**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**

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

 

**Forthe fiscal year ended** December 31, 2006

**OR**

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

 

**Forthe transition period from                           to**

**Commissionfile number:  0-23282**

**NMS COMMUNICATIONSCORPORATION**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                    |   | **04-2814586**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
| **100 Crossing Boulevard  Framingham, MA**                      |   | **01702**                             |
| (Address of  principal executive offices)                       |   | (Zip Code)                            |

 

**508-271-1000**(Registrant’stelephone number, including area code)

**None**(Former name,former address and former fiscal year, if changed since last report)

**Securities registered pursuant to Section 12(b) of the Act:**Common Stock,$0.01 par value per share

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

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o  No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act. Yes o  No x

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

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statements incorporatedby reference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o                  Accelerated filer x                  Non-accelerated filer o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o  No x

As ofJune 30, 2006, the aggregate market value of the registrant’s common stockheld by non-affiliates of the registrant was $188.7 million based on theclosing sale price as reported on the National Association of Securities Dealers AutomatedQuotation System Global Market System.

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

| **Class**                                |   | **Outstanding  at March 9, 2007** |
|------------------------------------------|--------|----------------------------------------|
| Common Stock,  $0.01 par value per share |   | 45,450,513 shares                      |

 

**DOCUMENTS INCORPORATED BY REFERENCE**

Portionsof the registrant’s Proxy Statement on Form Schedule 14-Arelating to the 2007 Annual Meeting of Stockholders of the registrant areincorporated by reference into Part III of this Form 10-K.

 

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***The following are trademarks and trade names of thecompany indicated.***

*NMS Communications,AccessGate, Convergence Generation (CG), e256, Mercury, Natural Access, MobilePlace, MyCaller, Openera, Open Access, PacketMedia, Sonata and Video Access* are trademarks; Studio Sound and Alliance Generation(AG) are registered trademarks of the registrant; and NMS is a trade name ofthe registrant. All other brand names or trademarks appearing in this Form 10-Kare the property of their respective holders.

This Form 10-K, future filings of theregistrant, press releases of the registrant and oral statements made with theapproval of an authorized executive officer of the registrant may containforward-looking statements. In connection therewith, please see the cautionarystatements and risk factors contained in “Item 1A—Risk Factors,’’ whichidentify important factors which could cause actual results to differmaterially 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 Corporationand its subsidiaries.

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**PART I**

**ITEM 1.     BUSINESS**

**Overview**

We are a leading provider of applications andplatforms that make possible the rapid creation and deployment of a broad rangeof value-added services, ranging from voice mail to interactive voicerecognition solutions to mobile television. Our customers include the world’sleading equipment providers, application developers and mobile and convergednetwork operators. For over 20 years, customers have been deploying ourproducts in networks and enterprises around the world, getting to marketquickly with innovative mobile voice, video and data services that providericher communications for businesses and consumers and can  help drive revenue and profits.

Telecommunications operators use our products toimprove customer acquisition and retention, diversify revenue streams andreduce operating costs and capital expenditures. Network equipment andapplication providers use our products to help deploy leading technology-basedsolutions for their telecom operators and enterprise customers in a timely andcost-effective manner.

We sell our productsworldwide through our direct sales force as well as through channel and systemintegrator partners. Our customers and partners include leadingtelecommunications operators, network equipment providers and applicationproviders such as Vodafone, “3” (Hutchison Telecom), MTN, Ericsson, LogicaCMG,Nokia, Siemens, Alcatel-Lucent, Comverse, Huawei, Tecore Wireless Systems, andMaterna.

**Industry Overview**

Telecommunicationsis a large, complex and rapidly evolving market that includes wireless andtraditional wireline communications services, and the related applications,equipment and infrastructure needed to deliver voice, video and data overcircuit, packet and broadband networks. Over the last 12 months, certainmarket segments of the industry have shown signs of growth. Several forces areenabling this growth, including

·  growthin Internet traffic;

·  strongconsumer adoption of wireless services, especially in emerging markets;

·  competitionamong service providers to deliver new types of services involving multimediacontent and data services;

·  thesubstitution of mobile for fixed-line voice and data communications by bothbusinesses and consumers;

·  increaseduse of Internet Protocol (IP) networks;

·  unceasingintroduction of new technologies such as WiMax (industry standard technologies,high speed, very long range wireless communications);

·  theincreasingly rapid change of communication devices such as handsets andinformation technology (IT) products; and

·  thedeployment of third generation (3G) networks by operators around the world.

Some industry analystsbelieve that for operators, equipment manufacturers, system integrators,application and content providers, the opportunities are strongest invalue-added services, particularly for mobile communications. Nonetheless,these opportunities are not without challenges for market participants.

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*Telecommunications Operators—Wireless and Wireline*

Telecommunicationsoperators, who provide wireless and wireline services, face a highlycompetitive and capital-intensive environment. Key challenges and initiativesin the industry include:

·  *Retaining customers.*   Changingindustry regulations are minimizing previous barriers to customer migrationbetween telecommunications operators, while customer acquisition costs arestill relatively high. Operators, particularly in the wireless market, areunder increasing pressure to reduce customer churn by providing high qualityvoice services as well as a wide range of other services and functionality,such as access to Internet content and video communications.

·  *Diversifying revenue streams.*   Intensecompetition has compromised operators’ ability to compete on price, furtherhighlighting the need for high quality service and new and differentiatedpremium service offerings. Additionally, operators are seeking to expandmargins and improve operating performance by increasing the average revenue percustomer through premium, value-added services that can be deployed rapidly andcost-effectively.

·  *Improving network performance.*   Aswireless telecommunications operators continue adding users and applications,overall network traffic is increasing. In this highly competitive industry,operators must respond to traffic growth with investments in network capacityand performance to avoid degradation in service standards. Wireless operatorsare aggressively upgrading their networks to next-generation infrastructures,including 2.5G, a standard which adds data (such as Internet access and textmessaging) to the current wireless infrastructure, and gradually migrating to3G, a new standard for bandwidth-intensive data services like video. Similarly,wireline operators are seeking to cost-effectively upgrade their networks usingIP technologies, in order to connect traditional telephone networks with packetnetworks.

*Network Equipment and Application Providers*

Network equipment providers, as well as applicationproviders, who include systems integrators, original equipment manufacturersand independent software vendors, provide network systems, applications and abroad range of value-added services to telecommunications operators andenterprises. These offerings include interactive voice response systems,automatic speech recognition, customer self-service and contact centersolutions, signaling and media services, conferencing over PSTN, IP and mobilenetworks, unified communications, multimedia messaging, call personalizationapplications, mobile video applications and services, and content-basedapplications like ringtones and ringback tones. These offerings enabletelecommunications operators to rapidly deploy premium services for theircustomers.

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

·  *Delivering products quickly and cost-effectively.*   Networkequipment and application providers are under continuous pressure to reduce thecosts and implementation times of product installations. These providers lookto leverage and customize third-party products to allow for the cost-effectiveand timely delivery of their products.

·  *Focusing on core competencies.*   Outsourcingcertain development activities allows these providers to focus their time andresources on their own core competencies, which include systems design,integration and application development.

·  *Accessing leading technologies.*   Inorder to help their customers gain a competitive advantage, network equipmentand application providers need access to enabling technologies and platforms,which incorporate systems building blocks and application programminginterfaces (APIs) that allow them to develop and/or operate their ownapplications and services.

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**Our Solutions**

Our offerings address a wide range of our customers’needs as they seek to develop and deploy enhanced voice and data services andapplications, and improve the quality and efficiency of communicationsnetworks. We believe that our offerings provide one or more of the followingbenefits to our customers:

*Speedtime to market for network equipment and application providers.*   Networkequipment and application providers leverage our offerings to provide lowercost, higher quality telecommunications systems more quickly to meet thedemands of their service provider and enterprise customers. Our offerings aredesigned for flexibility in various development and network environments,utilizing open interfaces and industry standards. We believe that with ourofferings, our network equipment and application provider customers are able toreduce product lifecycle costs, increase competitive value and remain focusedon their core competencies and technologies.

*Enablecost-effective and timely deployment of communications applications andservices.*   Our media servers and system buildingblock boards and software provide a comprehensive set of enabling technologiesfor developing and deploying next-generation applications.

