill and acquired technology associated with the ViaDSP acquisition. Based on the declining
historical and forecasted operating results of IML as they related to earlier estimates and the economic condition of the telecommunications industry as a whole, the estimated value of
IML's and ViaDSP's goodwill had decreased. Furthermore, based on the uncertain future utilization of the acquired technology, the estimated value of ViaDSP's acquired technology had
decreased. As a result, these assets were written-down to their fair value. The charge of approximately $55.6 million related to the write-down of goodwill is included
in the statement of operations classification "impairment charges" while the charge of approximately $388,000 related to acquired technology is included in the statement of operations classification
"cost of revenues."

It
is reasonably possible that the Company may incur additional impairment charges for long-lived assets, including goodwill, in future reporting periods.

Research and Development

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

Capitalized Software Development Costs

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

Financial Instruments

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, 2001 is approximately $76.4 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

49

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number of common shares 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 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 141 is effective for all business combinations for which the date of acquisition is after June 30, 2001 and requires that the purchase method of accounting be used for all business
combinations, establishes specific criteria for the recognition of intangible assets separately from goodwill and requires unallocated negative goodwill to be written off immediately as an
extraordinary gain. SFAS No. 142 requires that goodwill and indefinite lived intangible assets will no longer be amortized, goodwill will be tested for impairment at least annually at the
reporting unit level, intangible assets deemed to have an indefinite life will be tested for impairment at least annually and the amortization period of intangible assets with finite lives will no
longer be limited to forty years. The Company adopted FAS No. 141 and FAS No. 142 on January 1, 2002. The adoption of FAS No. 141 did not have a significant impact on the
Company's consolidated financial statements. The adoption of FAS No. 142 will eliminate the amortization expense of goodwill from the Company's consolidated statement of operations, resulting
in a decrease in its operating expense. However, this decrease will be offset by the amortization of intangible assets acquired during 2001. Additionally, as a result of the required periodic
impairment reviews of goodwill, if an impairment is indicated in a future reporting period, an impairment charge will be recorded in that reporting period to reflect the reduction of the carrying
value of goodwill to its fair value.

In
October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and provides a single accounting model for
long-lived assets to be disposed of. The Company is required to adopt SFAS No. 144 for the fiscal year beginning after December 15, 2001 and does not believe it will have a
significant impact on its consolidated financial statements.

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.

50

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3Mergers and Acquisitions

VES

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

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

Amount

Estimated
LifeAcquired technology

$
11,000

6Supply agreement with Lucent


12,000

3Trademarks and tradenames


200

6Net fair value of tangible assets acquired


9,462

Goodwill


28,965

Total purchase price allocation

$
61,627


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

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

Pro
forma data summarizing the combined results of the Company and VES have been omitted since the use of forward-looking information is necessary to meaningfully present the effects of
the acquisition.

51

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Mobilee

Effective April 10, 2001, the Company acquired Mobilee, Inc. ("Mobilee"), a privately held Massachusetts company, for a total cost of
$13.3 million, including transaction costs of approximately $150,000. In connection with the acquisition, the Company paid net aggregate cash consideration of $11.2 million to the
founders and shareholders of Mobilee. An additional $1.0 million was placed in escrow and will be released to the founders of Mobilee on April 10, 2002, less any potential losses
incurred by the Company that are allowed to be off-set against the escrow per the escrow agreement. This amount was recorded as deferred compensation and is being amortized as compensation
expense ratably over the one-year escrow period. The Company also will issue stock valued at approximately $300,000 to a founder of Mobilee in four equal quarterly installments beginning
July 31, 2001, provided that this individual is still employed by the Company at the time each respective stock issuance is to be made. This amount was recorded as deferred compensation and is
being amortized as compensation expense ratably over the one-year period.

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

Amount

Estimated
LifeAcquired technology

$
1,200

4Workforce


130

4Deferred compensation


1,300

1Net fair value of tangible assets acquired and liabilities assumed


673

Goodwill


9,948

4Total purchase price allocation

$
13,251


The
Company assigned values of $1.2 million and $130,000 to existing core technology and acquired workforce, respectively. The amounts allocated to acquired technology, workforce
and goodwill are being amortized over a four-year period. The amortization of acquired technology is included in the statement of operations classification, "Cost of revenues," and the
amortization of workforce and goodwill is included in the statement of operations classification, "Selling, general and administrative expense."

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

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

52

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valued the IML options that were exchanged for NMS options 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 were entitled to additional consideration based on the financial results of IML for the years then ended. The maximum potential total additional consideration was
$12.5 million and is payable in the common stock of the Company. During the year ended December 31, 2000, the Company had 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". During the first quarter of 2001, when it became
known that the financial results necessary to earn this additional compensation would not be met, the accrual was reversed. Furthermore, the original agreement that provided for this potential
additional consideration was amended in 2001 to eliminate this additional consideration provision.

During
2001, the Company wrote down approximately $55.3 million of impaired long-lived assets related to the goodwill associated with the IML acquisition. Based on the
declining historical and forecasted operating results of IML as they related to earlier estimates and the economic condition of the telecommunications industry as a whole, the estimated value of
IML's goodwill had decreased. As a result, these assets were written-down to their fair value.

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):

Amount

Estimated
LifeIn-process research and development

$
3,300

Acquired technology


6,000

4Customer list


6,300

4Workforce


1,600

4Deferred compensation


39,696

2-3Net fair value of tangible assets acquired and liabilities assumed


7,356

Goodwill


125,691

5Total purchase price allocation

$
189,943


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.

53

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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 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 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
amount allocated to deferred compensation of $39.7 million is the total of $25.9 million related to an employment agreement with the founder of IML and
$13.8 million related to the value of pre-acquisition options issued to IML employees that were converted into NMS options as a result of the acquisition.

As
part of the merger agreement, the Company entered into an employment agreement with the founder of IML. This employment agreement also served as a non-compete agreement.
Based on the terms of the agreement, 541,536 shares of NMS stock were placed in escrow and are being paid out to the founder of IML in quarterly increments over the two year period following the
closing date of the acquisition. The price of NMS shares on the closing date was $47.75, which results in this employment agreement being valued at $25.9 million. During 2001, the Company
terminated this employment agreement and the founder of IML forfeited the remaining unearned shares of 135,384 shares. As a

54

---

result, the associated unamortized deferred compensation of $9.1 million was written off by the Company.

The
value of $13.8 million assigned to the stock options issued in the IML acquisition was calculated using the guidance of Financial Accounting Standards Board Interpretation
No. 44,"Accounting for Certain Transactions Involving Stock Compensationan Interpretation of APB 25."The
value of the unvested stock options granted by NMS in exchange for stock options held by employees of IML were calculated as the intrinsic value of the replacement options at the closing date of the
acquisition. This amount is being amortized as compensation expense over the three-year remaining vesting period of the options.

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.

Twelve months ended December 31,1999

2000(in thousands, except
per share data)Revenue

$
85,696

$
142,948Operating loss

$
(65,980
)
$
(52,174
)Net loss

$
(61,328
)
$
(47,862
)Basic and diluted net loss per share

$
(2.40
)
$
(1.38
)


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 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.

55

---

Net
revenue for the combined companies in 1998 was $76.5 million which was totally related to NMS, 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 NMS 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 NMS and ($0.8) million related to QWES.

Net
revenue for the combined companies in 1999 was $79.5 million which was totally related to NMS, 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 NMS 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 NMS and ($2.8) million related to QWES.

.

4Restructuring and Other Special Charges

During 2001, the Company recorded restructuring and other special charges of approximately $11.5 million. These charges consist of approximately
$2.3 million for the closing of the IP Services Management operation in Tustin, California, approximately $2.6 million related to a long-term lease obligation and
approximately $6.6 million related to the restructuring and repositioning of the Company. For this total charge of $11.5 million, approximately $516,000 related to the
write-down of IP Services Management inventory and is included in the statement of operations classification, "cost of revenues." The remaining $11.0 million is included in the
statement of operations classification, "restructuring and other special charges." The details of each of these items are outlined below.



During 2001, the Company announced a plan to close its IP Services Management operation, which resulted in the recording of restructuring and other special
charges of $2.3 million. As part of this plan, all 30 employees of the IP Services Management operation were terminated. The charge consisted of approximately $616,000 of involuntary severance
related costs, approximately $650,000 of fixed asset write-downs, approximately $516,000 of inventory write-downs, approximately $406,000 of lease termination costs and approximately $139,000 of other
administrative closing costs. At December 31, 2001, the remaining accrued balance for this charge was approximately $536,000 and is included in the consolidated balance sheet classification,
"accrued expenses and other liabilities." The Company expects to utilize a majority of the remaining accrued balance during 2002.



The Company leases a facility in Schaumburg, Illinois that it is not currently occupying and will not occupy in the future. This facility was
sub-leased to a third party tenant for a sub-lease term equivalent to the original lease term, which ends on September 30, 2008. In April 2001, the Company was
notified that the tenant had filed for bankruptcy protection and it would be required to resume primary responsibility for the lease payments on this facility. The Company is currently working with a
real estate agent to find another sub-lease tenant for this facility. The Company has estimated that the difference between the committed lease payments over the life of the lease and the
sub-lease rental income will approximate $2.6 million, and this amount is included as restructuring and other special charges in 2001. At December 31, 2001, the remaining
accrued balance for this charge was approximately $2.2 million and is included in the consolidated balance sheet classification, "accrued

56

---

expenses and other liabilities." Due to the long-term nature of this liability, the Company expects to utilize the remaining accrued balance over the next five years.



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

Due
to this strategic repositioning, certain facilities and fixed assets were no longer being utilized by the Company and will not be utilized in the future. The Company is currently
working with real estate agents in an attempt to sub-lease the idle facilities that are located in the United States, Canada and throughout Europe. The Company has estimated that the
difference between the committed lease payments over the life of the lease and the sub-lease rental income will approximate $702,000, and this amount is included as restructuring and other
special charges in 2001. At December 31, 2001, the remaining accrued balance for this charge was approximately $702,000 and is included in the consolidated balance sheet classification,
"accrued expenses and other liabilities." The Company expects to utilize the majority of the remaining accrued balance during 2002. The Company also disposed of fixed assets that were no longer being
utilized. These fixed assets consist primarily of leasehold improvements on the idle leased facilities and computer equipment, furniture and fixtures and machinery and equipment that were used in
connection with activities that have been discontinued by the Company. The total charge for the fixed assets that is included as restructuring and other special charges in 2001 is $2.4 million.
At December 31, 2001, there is no accrual balance related to this charge.