*Enable cutting edge mobileservices such as ringback tones.*   We deliver anend to end solution that integrates with existing operator networks anddelivers music content and a subscriber profile and preference capability usedby service providers for revenue producing services such as ringback tones.

*Enableand support rapid growth in subscribers and reduce network infrastructureexpenditures.*   Our radio access network wirelessbackhaul optimization product line allows mobile operators to save operatingexpenses by reducing voice and data traffic (backhaul) expenses between cellsites and the operators’ switching sites while enabling accelerated deploymentof future services and infrastructure, including enhanced data global systemmobile communications (GSM) environment (EDGE) and universal mobiletelecommunications system (UMTS). Our wireless backhaul optimization productsuse patented aggregation and bandwidth reduction techniques to provide up to2:1 bandwidth savings in the radio access network of GSM networks.

*Provide flexible,interoperable, scalable and low cost of ownership solutions.*   Ourproducts are designed to provide maximum flexibility in designing and upgradingapplications, by utilizing open interfaces, industry standards and networkflexibility for public switched telephone network (PSTN), signalingsystem 7 (SS7) and internet protocol (IP) networks. Our products are alsohighly scalable and can address needs ranging from a handful of users tomillions of subscribers. Additionally, our servers, building block boards andapplications leverage mass-market components and custom silicon, with theobjective of price/performance leadership. Our products have lower acquisitioncosts than many competitive products, are space-efficient, consume minimalpower, and integrate with operators’ existing network infrastructure andbusiness and operational support systems (BSS/OSS), resulting in low cost ofownership.

**Products andServices**

We offer a comprehensive line of products and servicesthat address targeted customers’ needs as they seek to develop and deployenhanced voice, video and data services and applications in a variety ofnetworks.

On February 24, 2006we acquired Openera Technologies Inc. (“Openera”). Openera, whose operationsare based primarily in Bangalore, India, is a provider of mobile applicationhandset solutions for converged mobile networks. Openera has developed a set ofclient handset applications aimed at Internet Protocol Multimedia Subsystems(IMS) and peer-to-peer communications services. These applications includepeer-to-peer video, active phonebook, and location-based services. We believethis 

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new setof applications complements our existing application offerings in these growingmarket segments. We did not recognize any revenues from such products in 2006.

*Platform Solutions*

Our Platform Solutions Products team provides bothenabling technology and system-level products that allow our network equipmentand application provider customers to very rapidly develop and deploynext-generation voice, data, and video applications and services.

*OpenAccess.*   Our comprehensive offering of systemsbuilding blocks, called *Open Access*,is composed of hardware and software elements. The hardware elements consistprincipally of printed circuit boards that are used in computer systems orsubsystems. The software elements consist primarily of media processing andswitching functions, as well as APIs and a complete application developmentenvironment.

Our *Open Access*products are used to develop and deploy next-generation voice, video and dataapplications and services such as IP conferencing, speech activated services,music applications, and mobile video. Open Access products are available in avariety of form factors, including AdvancedTCA blades. All *Open Access*products are standards-based, IP-enabled, and comply with the emerging IMSstandards. Our *Open Access*products also offer a broad range of network interfaces, including analog anddigital PSTN, IP and asynchronous transport mode (ATM), and associated protocolsupport, including channel associated (tone) signaling, integrated servicesdigital network (ISDN), Signaling System 7 (SS7), and Session InitiationProtocol (SIP) for Internet Protocol (IP) networks, providing interoperabilitywith most legacy and next-generation networks and services around the world.These products are deployed in over 90 countries in enhanced communicationsservices, network infrastructure and enterprise applications.

*VisionFamily.*   The Vision family of media servers andgateways is a broad line of application-optimized communication serversdesigned to help OEMs and application providers rapidly develop and deployconverged multimedia applications in today’s converged communicationsinfrastructure and in the all-IP Multimedia Subsystem (IMS) networkarchitecture of the future. Leveraging our expertise in innovative enablingtechnology, Vision products are built on a layered architecture that isconfigurable, adaptable, and based on open standards. Our carrier-grade mediaserver capabilities include speech, mobile video, conferencing, SS7 signaling,fixed-mobile convergence, and text and multimedia messaging. The Vision serversare designed to be ready to deploy in a wide range of applications, includingnetwork announcements, messaging, prepaid card processing, conferencing,customer self-service, voice portals, call centers, IP and mobile Centrex,video chat, and more.

*Voice Quality Systems.*   OurVoice Quality Systems (“VQS”) products, which were built on pioneeringinnovations that originated at Bell Labs, include our patented Studio Soundsoftware, which creates an improved listening environment for all parties in awireless telephone conversation and is statistically proven to increasecustomer ratings on overall voice quality. Our voice quality products areavailable as a stand-alone system with multiple network interfaces or asembedded technology on blades (high-availability carrier-grade circuit boards),modules and chips. These products incorporate electrical echo cancellation andacoustic echo control technology to reduce or eliminate the echo inherent inlong distance, wireless and voice over IP (VoIP) networks. Utilizing our customtechnology and patented voice quality software, we are able to provide a highdensity solution that dramatically improves the quality of voice conversationsthrough noise reduction, automatic gain control, noise compression and dynamicspeech restoration. Our voice quality systems incorporate monitoring andmeasurement tools that give telecommunications operators the ability to observeand analyze the performance of their network via direct interaction with ourvoice quality systems. Our voice quality products have been deployed in thenetworks of over 100 leading wireless and wireline telecommunications operatorsworldwide.

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*Mobile Applications*

*MyCallerRingback.*   *MyCaller*allows mobilesubscribers to select original recordings of popular or other commercial music,sounds and voices for callers to hear in place of the conventional ringback(“ring, ring”) tone until the call is answered. *MyCaller* runs on an open, scalable, ready-to-deploy servicedelivery system that makes it possible for mobile operators worldwide to offermultiple services, including market-specific and content-based, on the samesystem.

*Mobile Place.*   Asingle framework that combines multiple applications with a powerful, completesubscriber and content management system (CCRM). Building on the *MyCaller* offering, the *Mobile Place*CCRM**enablesrapid, targeted rollout and management of new services and content to providean easy, cohesive and satisfying user experience. Mobile Place is open tooperators’ existing applications or applications from other vendors, and canleverage service delivery platforms from a variety of suppliers.

*Network Infrastructure*

*AccessGate.*   Firstlaunched in 2003, *AccessGate* is awireless backhaul optimization system that utilizes patented technologydesigned to improve the efficiency of wireless networks. Our technology allowsour mobile operator customers to carry up to twice as much voice and datatraffic over backhaul connections in GSM networks, thereby reducing theirbackhaul expenses without compromising voice or data quality and freeing upcapacity for the delivery of new services.

*Key features of our AccessGate solution include:*

·       Low-latencyA.bis compression that reduces the amount of bandwidth required to transportGSM voice and data traffic with less than 10 milliseconds of latency.

·       Low-latencystatistical multiplexing that aggregates 2G, 2.5G, 3G, GSM, time divisionmultiple access (TDMA), code division multiple access (CDMA) and/or enhanceddata GSM environment (EDGE) voice and data traffic onto the same T1 or E1 lineconnection, eliminating the need for multiple connections for the roll-out ofadvanced technologies.

·       Dynamicadaptation to changing networks simplifies management that reduces operatingcosts by efficiently utilizing existing bandwidth as traffic patterns change onhybrid 2G, 2.5G and 3G networks.

·       Simple software upgradescurrently in development that will allow our customers to utilize AccessGate inboth traditional TDM-based backhaul networks and next-generation IP andATM-based backhaul networks.

*NMS Services*

We offer a completerange of technical and operational support, system integration and professionalservices to support our customers throughout the product lifecycle includingplanning and design, evaluation, development, deployment and maintenance. Ourservice offerings span basic customer service and support to advancedarchitecture and system design based on the needs of our customers. Ourservices include the following:

·       *Technical and Operational Support Services.*   Forour systems building block hardware and software products, we provide acomplete range of developer support and maintenance service offerings. Our OEMand developer customers may choose the type and level of services they require,from options spanning basic telephone support to premium deployment serviceagreements. We also provide a complete portfolio of services for our system-leveland application products, from initial system configuration and site survey toinstallation and acceptance testing. We provide engineering and 

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installation as well asongoing system support, program management, return material authorization forreplacement of defective material and problem escalation services.