Additional
costs of approximately $670,000 related to the strategic repositioning have been charged to restructuring and other special charges. These costs consist primarily of contract
termination charges and other non-recurring charges associated with the repositioning. At December 31, 2001, the remaining accrued balance for this charge was approximately $520,000
and is included in the consolidated balance sheet classification, "accrued expenses and other liabilities." The Company expects to utilize the remaining accrued balance during 2002.

The
following table sets forth restructuring and other special charges accrual activity during the year ended December 31, 2001:

|                                                   |  | Employee
Related |        | Facility
Related |   | Impaired
Assets |   | Other |        | Total |  
|-------------------------------------------------- |  | ---------------- | ------ | ---------------- | - | --------------- | - | ----- | ------ | ----- | -
|
|Restructuring and other special charges            |  | $                | 3,463  |                  | $ | 3,688           |   | $     | 3,585  |       | $
|Cash payments                                      |  |                  | (1,705 | )                |   | (544            | ) |       |       |       |  
|Non-cash utilization                               |  |                  |       |                  |   |                |   |       | (3,585 | )     |  
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  
|Restructuring accrual balance at December 31, 2001 |  | $                | 1,758  |                  | $ | 3,144           |   | $     |       |       | $
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  

57

---

In
1999, as a result of a net lease commitment savings, the Company recorded a credit of $91,000 as restructuring and other special charges. At December 31, 2001, there are no
remaining accrual balances related to the initial restructuring and other special charges to which this credit relates.

5Business and Credit Concentration

No customer accounted for 10% or more of the Company's revenues for the years ended December 31, 1999, 2000 and 2001, respectively. The Company did have
two customers at the end of 1999 and 2000, and one customer at the end of 2001, that had ending accounts receivable balances that were greater than 10% of the Company's balance at December 31,
1999, 2000 and 2001. 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 $1,235,000, $433,000 and $882,000 in 1999, 2000 and 2001,
respectively.

58

---



NMS Communications Corporation        Notes to Consolidated Financial Statements

6Investments

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

December 31,2000

2001(in thousands)Money market mutual funds

$
36,425

$
71,180Corporate securities


246,451


75,150$
282,876

$
146,330Included in cash and cash equivalents


253,874


69,162Marketable securities

$
29,002

$
77,168


Since
it is the Company's intent to maintain a liquid portfolio, at December 31, 2001, all marketable securities are due to mature within one year and the unrealized gain (loss)
was $0 and $113,000 at December 31, 2000 and 2001, respectively. Proceeds from sale of securities for the years ended December 31, 1999, 2000 and 2001 were $16.4 million,
$650.6 million and $206.0 million, respectively. Gross realized gains (losses) from sale of securities for the years ended December 31, 1999 and 2000 were ($43,000) and $344,000,
respectively. There were no gross realized gains or losses from sale of securities for the year ended December 31, 2001.

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 amount of these investments was $7.6 million and $649,000 at December 31, 2000 and 2001, respectively. These investments are included in the
consolidated balance sheet caption "Other assets." The Company periodically evaluates the carrying value of these investments for other than temporary impairment. During 2001, the Company recorded a
charge of approximately $7.0 million to reflect the other than temporary decline in fair value of one of these equity investments. The investee company for which the charge was recorded has
experienced a significant decline in operating and financial results during the past year in comparison to the results forecasted at the time the investment was made. The Company determined the amount
of the charge by estimating the fair value of the underlying company based on a market approach which includes analysis of market price multiples of companies engaged in lines of business similar to
the company being evaluated. This charge is included in the consolidated statement of operations classification "Other expense." It is reasonably possible that the Company may incur additional charges
for this or other investments in future reporting periods.

For
the years ended December 31, 2000 and 2001, gross realized gains from the sale of equity investments was $2.2 million and $174,000, respectively. The Company did not
realize any gains or losses related to equity investments for the year ended December 31, 1999.

59

---

7Inventories

Inventories consist of the following:

December 31,2000

2001(in thousands)Raw materials

$
3,489

$
5,244Work in process


713


1,841Finished goods


3,579


3,977$
7,781

$
11,062


8Property and Equipment

Property and equipment consist of the following:

December 31,2000

2001(in thousands)Computer equipment

$
18,912

$
16,868Computer software


7,882


8,730Furniture and fixtures


3,143


3,068Machinery and equipment


2,637


2,329Land





220Building





808Leasehold improvements


6,053


6,35038,627


38,373Less accumulated depreciation


(18,859
)

(17,605
)$
19,768

$
20,768


Depreciation
and amortization expense was $5.3 million, $6.8 million and $9.0 million for the years ended December 31, 1999, 2000 and 2001, respectively.

60

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9Income Taxes

The components of income tax expense consist of the following:

|                                                            |                                  | Year Ended December 31, |        
|----------------------------------------------------------- | -------------------------------- | ----------------------- | -------
|
|
|Current income tax expense (benefit):                       |                                  |                         |        
|                                                            | Federal                          |                         | $      
|                                                            | State                            |                         |        
|                                                            | Foreign                          |                         |        
|                                                            |                                  |                         |        
|                                                            |                                  |                         | (3,813 
|Deferred income tax expense (benefit):                      |                                  |                         |        
|                                                            | Federal                          |                         |        
|                                                            | State                            |                         |        
|                                                            | Foreign                          |                         |        
|                                                            |                                  |                         |        
|                                                            |                                  |                         | 4,813  
|                                                            |                                  |                         |        
|                                                            |                                  | $                       | 1,000  
|                                                            |                                  |                         |        
|Deferred tax assets (liabilities) consist of the following: |                                  |                         |        
|                                                            | Net operating loss carryforwards |                         | $      
|                                                            | Tax credit carryforwards         |                         |        
|                                                            | Inventories                      |                         |        
|                                                            | Receivable allowances            |                         |        
|                                                            | Accrued expenses                 |                         |        
|                                                            | Intangible assets                |                         |        
|                                                            | Other                            |                         |        
|                                                            |                                  |                         |        
|                                                            |                                  | $                       | 11,056 
|                                                            |                                  |                         |        
|Fixed assets                                                |                                  |                         | (1,048 
|                                                            |                                  |                         |        
|Valuation allowance:                                        |                                  |                         | (10,008
|                                                            |                                  |                         |        
|Net deferred taxes                                          |                                  | $                       |       
|                                                            |                                  |                         |        

For
U.S. federal income tax purposes, the Company has net operating loss carryforwards available to reduce taxable income of approximately $59.1 million at December 31,
2001, 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 $13.8 million. The Company has $3.8 million of tax credits that are composed of federal research and development credits and state and local credits. These credits
expire beginning in 2002. 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 2001, the deferred tax asset valuation allowance increased by $48.5 million, primarily as the result of additional net operating loss carryforwards and the
amortization of intangible assets. The Company will continue to assess the valuation allowance and to the extent it is determined that such allowance is no longer required, the tax benefit of the
remaining net deferred tax assets will be recognized in the future. Approximately $1.3 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.

61

---

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

|                                                             |  | Year Ended December 31, |   
|------------------------------------------------------------ |  | ----------------------- | --
|
|Computed expected tax expense at U.S. federal statutory rate |  | (34.0                   | )%
|State income taxes, net of U.S. federal tax benefit          |  | (4.9                    | ) 
|Rate differential of foreign operations                      |  | 1.9                     |   
|State tax credits                                            |  | (3.4                    | ) 
|U.S, federal research and development credits                |  | (3.2                    | ) 
|Change in valuation allowance                                |  | 43.3                    |   
|Purchased in-process research and development                |  |                        |   
|Amortization of nondeductible intangibles                    |  | 1.9                     |   
|Acquisition expense                                          |  | 2.2                     |   
|Other                                                        |  | 1.9                     |   
|                                                             |  |                         |   
|Effective tax rate                                           |  | 5.7                     | % 
|                                                             |  |                         |   

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

|         |  | Year Ended December 31, |        
|-------- |  | ----------------------- | -------
|
|
|Domestic |  | $                       | (15,435
|Foreign  |  |                         | (2,253 
|         |  |                         |        
|         |  | $                       | (17,688
|         |  |                         |        

10Accrued Expenses and Other Liabilities

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

|                                                |  | December 31,
|----------------------------------------------- |  | ------------
|
|
|Accrued compensation and related expenses       |  | $           
|Accrued interest expense                        |  |             
|Income taxes payable                            |  |             
|Accrued restructuring and other special charges |  |             
|Other liabilities                               |  |             
|                                                |  |             
|                                                |  | $           
|                                                |  |             

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,

62

---

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 and
$3.3 million at December 31, 2000 and 2001, respectively, are included in the consolidated balance sheet caption "Other assets."

During
2001, the Company paid $27.1 million to extinguish $46.6 million face value of convertible debt. As a result, the Company wrote off $1.2 million of
unamortized debt issuance costs and recorded a related extraordinary gain of $11.3 million, net of tax expense of $7.6 million. It is reasonably possible that the Company will record
further extraordinary gains or losses related to early debt extinguishment in future reporting periods.

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 August 30, 2001.
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 certain covenants under the agreement. The most significant of these covenants require the
maintenance of certain equity and liquidity ratios, timely financial reporting to the bank and the maintenance of depository and operating accounts with the bank. The Company is currently compliant
with all covenants under the line, and there are no amounts currently outstanding. This credit agreement, as amended, is subject to renewal on May 13, 2002.

Other Debt

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

As
part of the acquisition of QWES, the Company assumed its outstanding debt which consisted of promissory notes and notes payable. In connection with the issuance of some of the notes,
the Company issued warrants to purchase 169,670 shares of common stock of the Company at an exercise price of $.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, 2001, warrants to purchase 5,342 shares were
outstanding.

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, 1999, 2000 and 2001 was $452,000, $588,000 and $1.1 million, respectively.

63

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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 $10,500 per
calendar year.