·       *Training Services.*   We provideprofessionally developed technical training curriculum for our products, basedon self-contained modules that are created in a standard format with learningobjectives, exercises and tests.

**Growth Strategy**

We aim to be aleading provider of applications and platforms for value-added services, withour primary focus on mobility and next generation services. Our strategies forachieving this objective include the following elements:

·       Provideour customers high value offerings that enable them to get services to marketquickly and cost effectively.

·       Focuson growing market niches, where we can create a sustainable leadership position- a top 3 position in market share.

·       Leverageour leadership in media processing, networks and mobile applications, our “bestpartner” practices and our supply chain expertise.

**Customers**

Wesell on a direct basis as well as through channel partners (which includevalue-added resellers, distributors, systems integrators and equipmentproviders) to telecommunications operators and network equipment andapplication providers. Our network equipment and application provider customersalso sell our products to enterprises. One channel partner, Lucent Technologies(“Lucent”), represented 13% of our 2006 revenues. Revenues from customers basedoutside the Americas were 59%, 62% and 46% in 2006, 2005 and 2004,respectively. At December 31, 2006 and 2005, we do not have a significantbacklog of unfilled orders. Further information relating to our revenues andlong-lived assets by geographic area is set forth in Note 17 “Segment andGeographic Information” to the consolidated financial statements included inthis Annual Report on Form 10-K. The table below sets forth arepresentative list of our customers and channel partners:

| **Telecommunication Operators**                                                                                           | ** ** | **Network Equipment Providers**                                                          |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------|
| “3” (Hutchison Telecom)  Celtel  Digitel  Etisalat  France Telecom  Movilnet  MTN  NTT DoCoMo  Rogers  Vodafone |       | Alcatel-Lucent  Avaya  Comverse  Ericsson  Huawei  Nokia  Siemens  Intervoice            |
| **Channel Partners**                                                                                                      | ** ** | **Application Providers**                                                                |
| Avnet  Beijing Linkhead  Channel Access  INTEGRYS  Nekotec Tecno SA de CV                                                 |       | BCGI  Crealog  European Computer Telecommunications  General Dynamics  Interactive Media |

 

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**Sales and Marketing**

We sell our products on a direct basis as well throughsystem integration and channel partners. Our direct sales and marketing effortsare focused on approximately 50 telecommunications operators and 20 networkequipment and application providers. As of December 31, 2006, our salesand marketing organization consisted of 91 employees in 22 offices worldwide,including 36 in North America, 22 in Europe and 33 in Asia. A significantportion of our direct sales force has been focused on selling our PlatformSolutions products to network equipment and application providers. Anothersegment of our direct sales force is focused on selling Mobile Applications andour wireless backhaul optimization products to network operators and mobilevirtual network operators (MVNOs).

At the same time, we haverecruited additional channel partners to expand the reach and improve coveragefor Platform Solutions products and to enhance geographic coverage for ourmobile applications offerings and wireless backhaul optimization products. Inaddition to performing sales and some level of marketing support, these channelpartners provide all or some of the following: pre- and post-sales support,systems integration, and fulfillment and credit services. For 2006, 48% ofworldwide total Company revenues was generated by direct sales, and 52% wasderived through channel partners. For 2005, 39% of worldwide total Companyrevenues was generated by direct sales, with 61% derived through channel partners.Our marketing strategy consists of three primary methods to increase awarenessand create demand for our offerings. Our public relations efforts are focusedon communications industry-related and general business mediarelationships, which increase general awareness of our business and products,and on industry analysts who can act as independent references and provideopinions on our technologies. With our direct marketing effort, we targetspecific audiences with a variety of promotional materials consisting of mostlyweb-based communications. We also participate in selected industry trade showsaround the world.

**Manufacturing**

We utilize third-party contract manufacturing partnersto assemble all of our systems building blocks and other product offerings withthe exception of our MyCaller products, which we assemble and then integrateinto customer systems at customer sites. Through a supply agreement, weoutsource the manufacturing and order fulfillment of all printed circuit boardproducts and subassemblies to Plexus Corp., a provider of advanced electronicsdesign, testing and manufacturing services. Arrow Electronics, Inc., aprovider of manufacturing services, manufactures our Vision products.

We seek to useindustry-standard components for our products. Many of these components aregenerally available from multiple suppliers, including our current supplier,Texas Instruments Inc. However, we also use certain custom integratedcircuits and other devices in our products that are sourced from various singlesuppliers such as, Agere Systems Inc. Although we believe we could developother sources for each of these custom devices, the process to qualify newsuppliers could take several months. The manufacturing processes for ourproducts are designed to comply with Federal Communications Commission (FCC),Canadian Standards Association (CSA) and Underwriters Laboratories (UL) safetyrequirements and to IPC-610 standards of assembly workmanship.Additionally, we maintain a formal product-specific structure for all requiredinternational regulatory and compliance testing. Consistent with our commitmentto provide the highest quality products and services to our customers, in 2002and 2005 we received ISO 9001:2000 certification. This certification includesall design and development activities. In 2005, we also received ISO 14001certification. All of our products are ROHS 5/6 compliant, with the leadexemption for telecommunication products.

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**Research and Product Development**

We believe that theextension and enhancement of existing products, the development of new productsand the development of open technologies proprietary to us are critical to ourfuture success. Therefore, we undertake direct research and development, engagein joint product development with selected partners and participate in thedevelopment of industry standards where appropriate. Our research anddevelopment activities are primarily based on the business units describedabove. During 2006, 2005 and 2004, we spent $25.7 million, $26.2 and $23.9million, or 26%, 24%, and 24%, respectively, of our revenue on research anddevelopment. As of December 31, 2006, our current product development isconducted by 214 employees located at our headquarters in Framingham,Massachusetts, and at our offices in, Schaumburg, Illinois, St.-Hubert, Quebecand Bangalore, India.

**Intellectual Property**

Our success depends in part on proprietary technologyand know-how. We rely primarily on a combination of trade secret and copyrightlaws and restrictions on access to protect our trade secrets and proprietaryrights and we hold 32 issued patents and have filed an additional 24 patentapplications. We distribute our software products under license agreements,which grant customers a non-exclusive license to use the software and containcertain terms and conditions prohibiting its unauthorized reproduction ortransfer. We enter into confidentiality agreements with our suppliers andcustomers when we disclose proprietary information to them. In addition, weenter into confidentiality agreements and assignment of invention agreementswith our employees and consultants. Despite these precautions, unauthorizedthird parties may copy aspects of our products or obtain information that weregard as proprietary. We believe that our products and technology do notinfringe on any existing proprietary rights of others.

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

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

**Competition**

Competition in the highgrowth markets that we target for our products is intense and diverse. There isalways the potential for new competitors to enter the markets we serve in thefuture. A significant number of our target customers, both telecommunicationsoperators and network equipment and application providers, currently usein-house development to provide products and solutions similar to ourofferings. While we must compete against these companies’ in-house efforts, webelieve that a trend towards outsourcing this type of development will continueto broaden our market opportunity. We also believe that the key competitivedifferentiators in these markets include product quality and functionality,ease-of-use, integration capabilities, price performance, cost of ownership,speed of deployment, technical support and integration and professionalservices. Current third party competitors for our product areas include:

*Platform Solutions products:*

OpenAccess and Vision Family—AudioCodes Ltd., Dialogic Corporation, andCantata Corporation.

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*Mobile Applications:*

*MyCaller Ringback and MobilePlace*—ComverseInc. and WiderThan Co., Ltd. (recently acquired by Real Networks, Inc.).

*Network Infrastructure:*

*AccessGate*—Celtro Ltd., Carrier AccessCorporation, Memotec Inc., and Cisco Systems, Inc.

**Employees**

As of December 31,2006, we had 425 full-time employees, consisting of 68 in sales, 23 inmarketing and business development, 214 in research and development, 21 inservices, 35 in operations and 64 in administration and finance. None of ouremployees are represented by a labor union. We have never experienced a workstoppage and consider our relations with our employees to be good.