13Earnings Per Share

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

|                                              |  | Loss
(Numerator) |          | Shares
(Denominator) |        | Per Share
Amount |  
|--------------------------------------------- |  | ---------------- | -------- | -------------------- | ------ | ---------------- | -
|
|Year Ended December 31, 2001                  |  |                  |          |                      |        |                  |  
|Basic net loss per common share               |  | $                | (142,658 | )                    | 36,551 |                  | $
|Effect of dilutive securities (stock options) |  |                  |         |                      |       |                  |  
|                                              |  |                  |          |                      |        |                  |  
|Diluted net loss per common share             |  | $                | (142,658 | )                    | 36,551 |                  | $
|                                              |  |                  |          |                      |        |                  |  
|Year Ended December 31, 2000                  |  |                  |          |                      |        |                  |  
|Basic net loss per common share               |  | $                | (27,651  | )                    | 33,147 |                  | $
|Effect of dilutive securities (stock options) |  |                  |         |                      |       |                  |  
|                                              |  |                  |          |                      |        |                  |  
|Diluted net loss per common share             |  | $                | (27,651  | )                    | 33,147 |                  | $
|                                              |  |                  |          |                      |        |                  |  
|Year Ended December 31, 1999                  |  |                  |          |                      |        |                  |  
|Basic net loss per common share               |  | $                | (18,688  | )                    | 22,965 |                  | $
|Effect of dilutive securities (stock options) |  |                  |         |                      |       |                  |  
|                                              |  |                  |          |                      |        |                  |  
|Diluted net loss per common share             |  | $                | (18,688  | )                    | 22,965 |                  | $
|                                              |  |                  |          |                      |        |                  |  

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, 1999, 2000, and 2001 were 5,496,700, 7,773,884 and 9,615,378, respectively.

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

64

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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. In March 2000, the Board of Directors superseded the Directors Plan with the 2000 Plan and no further grants under the Directors Plan will be made after the adoption of the 2000
Plan. As of December 31, 2000, 280,000 shares had been granted at prices ranging from $2.44 to $24.63 per share. Options granted previously under the Directors Plan will continue to be governed
by the terms of the Directors Plan.

1995 Non-Statutory Stock Option Plan

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

2000 Equity Incentive Plan

In March 2000, the Company's Board of Directors adopted and in April 2000 the Company's stockholders approved the 2000 Equity Incentive Plan (the
"2000 Plan"). The 2000 Plan provides for the grant of incentive stock options and stock appreciation rights to employees and non-statutory stock options, stock bonuses, rights to purchase
restricted stock and other awards based on the Company's common stock (collectively, "Stock Awards") to employees, non-employee directors and consultants. The aggregate number of shares
which may be issued under the 2000 Plan is 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

65

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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.

|                                   |  | Year Ended
December 31, 1999 |   | Year Ended
December 31, 2000 |      | Year Ended
December 31, 2001
|---------------------------------- |  | ---------------------------- | - | ---------------------------- | ---- | ----------------------------
|
|Outstanding at beginning of period |  | 4,729,016                    |   | $                            | 5.70 |                             
|Granted                            |  | 2,060,894                    |   |                              | 4.94 |                             
|Exercised                          |  | (607,122                     | ) |                              | 3.68 |                             
|Forfeited or expired               |  | (686,088                     | ) |                              | 4.79 |                             
|                                   |  |                              |   |                              |      |                             
|Outstanding at end of period       |  | 5,496,700                    |   |                              | 5.74 |                             
|                                   |  |                              |   |                              |      |                             
|Exerciseable at end of period      |  | 2,352,920                    |   |                              | 5.75 |                             
|                                   |  |                              |   |                              |      |                             

The
following table summarizes information concerning currently outstanding and exercisable options as of December 31, 2001:

|Range of
Exercise Prices |              | Weighted
Average
Number
Outstanding |           | Weighted
Remaining
Contractual Life |     | Weighted
Average
Exercise Price |   | Number
Exercisable |  | Average
Exercise Price |  |  
|------------------------ | ------------ | ----------------------------------- | --------- | ----------------------------------- | --- | ------------------------------- | - | ------------------ |  | ---------------------- |  | -
|$                        | 0.17-$10.00  |                                     | 6,283,987 |                                     | 4.9 |                                 | $ | 4.64               |  | 2,960,936              |  | $
|$                        | 10.01-$20.00 |                                     | 339,026   |                                     | 5.4 |                                 |   | 15.02              |  | 276,497                |  |  
|$                        | 20.01-$30.00 |                                     | 171,262   |                                     | 6.7 |                                 |   | 24.01              |  | 98,473                 |  |  
|$                        | 30.01-$40.00 |                                     | 1,559,182 |                                     | 3.4 |                                 |   | 32.64              |  | 819,882                |  |  
|$                        | 40.01-$50.00 |                                     | 1,165,489 |                                     | 3.2 |                                 |   | 46.00              |  | 583,967                |  |  
|$                        | 50.01-$60.00 |                                     | 36,562    |                                     | 3.5 |                                 |   | 56.56              |  | 13,957                 |  |  
|$                        | 60.01-$70.00 |                                     | 11,248    |                                     | 3.1 |                                 |   | 65.19              |  | 5,182                  |  |  
|$                        | 70.01-$80.00 |                                     | 48,622    |                                     | 3.0 |                                 |   | 72.20              |  | 23,461                 |  |  
|                         |              |                                     |           |                                     |     |                                 |   |                    |  |                        |  |  
|                         |              |                                     | 9,615,378 |                                     | 4.5 |                                 |   | 15.51              |  | 4,782,355              |  |  
|                         |              |                                     |           |                                     |     |                                 |   |                    |  |                        |  |  

Other Stock Option Information

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 up
to 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.