**Additional Information**

We maintain a website withthe address www.nmscommunications.com. We are not including the informationcontained on our website as a part of, or incorporating it by reference into,this Annual Report on Form 10-K. We make available, free of chargethrough our website, our proxy statements, registration statements, AnnualReports on Form 10-K, Quarterly Reports on Form 10-Q andCurrent Reports on Form 8-K, and amendments to these reports, assoon as reasonably practicable after we electronically file such material with,or furnish such material to, the United States Securities and ExchangeCommission (SEC). Our SEC filings are also available over the Internet at theSEC’s website at www.sec.gov. You may also read and copy any document we fileby visiting the SEC’s public reference room in Washington, D.C. Please call theSEC at 1-800-SEC-0330 for further information about thepublic reference room.

**Forward-Looking Information**

This Form 10-Kincludes and incorporates by reference forward-looking statements that involvesubstantial risks and uncertainties and are “forward-looking statements” withinthe meaning of Section 27A of the Securities Exchange Act of 1933 andSection 21E of the Securities Exchange Act of 1934. You can identify theseforward-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 oraffirmative. We cannot guarantee that we actually will achieve these plans,intentions and expectations disclosed in the forward-looking statements wemake. Factors that could cause or contribute to such differences include, butare not limited to, those discussed in Item 1A. “Risk Factors” below, aswell as other risks and uncertainties referenced in this Form 10-K.We do not assume any obligations to update any of the forward-lookingstatements after the date of this Form 10-K to conform thesestatements to actual results.

**ITEM 1A.**        RISKFACTORS

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

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**We experienced losses in 2006 and modest profitabilityin 2005 and 2004. We are not assured of profitability.**

We experienced losses in2006 and modest profitability in 2005 and 2004. We experienced operating lossesin two of the four preceding fiscal years. Past operating losses have adverselyaffected our working capital, total assets and stockholders’ equity. Weincurred losses in 2006 due to a decrease in demand for our Platform Solutionsproducts, the adoption of Statement of Financial Accounting StandardNo. 123R, “Stock-Based Compensation” (“SFAS 123R”), stock-basedcompensation costs and other costs associated with the acquisition of Openera Technologies, Inc.(“Openera”),  and costs related to restructuringactions taken in the second half of 2006. Our current operating plan hasestablished a cost structure that, based on expected revenue, will contributeto our profitability. If revenues do not improve, or if expenses are greaterthan we anticipate, we may experience losses again. Losses could force us tocurtail our operations.

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

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

·       fluctuationsin our customers’ businesses;

·       demandfor our customers’ products that incorporate our products;

·       timingand market acceptance of new products or enhancements introduced by us or ourcompetitors;

·       availabilityof components from our suppliers and the manufacturing capacity of oursubcontractors;

·       timingand level of expenditures for sales, marketing and product development;

·       changesin the prices of our products or of our competitors’ products; and

·       generalindustry trends.

In addition, we have historically operated with nosignificant backlog and a customer order pattern that is skewed toward thelater weeks of the quarter. Any significant deferral of orders for our productswould cause a shortfall in revenues for the quarter. If our quarterly revenueor operating results fall below the expectations of investors or public marketanalysts, our common stock price may decline substantially.

Higher average sellingprices and installation obligations for our products stemming from our offeringof systems may result in sharper fluctuations in our financial results in anyparticular quarter as the delay of any given sale or installation will have agreater impact on our revenues from period to period. We may receive one ormore large orders in one quarter from a customer and then receive no ordersfrom that customer in the next quarter. As a result, our revenues may varysignificantly from quarter to quarter.

**The markets we target may not develop in the manner orat the growth rate that we anticipate which could limit our future revenues.**

Our focus is on deliveringor enabling mobile applications, particularly in the areas of next-generationvoice messaging and video. Although we expect growth in these areas, each of these markets includemany nascent segments, like mobile TV and video publishing, and they are attimes characterized by rapid technological change. As a result of theseuncertainties, we may fail to generate demand for our products at the levels weanticipate which could limit our future revenues and harm our business.

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**We have launched significant initiatives involving newmarkets, products and sales and marketing strategies. We may not be successfulwith these initiatives, which could result in reduced revenues and/or increasedexpenses.**

Historically, our directsales force has been focused on selling systems building blocks offered by ourPlatform Solutions business to network equipment and application developers.Over the past three years, we have evolved to selling more complex system-levelproducts and applications to telecommunications operators and large networkequipment providers. At the same time, we have recruited additional channelpartners to expand the reach and improve coverage for all of our product lines.In addition to performing sales and some level of marketing support, thesechannel partners provide all or some of the following: pre- and post-salessupport, systems integration, and fulfillment and credit services. These systemlevel product sales and application product sales are more complex and havelonger sales cycle. In order to succeed in this initiative, we must besuccessful in selling to our customers’ laboratories for evaluation and fieldtrial, to their purchasing decision-makers, to their new servicesdecision-makers, and to the appropriate network operations staff in order toachieve customer acceptance of our systems products. Repeated customeracceptance is required to achieve market acceptance of our systems offerings.There can be no assurance that we will be successful at implementing ourinitiatives, and if we fail, our revenues could be reduced and/or our expensesincreased. Additionally, our channel partners may not perform as agreed orexpected.

**We are dependent on channel partners to sell asubstantial portion of our revenues and on other third parties to perform otherfunctions important to our business.**

In concert with our greater emphasis on systemsofferings, we shifted the primary sales method of our systems building blocksto indirect sales through channel partners and network equipment providers.These channel partners are companies in the business of resellingcommunications products like those we produce to application developers,systems integrators and others. In the past, we have sold the vast majority ofthese products directly with our own sales force. As a result, we areincreasingly reliant on the effectiveness of channel partners’ and networkequipment providers’ sales, marketing, and distribution capabilities togenerate and fulfill demand for our products. In 2006, 52% of our revenues wasattributable to channel partners.

We are also increasingly reliant on strategicalliances with hardware, software, technology, application, content and systemintegration partners to bring our offerings to market and to reach targetedcustomers.

Similarly, we permit andtrain certain channel partners to provide first line maintenance and technicalsupport of our systems building blocks products to external suppliers.Therefore, we are increasingly reliant on these channel partners to maintainthe quality of our systems building blocks products and to provide timely andeffective technical support to a segment of our customer base. Moreover, we donot control the amount of resources that these channel partners commit tomarketing our products or products incorporating our technologies or performingthese other functions. If they do not commit sufficient resources to theseactivities, our revenues could suffer.

**Our revenue growth depends significantly on the timelydevelopment and launch of new products and product enhancements, and we cannotbe sure that our new products will gain wide market acceptance.**

The communications industry is characterized by rapidtechnological change, which requires continual development and introduction of newproducts and product enhancements that respond to evolving market needs andindustry standards on a timely and cost-effective basis. Successfullydeveloping new products requires us to accurately anticipate technologicalevolution in the communications industry as well as the technical and designneeds of our customers. In addition, new product development and launch 

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require significantcommitments of capital and personnel well in advance of when they can beexpected to result in revenue. We are continuing to invest significant researchand development resources into new product categories, including voiceapplications and IP infrastructure, and supporting technologies. The marketacceptance and commercial viability of these new product categories have notbeen proven. Failure to successfully update and enhance current products and todevelop and launch new products would harm our business.

We have experienced, andmay in the future experience, delays in developing and releasing new productsand product enhancements. These delays have led to, and may in the future leadto, delayed sales, increased expenses and lower quarterly revenues thananticipated. Our failure to timely introduce a new product or productenhancement could harm our reputation with our customers or reduce demand forthat product.

**The markets we serve are highly competitive, and wemay be unable to compete effectively, which could adversely affect demand forour products.**

There are numerouscompanies currently marketing products that compete directly with our products.Moreover, our competitors and customers may be able to develop products andservices that are superior to our products and services that achieve greatercustomer acceptance or that have significantly improved functionality ascompared to our existing and future products and services. Moreover, many ofour competitors have significantly greater financial resources than we do andtherefore are better able to invest in the research and development activitiesnecessary to bring innovative new products to market. By focusing all of theirefforts on a specific niche of the market, some of our competitors may succeedin introducing products that change the competitive dynamic in that marketniche and adversely affect demand for our products. Certain of our competitorsmay be able to negotiate alliances with strategic partners on more favorableterms than we are able to negotiate. Many of our competitors havewell-established relationships with our existing and prospective customers, includingthose on which we have focused significant sales and marketing efforts. Thesecompetitive factors could render one or more of our products obsolete, whichwould adversely affect our revenues.

**Internal development efforts by our customers mayadversely affect demand for our products.**

Many of our customers,including the large network equipment and application providers on which wefocus a significant portion of our sales and marketing efforts, have thetechnical and financial ability to design and produce components replicating orimproving on the functionality of most of our products. These organizationsoften consider in-house development of technologies and products as analternative to doing business with us. We cannot be certain that thesecustomers will resolve these “make-buy” decisions in favor of working with us,rather than attempting to develop similar technology and products internally orobtaining them through acquisition. If our customers choose to produceinternally rather than purchase from us, it will decrease the size of themarket for our products.

**Offering to sell system-level products that competewith the products manufactured by our customers could negatively affect ourbusiness.**

We have broadened ourproduct offerings from systems building blocks to subsystems and platforms, aswell as full systems. These products could compete with products offered bysome of our customers. These customers could decide to decrease purchases fromus because of this competition. This could result in a material adverse effecton our results of operations.

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**Our products typically have long sales cycles, causingus to expend significant resources before achieving agreements, “design wins”or “successful trials” and ultimately recognizing revenue.**

The length of our salescycle typically ranges from six to eighteen months and variessubstantially from customer to customer. Prospective customers generally mustcommit significant resources to test and evaluate our products and integratethem into their operating environment or product offering. This evaluation periodis often prolonged due to delays associated with approval processes thattypically accompany the design and testing of new communications equipment byour customers. In addition, the rapidly emerging and evolving nature of themarkets in which our customers and we compete may cause prospective customersto delay their purchase decisions as they evaluate new technologies and developand implement new systems. During the period in which our customers areevaluating whether to place an order with us, we often incur substantial salesand marketing expenses, without any assurance of future orders or their timing.Even after we achieve an agreement, “design win” or “successful trial” and ourproduct is expected to be utilized in a product or service offering beingdeveloped by our customer, the timing of the development, introduction andimplementation of the product is controlled by, and can vary significantly withthe needs of our customers and may exceed several months. This complicates ourplanning processes and reduces the predictability of our revenues. If salesforecasted from a specific customer for a particular quarter are not realizedin that quarter, we may fail to achieve our revenue goals.

**We acquired a business in 2006 and may acquire otherbusinesses or technologies in the future; we may be unable to integrate our newbusiness, or businesses we acquire in the future, with our business.**

We acquired Openera onFebruary 24, 2006. The process of integrating Openera’s business into oursmay absorb significant management attention, produce unforeseen operatingdifficulties and expenditures and may not produce the favorable business andmarket opportunities the acquisition was intended to provide. While theintegration process is ongoing to date, we have not experienced any operatingdifficulties or expenditures. Additionally, the 4,347,000 shares of commonstock and options to buy common stock that we issued in connection with theacquisition will have a dilutive impact on the number of our shares outstanding. Ifwe are presented with appropriate opportunities, we may acquire otherbusinesses or technologies. We may not be able to identify, negotiate, orfinance any future acquisition successfully. If we engage in an acquisitiontransaction, the process of integration may produce unforeseen operatingdifficulties and expenditures and may absorb significant attention of ourmanagement that would otherwise be available for the ongoing development of ourbusiness. If we make future acquisitions, we may issue shares of stock thatdilute other stockholders, incur debt, assume contingent liabilities, or createadditional expenses related to amortizing intangible assets, any of which mightharm our financial results and cause our stock price to decline. Any financingthat we might need for future acquisitions may only be available to us on termsthat restrict our business or that impose on us costs that reduce our netincome.

**We rely on third parties to assemble, and in certaincases, to ship, distribute and install our products. Failures or delays by suchparties in executing their responsibilities could subject us to productshortages or quality assurance problems, which, in turn, could lead to anincrease in the cost of manufacturing or assembling our products.**

We do not have in-housemanufacturing capabilities and currently rely on third-party contractmanufacturers to assemble our systems building blocks and systems. Ourmanufacturing requirements are primarily fulfilled by Plexus Corp. In addition,Plexus ships some of our products directly to our customers from itsfabrication facility. Our supply agreement with Plexus expires inOctober 2007 but automatically extends for consecutive one-year periodsunless either party gives notice 120 days prior to the expiration date ofthe then-current term. We also rely on other third parties to providedistribution and installation services. This reliance could subject us toproduct shortages or quality assurance problems, which, in turn, could lead toan increase in the cost of manufacturing or assembling our products. Anyproblems that 

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occurand persist in connection with the manufacture, delivery, quality or cost ofthe assembly of our products could affect our ability to ship product andrecognize revenue and harm our relationship with our customers.

**We depend on sole source suppliers for certaincomponents used in our products; any interruption in our supplies could affectour ability to deliver products to our customers and record associated revenue.**

We rely on vendors tosupply components for our products, and we rely on sole source suppliers forcertain custom integrated circuits and other devices that are components of oneor more of our products. In particular, Texas Instruments, Inc. (“TexasInstruments”) is our sole source for the DSPs used in many of our products andcustomarily requires order lead times of 12 to 14 weeks or more to ensuredelivery in desired quantities. In addition, Agere Systems, Inc. (“Agere”)is a sole source supplier for certain integrated circuit components used inmany of our products and customarily requires order lead times of 13 weeks ormore. Neither Texas Instruments nor Agere is under a contractual obligation tosupply us with our needs for these devices. An interruption in supply from or atermination of the relationship with either Texas Instruments or Agere woulddisrupt production, thereby adversely affecting our ability to deliver productsto our customers and record associated revenues. Converting to an alternativesource for key components could require a large investment in capital andmanpower resources and might cause significant delays in introducingreplacement products. Although we believe we could identify alternative sourcesfor all of our components, the process to qualify our suppliers could takeseveral months, and any interruption in our supplies could affect our abilityto deliver products to our customers and record associated revenue.Additionally, our agreement with Plexus specifies that if Plexus’ inventoryrelated to manufacture of our products is not turned eight times per year, weare required to purchase enough inventory to bring Plexus up to eight turns.This is assessed on a quarterly basis.

**We do not obtainbinding purchase commitments from our customers and rely on projectionsprepared by our customers and channel partners in assessing future demand forour products.**

Our volume purchaseagreements, pursuant to which we sell products, do not require our customers orchannel partners to purchase any minimum number of products. Therefore, therecan be no assurance that these agreements will result in purchase orders forour products. After we begin receiving initial orders for a product from acustomer, we rely heavily on the customer’s projections as to future needs forour product, without having any binding commitment from the customer as tofuture orders. Because our expenses are based on forecasting of future orders,a substantial reduction or delay in orders for our products from our customerscould negatively impact our operating results.

**If we do notsuccessfully implement our enterprise resource planning application (ERP), wemay experience future weakness in our internal controls and financial reportingsystem and may suffer a disruption in our business.**

We will need to continueto improve existing operational and financial systems, procedures and controlsand implement new operational and financial systems, procedures and controls tomanage our business effectively in the future. As a result, we have licensedERP software and are in the midst of upgrading our operational and financialsystems. Phase one of the implementation which included corporate operatingactivities was completed in April 2006. We are currently engaged in phasetwo of the implementation, which includes additions to the functionality of ourERP system. Any delay in the implementation of, or disruption in the transitionto, our new or enhanced systems, procedures or internal controls, couldadversely affect our ability to manage our supply chain, achieve accuracy inthe conversion of electronic data and records, and report financial andmanagement information, including the filing of our quarterly or annual reportswith the SEC, on a timely and accurate basis. As a result of the conversion fromprior systems and processes, data integrity problems may be discovered that ifnot corrected could 

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impactour business or financial results. As we add functionality to the ERP softwareand improve our procedures, new issues could arise that we have not foreseen.Failure to properly or adequately address these issues could result in thediversion of management’s attention and resources, impact our ability to manageour business and negatively impact our results of operations, cash flows andstock price.

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

The loss of any of oursenior management or key technical, sales or marketing personnel, particularlyif lost to competitors, could harm our business. Our future success will dependin large part on our ability to attract, retain and motivate highly skilledemployees.