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

The
weighted average fair value at date of grant for stock options granted during the years ended December 31, 1999, 2000 and 2001 was $3.42, $30.83 and $3.64, 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, 1999, 2000 and 2001, would have been $23.6 million, $51.1 million and $192.7 million and $1.03, $1.54 and $5.27,
respectively. The fair value of each option granted during the years ended December 31, 1999, 2000 and 2001 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, 80.0% expected volatility in 1999, 100.0% in 2000 and 100.0% in 2001, and a risk free interest rate of 6.4% for 1999, 6.1%
for 2000 and 4.6% for 2001.

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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, 2001,
1,002,035 shares have been issued under the Purchase Plan at prices ranging from $1.96 to $34.11 per share.

Stock Repurchase Program

During 2001, the Board of Directors approved a stock repurchase program authorizing the Company to repurchase up to 2,500,000 shares of its outstanding common
stock for an aggregate purchase price not to exceed $5.0 million. As of December 31, 2001, the Company has repurchased 400,000 shares for an aggregate purchase price of
$1.9 million.

15Commitments and Contingencies

The Company leases its current corporate headquarters office facilities under non-cancelable leases extending to May 31, 2012. The Company
occupies other facilities under leases, which expire within one to seven years. Rental expenses under all operating lease agreements in effect during December 31, 1999, 2000 and 2001 amount to
approximately $1.8 million, $2.7 million and $4.2 million, respectively.

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

At
December 31, 2001, commitments under operating leases for minimum future payments consist of the following, and $3.1 million of these future operating lease payments
have been accrued as part of the Company's restructuring and other special charges and will not impact the Company's results of operations in future periods:

Year ending December 31,

(in thousands)2002

$
4,9722003


4,3252004


4,0642005


3,6462006


3,678Thereafter


16,711$
37,396


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

67

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damages in an unspecified amount. The patent relates to a specific routing protocol. The action is in the 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 is defending the claim vigorously.

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, 2001 the Company had operations established in 13 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.

|                                       |      | North America |   | Europe   |   | Other |        | Corporate |   | Total  |  
|-------------------------------------- | ---- | ------------- | - | -------- | - | ----- | ------ | --------- | - | ------ | -
|
|Net Sales to unaffiliated customers:   |      |               |   |          |   |       |        |           |   |        |  
|                                       | 2001 |               | $ | 51,082   |   | $     | 13,403 |           | $ | 16,499 |  
|                                       | 2000 |               |   | 96,471   |   |       | 18,376 |           |   | 19,765 |  
|                                       | 1999 |               |   | 57,664   |   |       | 14,329 |           |   | 7,483  |  
|Income (loss) from operations:         |      |               |   |          |   |       |        |           |   |        |  
|                                       | 2001 |               | $ | (154,999 | ) | $     | (4,000 | )         | $ | 7,398  |  
|                                       | 2000 |               |   | (46,540  | ) |       | 2,070  |           |   | 8,915  |  
|                                       | 1999 |               |   | (16,780  | ) |       | (608   | )         |   | (481   | )
|Segment assets:                        |      |               |   |          |   |       |        |           |   |        |  
|                                       | 2001 |               | $ | 164,042  |   | $     | 9,242  |           | $ | 1,482  |  
|                                       | 2000 |               |   | 200,257  |   |       | 13,773 |           |   | 1,879  |  
|                                       | 1999 |               |   | 47,287   |   |       | 9,764  |           |   | 1,355  |  
|Long-lived assets:                     |      |               |   |          |   |       |        |           |   |        |  
|                                       | 2001 |               | $ | 120,516  |   | $     | 1,156  |           | $ | 255    |  
|                                       | 2000 |               |   | 137,456  |   |       | 1,458  |           |   | 282    |  
|                                       | 1999 |               |   | 17,275   |   |       | 1,153  |           |   | 248    |  
|Capital expenditures:                  |      |               |   |          |   |       |        |           |   |        |  
|                                       | 2001 |               | $ | 12,580   |   | $     | 126    |           | $ | 92     |  
|                                       | 2000 |               |   | 9,286    |   |       | 1,050  |           |   | 143    |  
|                                       | 1999 |               |   | 5,668    |   |       | 423    |           |   | 103    |  
|Depreciation and amortization expense: |      |               |   |          |   |       |        |           |   |        |  
|                                       | 2001 |               | $ | 31,817   |   | $     | 445    |           | $ | 128    |  
|                                       | 2000 |               |   | 21,488   |   |       | 524    |           |   | 108    |  
|                                       | 1999 |               |   | 6,028    |   |       | 497    |           |   | 56     |  

Included
in North America are the United States and Canada. Net sales to unaffiliated customers from the United States were $57.7 million, $96.5 million and
$51.1 million for the years ended December 31, 1999, 2000 and 2001, respectively. Long-lived assets in the United States were $17.2 million, $17.9 million and
$79.5 million at December 31, 1999, 2000 and 2001, respectively. Additionally, Canada had long-lived assets of $119.5 million and $41.0 million at
December 31, 2000

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and 2001, respectively. There are no other countries that had material net sales to unaffiliated customers or long-lived assets.