**We may not be ableto adequately protect our intellectual property, which may facilitate thedevelopment of competing products by others.**

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

**Our products mayinfringe on the intellectual property rights of third parties, which may resultin lawsuits and prohibit us from selling our products.**

There is a risk that thirdparties have filed or will file applications for, or have received or willreceive, patents or obtain additional intellectual property rights relating tomaterials or processes that we use or propose to use. As a result, from time totime, third parties may assert patent or other intellectual property rights totechnologies that are used in our products or are otherwise important to us. Inaddition, third parties may assert claims or initiate litigation against us orour manufacturers, suppliers or customers with respect to existing or futureproducts or other proprietary rights. We generally undertake to indemnify ourcustomers against intellectual property infringement claims asserted againstthem with respect to the products we sell to them. Any claims against us orcustomers that we indemnify against intellectual property claims, with orwithout merit, may be time-consuming, result in costly litigation and diversionof technical and management personnel or require us to develop non-infringingtechnology. If a claim is successful, we may be required to obtain a license fromthe parties claiming the infringement. If we are unable to obtain a license, wemay be unable to market our affected products. Limitations on our ability tomarket our products and delays and costs associated with monetary damages andredesigns in compliance with an adverse judgment or settlement could harm ourbusiness.

**Defects in ourproducts or problems arising from the use of our products together with othervendors’ products may result in lost revenues or customer relationships andcould be detrimental to our reputation.**

Products as complex asours may contain known or undetected errors or performance problems. Defectsare frequently found during the period immediately following introduction andinitial implementation of new products or enhancements to existing products.Although we attempt to resolve errors before implementation, our products arenot error-free. These errors or performance problems could result in lostrevenues or customer relationships and could be detrimental to our business andreputation generally. Additionally, reduced market acceptance of our servicesdue to errors or defects in our technology would harm our business by reducingour revenues and damaging our reputation. In some of our contracts, we haveagreed to indemnify our customers against certain liabilities arising fromdefects in our products. In addition, our customers generally use our productstogether with their own products 

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andproducts from other vendors. As a result, when a problem occurs in the network,it may be difficult to identify the source of the problem. These problems maycause us to incur significant warranty and repair costs, divert the attentionof our engineering personnel from our product development efforts, and causesignificant customer relations problems. To date, defects in our products orthose of other vendors’ products with which ours are used by our customers havenot had a material negative effect on our business. However, we cannot becertain that a material negative effect will not occur in the future.

**Because we derive asignificant portion of our revenues from international sales, our businesscould be adversely affected by downturns in economic conditions in countriesoutside North America and other risks associated with international operations.**

Sales to customers outsideNorth America accounted for approximately 59% of our revenues in 2006, and webelieve a material portion of our domestic sales results in the use of ourproducts outside North America. Because of our dependence upon internationalsales, we are subject to a number of risks, including volatility in currencyexchange rates, political and economic instability in other countries, theimposition of trade and tariff regulations by foreign governments and thedifficulties in managing operations across disparate geographic areas. These orother factors may limit our ability to sell our products in other countries,which could result in lost revenues and negatively impact our financialcondition.

**Future regulationor legislation could restrict our business or increase our costs.**

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

**Anti-takeoverprovisions in Delaware law and our corporate documents may affect the value ofour common stock.**

Provisions of Delaware lawand our corporate documents may make it difficult and expensive for a thirdparty to remove our board of directors or management or to acquire us. Forexample, our certificate of incorporation provides for the election of membersto our board of directors for staggered three-year terms and we have adopted ashareholder rights plan. The existence of these anti-takeover provisions maysubstantially impede the ability of a third party to acquire control of us oraccumulate large blocks of our common stock, which may adversely affect ourstock price.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

None.

**ITEM 2.**                PROPERTIES

We lease two facilities totaling approximately 145,000square feet for our corporate headquarters in Framingham, Massachusetts. Theleases on these facilities expire in May 2012. We sublease approximately 46,000square feet of our corporate headquarters in Framingham Massachusetts to severalthird parties. We previously used the subleased office space as supplementaryconference, training and corporate office space. The subleases on thesefacilities expire in May 2012.

We lease facilities in Bangalore, India (primarilyused in connection with our Mobile Applications business unit),  St. Hubert, Quebec (used in connectionwith our Platform Solutions and Network Infrastructure business units), andSchaumburg, Illinois, in which we conduct design and engineering 

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operations. We also leasea facility in Reading, United Kingdom that serves as our European sales andservice headquarters. In addition, we have short-term leases for 9 salesoffices throughout North America, Europe and Asia.

We believe our facilitiesare adequate for our current needs and that we will be able to secure suitablespace as needed in the future. Unless specified otherwise our facilities areused across all our business segments.

**ITEM 3.**                LEGALPROCEEDINGS

From time to time, we area party to various legal proceedings incidental to our business. However, wehave no material legal proceedings currently pending.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITIES HOLDERS

None during the fourthquarter of 2006.

**PART II**

**ITEM5.**                MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**Price Range ofCommon Stock**

Our common stock is quotedon the NASDAQ Global Market under the symbol “NMSS.” The table below shows thehigh and low sale prices per share of our common stock, as reported on theNASDAQ Global Market, for the periods indicated.

| **Year Ended December 31, 2005** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First Quarter                                        |       | $          | 6.90       |     | $          | 4.11    |       |
| Second Quarter                                       |       | 4.38       |       | 2.51     |       |
| Third Quarter                                        |       | 3.94       |       | 2.76     |       |
| Fourth Quarter                                       |       | 4.04       |       | 3.21     |       |
|                                                      |            |            |            |          |            |         |            |  |  |

 

| **Year Ended December 31, 2006** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First Quarter                                        |       | $          | 4.19       |     | $          | 3.32    |       |
| Second Quarter                                       |       | 5.00       |       | 3.35     |       |
| Third Quarter                                        |       | 3.72       |       | 2.20     |       |
| Fourth Quarter                                       |       | 2.89       |       | 1.65     |       |
|                                                      |            |            |            |          |            |         |            |  |  |

 

As of March 9, 2007,we had approximately 201 stockholders of record of our common stock.

**Dividend Policy**

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

**Comparison ofCumulative Stockholder Return**

Thefollowing performance graph assumes an investment of $100 on December 31,2001 and compares the change to December 31, 2006 in the market price ofthe Common Stock with a broad market index (S&P 500) and an industry index(S&P Communications Equipment). The Company paid no dividends during theperiods shown. The performance of the indices is shown on a total return(dividend 

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reinvestment basis). The graph lines merely connectthe prices on the dates indicated and do not reflect fluctuations between thosedates.

| ** **                            | ** ** | **Cumulative Total Return ($)** | ** ** |
|---------------------------------------|------------|------------------------------------------------|------------|
| ** **                            | ** ** | **12/01**                                      | ** ** | **12/02** | ** ** | **12/03** | ** ** | **12/04** | ** ** | **12/05** | ** ** | **12/06** | ** ** |
| **NMS  COMMUNICATIONS CORP.**         | ** ** | **100.00**                                     | ** ** | **39.83** | ** ** | **129.46** | ** ** | **130.91** | ** ** | **72.41** | ** ** | **42.53** | ** ** |
| **S&P  500**                      | ** ** | **100.00**                                     | ** ** | **77.90** | ** ** | **100.25** | ** ** | **111.15** | ** ** | **116.61** | ** ** | **135.03** | ** ** |
| **S&P COMMUNICATIONS  EQUIPMENT** | ** ** | **100.00**                                     | ** ** | **45.83** | ** ** | **76.12** | ** ** | **78.42** | ** ** | **80.08** | ** ** | **92.50** | ** ** |

 

***THE COMPARISON OFCUMULATIVE TOTAL STOCKHOLDER RETURN ABOVE SHALL NOT BE DEEMED “SOLICITINGMATERIAL” OR INCORPORATED BY REFERENCE INTO ANY OF THE COMPANY’S FILINGS WITHTHE SECURITIES AND EXCHANGE COMMISSION.***

**Issuance ofUnregistered Securities**

We acquired Inno Media Logic Company (IML) ofSt.-Hubert, Quebec in July 2000 for a combination of cash and stock. Weand our wholly owned Canadian subsidiaries issued to the stockholders of IML982,296 shares of our common stock and shares exchangeable into an additional1,653,004 shares of our common stock. As of December 31, 2006, anaggregate of 1,377,500 additional shares of our common stock had been issued inexchange for these exchangeable shares. The shares of our common stock and theexchangeable shares were issued, as to acquirers in the United States, inreliance on the exemption set forth in Section 4(2) of the Securities Actof 1933 (the Act) and, as to acquirers outside the United States, pursuant toRegulation S under the Act. We registered on Form S-3 under theAct, effective August 25, 2000, for public sale in the United States, allthe shares of our common stock which were or are to be issued to the formershareholders of IML.

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**Issuer Repurchaseof Equity Securities**

On July 25, 2006, the Company’s Board ofDirectors authorized the repurchase of up to $20,000,000 of the Company’scommon stock by March 31, 2007 (the “July Program”). The July Program,which as publicly announced on July 27, 2006, superseded the stockrepurchase program previously authorized by the Board of Directors on April 27,2006 for the repurchase of up to 1,100,000 shares of the Company’s common stockby December 31, 2006 (the “April Program”). All repurchases under theJuly Program and the April Program were made in open-markettransactions.

Our stock repurchaseactivity for the year ended December 31, 2006 was as follows:

| **Period**          | ** ** | ** ** | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price Paid  Per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Programs** | ** ** | **Maximum Number  or Approximate  Dollar Value of  Shares that May  Yet be Purchased  Under the Program** | ** ** |
|---------------------|------------|------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| April 2006     |       |       | —     |                                                 |       |                                             | —     |                                                                                                              |       |                                                                                                                                                        | —     |   |   | 1,100,000 shares |   |
| May 2006       |       |       | 825,212    | *                                                    |       |                                             | $          | 3.79                                                                                                              |       |                                                                                                                                                        |       | 550,000 |   |   | 550,000 shares |   |
| June 2006      |       |       | —     |                                                 |       |                                             | —     |                                                                                                              |       |                                                                                                                                                        | —     |   |   | 550,000 shares |   |
| July 2006      |       |       | —     |                                                 |       |                                             | —     |                                                                                                              |       |                                                                                                                                                        | —     |   |   | $ | 20,000,000 |   |
| August 2006    |       |       | 3,017,200  |                                                 |       |                                             | $          | 2.66                                                                                                              |       |                                                                                                                                                        |       | 3,017,200 |   |   | $ | 11,943,062 |   |
| September 2006 |       |       | 4,046,573  |                                                 |       |                                             | $          | 2.93                                                                                                              |       |                                                                                                                                                        |       | 4,046,573 |   |   | $ | — |   |

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*                    275,212of these shares were repurchased on May 2, 2006 in a privately negotiatedtransaction not part of a publicly announced program for $0.8 million from anentity that had acquired those shares at fair value in connection with theCompany’s acquisition of Openera.

**ITEM 6.**                SELECTEDFINANCIAL DATA

Componentsof selected financial information consist of the following:

| ** **                                                                       | ** ** | **Year Ended December 31,**                         | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                       | ** ** | **(In thousands, except per share data)** | ** ** |
| Revenues                                                                         |       | $                                                                  | 99,606     |   | $ | 109,474 |   | $ | 101,512 |   | $ | 87,147 |   | $ | 102,693 |   |
| Gross profit                                                                     |       | 63,560                                                             |       | 70,054 |   | 63,460 |   | 38,796 |   | 44,907 |   |
| Impairment  charges                                                              |       | —                                                             |       | — |   | — |   | 18,319 |   | 66,482 |   |
| Restructuring and  other related charges                                         |       | 5,469                                                              |       | — |   | — |   | 6,948 |   | 5,010 |   |
| Operating income  (loss)                                                         |       | (16,457                                                            | )          | 3,985 |   | 5,800 |   | (54,332 | ) | (120,106 | ) |
| Income (loss) before  income taxes                                               |       | (15,513                                                            | )          | 5,340 |   | 4,168 |   | (55,891 | ) | (99,975 | ) |
| Income tax  expense (benefit)                                                    |       | 238                                                                |       | 368 |   | 66 |   | 115 |   | (1,436 | ) |
| Net income (loss)                                                                |       | (15,751                                                            | )          | 4,972 |   | 4,102 |   | (56,006 | ) | (98,539 | ) |
| Earnings (loss)  per share:                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                                                |       | $                                                                  | (0.33      | ) | $ | 0.10 |   | $ | 0.09 |   | $ | (1.54 | ) | $ | (2.73 | ) |
| Weighted average  common shares used in computing net earnings (loss) per share: |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                                                            |       | 48,467                                                             |       | 47,884 |   | 44,709 |   | 36,430 |   | 36,069 |   |
| Diluted                                                                          |       | 48,467                                                             |       | 48,285 |   | 46,894 |   | 36,430 |   | 36,069 |   |

 

| ** **     | ** ** | **December 31,**   | ** ** |
|----------------|------------|-------------------------|------------|
| ** **     | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **     | ** ** | **(In thousands)** | ** ** |
| Total assets   |       | $                       | 69,330     |   | $ | 93,303 |   | $ | 108,427 |   | $ | 86,328 |   | $ | 155,083 |   |
| Long-term debt |       | —                  |       | — |   | — |   | 57,742 |   | 69,067 |   |
|                |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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**ITEM 7.**             MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS.

**Overview**

The Company operates in the large and rapidly evolvingtelecommunications industry. Our products include systems building blocks,service delivery systems and personalized mobile entertainment applications,voice quality systems and a wireless backhaul optimizer. We sell our productsthrough channel partners, distributors, and system integrators and directly toend users. We have established businesses in North and South America(Americas), Europe, the Middle East, Africa (EMEA) and Asia. The majority ofour products are manufactured by a third party manufacturer, Plexus. Ourresearch and development activities focus primarily on opportunities relatingto emerging wireless applications, network infrastructure efficiencies andemerging IP-based services, including VoIP.

As part of our strategy to grow revenues in the areaof mobile applications and to reduce costs associated with our research anddevelopment activities, on February 24, 2006, we purchased OpeneraTechnologies, Inc. (“Openera”). Openera, whose operations are basedprimarily in Bangalore, India, is a provider of mobile application handsetsolutions for converged mobile networks. In connection with the acquisition, weissued 3,977,518 shares of our common stock, approximately 51% of which willvest over the 30-month period following the closing contingent on thecontinued employment of certain key employees of Openera over the same period.In addition, we issued options to certain employees of Openera to purchase anaggregate of 369,175 additional shares of our Common Stock. The operatingresults of Openera are included in our consolidated financial statements sincethe acquisition date.

In order to manage the cost structure of the Company,management took restructuring actions in the last half of 2006 including theclosure of our New Jersey facility, workforce reductions and the sublease ofcertain of our corporate headquarters office space. In 2007, management expectsan improvement in operating results as a result of these cost reductions coupledwith a goal to strengthen sales. Management continually monitors the activitiesof our competitors and analyzes the future of our industry to appropriatelyalign our business focus. Management also reviews the risks presented by thevolatile telecommunications industry to ensure our actions are within the scopeof our objectives.

In order to achieve focus and domain knowledge in themarket segments where we choose to compete, we have organized our productmanagement and development activities around specific target markets. OurPlatform Solutions (PS) business unit focuses on systems building blocks orenabling technology solutions that are targeted toward communications solutionproviders such as network equipment providers, application developers andsystems integrators. The PS business unit also manages our voice qualitysystems (VQS) product lines, because we increasingly see these technologiesbeing delivered to customers as systems building blocks or enablingtechnologies. The Mobile Applications (MA) business unit, previously referredto as Network Solutions (NS), is aimed at delivering mobile solutions andrelated services to mobile operators, and the Network Infrastructure (NI)business unit is focused on solutions targeted at the radio access network(RAN) portion of mobile operators’ infrastructure. In 2007, Management plans tobegin increasing its service offerings in the area of Mobile Applications andintroducing new product offerings related to mobile video applications thatwill modestly contribute to revenues in 2007.