17Subsequent Events

During January and February, the Company paid $2.2 million to extinguish $3.4 million face value of convertible debt. As a result, the Company wrote
off $84,000 of unamortized debt issuance costs and recorded a related extraordinary gain of $709,000, net of tax expense of $473,000.

During
February, under the Board of Directors approved stock repurchase program, the Company repurchased 450,000 shares of its outstanding common stock for an aggregate purchase price of
$2.6 million.

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

None.

VALUATION AND QUALIFYING ACCOUNTS

Schedule VIII

|Column A |  | Column B |           | Column C |   | Column D  |  | Column E |         | 
|-------- |  | -------- | --------- | -------- | - | --------- |  | -------- | ------- | 
|
|12/31/99 |  | $        | 778,997   |          | $ | 1,235,480 |  | $        | 605,993 | 
|12/31/00 |  | $        | 1,408,484 |          | $ | 433,073   |  | $        | 581,195 | 
|12/31/01 |  | $        | 1,260,362 |          | $ | 882,200   |  | $        | 964,848 | 

---

PART III

Item 10.    Directors and Executive Officers of the Registrant.

The following table lists our executive officers and directors as of December 31, 2001:

|Name                  |  | Age |  | Position                                                                                               
|--------------------- |  | --- |  | -------------------------------------------------------------------------------------------------------
|Robert P. Schechter   |  | 53  |  | Chairman of the Board, President and Chief Executive Officer                                           
|Robert E. Hult        |  | 54  |  | Senior Vice President of Finance and Operations, Chief Financial Officer and Treasurer                 
|Clarke Ryan           |  | 47  |  | Senior Vice President and General Manager, Voice Enhancement Systems                                   
|Dorothy A. Terrell    |  | 56  |  | Senior Vice President of Worldwide Sales and Services and President of the Platforms and Services Group
|R. Brough Turner      |  | 55  |  | Senior Vice President of Technology                                                                    
|Alex N. Braverman     |  | 42  |  | Vice President and Corporate Controller                                                                
|Brian Demers          |  | 38  |  | Vice President and General Manager, Network Solutions                                                  
|William E. Foster     |  | 57  |  | Director                                                                                               
|Ofer Gneezy           |  | 50  |  | Director                                                                                               
|W. Frank King, Ph. D. |  | 62  |  | Director                                                                                               
|Pamela D. A. Reeve    |  | 52  |  | Director                                                                                               
|Ronald W. White       |  | 61  |  | Director                                                                                               

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. Schechterhas served as a member of the Board, President and Chief Executive Officer of NMS Communications 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 business software applications for enterprises and
Moldflow Corporation, a provider of solutions for optimizing the design and manufacture of plastic products.

Mr. Hultjoined NMS Communications 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

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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, a provider of enterprise software and services for eLearning and business collaboration.

Mr. Ryanjoined NMS Communications in December 2001 as part of the acquisition of Lucent Technologies, Inc.'s
("Lucent") Echo Cancellation Business. Mr. Ryan has over 20 years of experience in the telecommunications business and has held numerous positions within Lucent, including Chief
Technical Officer of the Transmission Business Unit, Concept Center Director, and, most recently, Signal Processing Systems Director.

Ms. Terrelljoined NMS Communications 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 Services and President of the Platforms and Services Group in April 1999. From 1991 until 1997, she was President of
SunExpress, Inc., the 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 NMS Communications, has served as our Senior Vice President of Technology since 1994. He
served as Vice President of Operations from 1983 to 1994.

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

Mr. Demersjoined NMS Communications in 1997 as part of the acquisition of ViaDSP, where he was Co-founder and Vice
President of Engineering. At NMS, Mr. Demers has been in engineering management with responsibility for product development, most recently serving as Director of Media Products. Prior to
co-founding ViaDSP in January 1996, Mr. Demers held various management and product development positions in the telecommunications industry at companies including
Lockheed/Sanders, M/A-COM and DSP Software Engineering.

Mr. Fosterbegan serving as a director of NMS Communications 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 manufacturer of fault-tolerant computer systems and served as
its Chairman and Chief Executive Officer until 1997. Prior to 1980, Mr. Foster spent 14 years in the computer industry, serving as Vice President of Software for Data General Corporation
and in management and technical positions with Hewlett Packard Company.

Mr. Gneezybegan serving as a director of NMS Communications 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.

Dr. Kinghas served as a director of NMS Communications since 1997. He has been, since November 1998, a private investor.
From 1992 to 1998, he was Chief Executive Officer and a director of PSW Technologies, Inc., a provider of software services. From 1988 to 1992, Dr. King was a Senior Vice President of
Development of Lotus Development Corporation and for the previous 19 years 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,

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formerly known as Cortelco Systems, Inc., a provider of telecommunications applications; Concero, formerly known as PSW Technologies, Inc., Perficient, Inc., a provider of
virtual professional services organizations to Internet software companies; iBasis, Inc., a provider of Internet telephony services and Aleri, Inc., a provider of data analytic software.

Ms. Reevehas served as a director of NMS Communications 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 American Tower Corporation, a provider of infrastructure facilities and services to the wireless, Internet and broadcasting industries.

Mr. Whitehas served as a director of NMS Communications since 1988. Since October 1997, he has been a partner of Argo
Global 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.

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 April 26, 2002 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 April 26, 2002 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 April 26, 2002 is incorporated herein by reference.

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, 2000 and 2001.
Consolidated Statements of Operations for the Years Ended December 31, 1999, 2000 and 2001.
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1999, 2000 and 2001.
Consolidated Statements of Cash Flow for the Years Ended December 31, 1999, 2000 and 2001.
Notes to the Consolidated Financial Statements.

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(A)(2) FINANCIAL STATEMENT SCHEDULES

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

|                                                |  | Page No.
|----------------------------------------------- |  | --------
|Report of Independent Accountants on Schedule   |  | 41      
|Schedule VIII Valuation and Qualifying Accounts |  | 70      

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 75, is incorporated herein by reference.

(B) REPORTS ON FORM 8K

The Registrant filed a current report on Form 8-K on December 14, 2001 regarding the acquisition of the voice enhancement and echo
cancellation business ("VES") of Lucent Technologies Inc. Under the terms of the agreement, the Registrant paid cash totaling $60 million for all assets of VES. This acquisition was
completed on November 30, 2001 and has been accounted for as a purchase business combination.

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SIGNATURES

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

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

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.

|Name                                          |  | Title                                                                                                                |  | Date          
|--------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------- |  | --------------
|                                              |  |                                                                                                                      |  |               
|/s/ROBERT P. SCHECHTERRobert P. Schechter     |  | President, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer)              |  | March 27, 2002
|/s/ROBERT E. HULTRobert E. Hult               |  | Senior Vice President of Finance and Operations, Chief Financial Officer and Treasurer (Principal Financial Officer) |  | March 27, 2002
|/s/ALEX N. BRAVERMANAlex N. Braverman         |  | Vice President and Corporate Controller (Chief Accounting Officer)                                                   |  | March 27, 2002
|/s/WILLIAM E. FOSTERWilliam E. Foster         |  | Director                                                                                                             |  | March 27, 2002
|/s/OFER GNEEZYOfer Gneezy                     |  | Director                                                                                                             |  | March 27, 2002
|/s/W. FRANK KING, PH. D.W. Frank King, Ph. D. |  | Director                                                                                                             |  | March 27, 2002
|/s/PAMELA D. A. REEVEPamela D. A. Reeve       |  | Director                                                                                                             |  | March 27, 2002
|/s/RONALD W. WHITERonald W. White             |  | Director                                                                                                             |  | March 27, 2002

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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.

|Exhibit
No. |  | Title                                                                                                                                                                                                                                                                   
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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).
|2.6*        |  | Merger Agreement dated as of May 18, 2000 by and among the Registrant, NMS 3758982 Canada Inc., Michel Laurence, Michel Brule, Stephane Tremblay, and Investissements Novacap Inc. (filed with the Registrant's
Form 8-K dated July 20, 2000).                          
|2.7*        |  | Asset Purchase Agreement, dated October 15, 2001, by and between the Registrant and Lucent Technologies, Inc. (filed with the Registrant's Form 10-Q for the quarter ended September 30, 2001).                                                                         
|3.1*        |  | Fourth Restated Certificate of Incorporation of the Registrant (filed with the Registrant's Form 10-K for the year ended December 31, 1995).                                                                                                                            
|3.2*        |  | By-laws of Registrant, as amended (filed with Registrant's registration statement on Form S-1 (#33-72596)).                                                                                                                                                             
|3.4*        |  | Certificate of Amendment to Fourth Restated Certificate of Incorporation of the Registrant (filed with the Registrant's Form 8-K dated May 4, 2001).                                                                                                                    
|4.1*        |  | Specimen Certificate for the Common Stock (filed with 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).                                                                                                                                                                                      
|10.11#*     |  | 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)).                                                                                                                    
|10.19#*     |  | 1995 Non-Statutory Stock Option Plan, as amended and restated (filed with the Registrant's registration statement on Form S-8 (333-40940)).                                                                                                                             
|10.20*      |  | Lease Amendment between Registrant and National Development of New England, LLC dated October 1996 (filed with the Registrant's Form 10-K for the year ended December 31, 1996).                                                                                        
|10.23#*     |  | 2000 Equity Incentive Plan (filed with Registrant's registration statement on Form S-8 (333-40940)).                                                                                                                                                                    

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|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).                                                                                           
|10.27* |  | Lease Agreement between the Registrant and National Development of New England, LLC dated April 1, 2000 (filed with the Registrant's Form 10-Q for the quarter ended March 31, 2001).                                                                                                  
|10.28* |  | Third Loan Modification Agreement dated August 30, 2001 between the Registrant and Silicon Valley Bank (filed with the Registrant's Form 10-Q for the quarter ended September 30, 2001).                                                                                               
|10.29* |  | Supply Agreement, dated November 30, 2001, between the Registrant and Lucent Technologies, Inc. (filed with the Registrant's Form 8-K dated December 14, 2001).                                                                                                                        
|10.30* |  | Intellectual Property Agreement, dated November 30, 2001, by and among the Registrant and Lucent Technologies, Inc. and Lucent Technologies GRL Corporation relating to the sale of Lucent's Echo Cancellation Business
(filed with the Registrant's Form 8-K dated December 14, 2001).
|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).                                                                                                          

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