Our 2006 net loss was primarily due to declines insales of our VQS products and Open Access products, recognition of stock-basedcompensation expense attributable to the adoption of SFAS 123R andrestructuring actions taken to reduce our infrastructure and certain operatingexpenses. Our net loss was partially offset by growth in our MyCaller andAccessGate revenues. As noted in Note 2 in the Notes to the ConsolidatedFinancial Statements included in this Annual Report on Form 10-K,effective January 1, 2006 we adopted the provisions of SFAS 123R, whichresulted in stock-based compensation expense of $2.3 million during the yearended December 31, 2006. We also recorded $2.5 million of stock-based 

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compensation expense as aresult of the acquisition of Openera, as vesting of certain awards given toformer employees of Openera is subject to continued employment at the Company.As described in Note 6 in the Notes to the Consolidated Financial Statements,we incurred $5.5 million of restructuring and other related charges associatedwith the closure of our New Jersey facility in the third quarter of 2006, andadditional workforce reductions in the fourth quarter of 2006. We also enteredinto an agreement to sublease office space located at our headquarters inFramingham, Massachusetts. This sublease resulted in a change in estimate of apreviously recognized restructuring charge.

In 2006, we utilized $5.5 million of cash to supportoperations and we utilized $23.3 million to repurchase common stock. We haveused, and may continue to use, our cash for general corporate purposes, whichmay include working capital, capital expenditures and potential acquisitions.As of December 31, 2006, we had $32.3 million in cash, cash equivalentsand short-term marketable securities. We believe the Company has sufficientcash available to execute on its business objectives in 2007.

We expect 2007 revenues tobe lower than 2006 revenues primarily due to a significant decrease in VQSsales as discussed in more detail below. Growth in other product lines,particularly Mobile Applications as we expand our service offerings, isexpected to partially offset the anticipated decline in VQS demand.

**Critical AccountingPolicies**

Our discussion and analysis of our financial conditionand results of operations are based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these financialstatements requires us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses, and related disclosureof contingent assets and liabilities. On an on-going basis, we evaluate ourestimates, including those related to stock-based compensation, revenuerecognition,  allowances for doubtful accounts, write-downs for excess andobsolete inventories, possible impairment of long-lived assets and goodwill,income taxes, restructuring and other related charges, and accounting foracquisitions. We base our estimates on historical experience and on variousother assumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources. Wehave noted that our estimates used in the past have been consistent with actualresults. Actual results may differ from these estimates under different assumptionsor conditions. For a discussion of how these estimates and other factors mayaffect our business, see also our discussion under the heading “Risk Factors”in this Annual Report on Form 10-K.

We believe the following critical accounting policiesinvolve our more significant judgments and estimates used in the preparation ofour consolidated financial statements:

*RevenueRecognition.**  *Wederive revenue primarily from two sources: (1) sales of products,including hardware and software licenses, and (2) services, includingmaintenance, support and professional services. Maintenance and supportservices consist of on-site support, telephone support, and training.Professional services consist of multiple elements of hardware and/or softwarecustomization projects provided to customers. We sell our products and servicesthrough direct sales and through channel partners, which includes resellers,distributors and system integrators. Our products are sold together as abundled hardware and software solution. When the software is essential to thefunctionality of the hardware, we recognize revenue in accordance with theprovisions of the American Institute of Certified Public Accountants Statementof Position (SOP) 97-2, *Software RevenueRecognition*, and related interpretations*.* Werecognize revenue from the sale of products when persuasive evidence of anarrangement exists, delivery has occurred, the fee is fixed or determinable,and collection is considered probable. We reduce revenue by provisions forestimated sales returns associated with rights offered to a limited number of 

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channel partners. Theserights allow the channel partner to exchange a percentage of its inventorybased on the volume of its prior quarter purchases. We provide for these returnrights each quarter in an amount equal to estimated returns. On a quarterlybasis, we review our estimates and compare our actual returns to our previousestimations. Our actual results have been in line with our expectations. We donot offer rights of return on sales made through our direct sales force. Anincrease in our allowance for sales returns would reduce our revenue in theperiod for which the increase is recorded.

We evaluate our revenue recognition policies based on thespecific facts and circumstances related to each of our channel partners. Whenselling to resellers and distributors, we generally do not recognize revenueupon shipment, since many of these customers are thinly capitalized and theirability to pay is, in substance, contingent upon their resale of our product.In these cases, we defer revenue until collectibility is probable. When revenueis deferred, if reliable reporting from the reseller or distributor exists, wewill recognize revenue when the reseller or distributor sells the product to anend-user (“sell through”). When reliable reporting does not exist, revenue willbe recognized upon our receipt of payment, or in limited circumstances receiptof a letter of credit. We further monitor the payment history of our resellersand distributors and overall days sales outstanding. We believe this revenuerecognition policy minimizes the risk that product is shipped in excess ofend-user demand and allows us to reasonably and reliably estimate productreturns.

For all sales, we use a binding contract, purchaseorder or another form of documented agreement as evidence of an arrangementwith the customer. Sales to our distributors are evidenced by a masteragreement governing the relationship, together with binding purchase orders ona transaction-by-transaction basis. We consider delivery to occur when we shipthe product, so long as title and risk of loss have passed to the customer. Atthe time of a transaction, we assess whether the sale amount is fixed ordeterminable based upon the terms of the documented agreement. If we determinethe fee is not fixed or determinable, we recognize revenue when the fee isfixed.

We assess if collection is probable based on a numberof factors, including past transaction history and the creditworthiness of thecustomer. If we determine that collection is not probable, we do not recordrevenue until such time as collection becomes probable, which is generally uponthe receipt of cash.

For arrangements with customers that includeacceptance provisions, we recognize revenue upon the customer’s acceptance ofthe product, which occurs upon the earlier of receipt of a written customeracceptance or expiration of the acceptance period.

When an arrangement involves multiple elements, suchas hardware and software products, maintenance and/or professional services, weallocate the entire sale price to each respective element based on vendorspecific objective evidence (“VSOE”) of fair value for each element. Whenarrangements contain multiple elements and VSOE of fair value exists only forall undelivered elements, we recognize revenue for the delivered elements usingthe residual method. We base our determination of VSOE of fair value of theundelivered elements based on either substantial renewal rates of maintenanceand support agreements, the price we charge when the same element is soldseparately or the price established by the members of our management, who havethe relevant authority to set prices, for an element not yet sold separately.For arrangements containing multiple elements where VSOE of fair value does notexist for all undelivered elements, we defer revenue for the delivered andundelivered elements until VSOE of fair value exists or all elements have beendelivered.

Service revenue represented 9.1%, 7.4% and 8.8% ofrevenue for the years ended December 31, 2006, 2005 and 2004,respectively. Service revenue is primarily comprised of engineering servicesand maintenance and support services. Professional services consist of hardwareand/or software customization projects provided to customers. We recognizerevenue allocated to professional service elements as the services areperformed for time and materials contracts. When the customization is essentialto the functionality of the licensed software, both the software license andprofessional services revenue are 

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recognized under thepercentage of completion method, which requires revenue to be recognized asservices are performed. We recognize revenue and gross profit using labor hoursas an input measure of progress to completion on these arrangements.Maintenance and support services, which are typically sold separately fromproducts, consist of on-site support, telephone support and training. We defermaintenance and support services revenue, whether sold separately or as part ofa multiple element arrangement, and recognize it ratably over the term of themaintenance contract, generally twelve months. When maintenance and supportservices are not sold separately we determine VSOE on maintenance and supportservices based on substantive renewal price as a percentage of the sale priceof arrangements.

When there are shipping and handling fees, we invoicecustomers for such fees. We recognize the invoiced amounts as revenue. Therelated costs are recognized in cost of revenue.

*Allowancefor Doubtful Accounts.**  *Wemaintain an allowance for doubtful accounts based upon our historicalexperience and any specifically identified customer collection issues. Wemonitor and analyze accounts receivable and the composition of the accountsreceivable aging, historical bad debts, and current economic trends, regionalfactors and other known factors when evaluating the adequacy of the allowancefor doubtful accounts. Based upon the analysis and estimates of theuncollectibility of our accounts receivable, we record an increase in theallowance for doubtful accounts when the prospect of collecting a specificaccount receivable becomes doubtful. Actual results could differ from theallowances for doubtful accounts of $0.8 million recorded as of December 31,2006, and this difference may have a material effect on our financial positionand results of operations.

*Write-downof Excess and Obsolete Inventories.**  *We value our inventories at thelower of cost (first-in, first-out method) or market. We regularly review ourinventories and record charges for excess and obsolete inventory basedprimarily on our estimated forecast of product demand and productionrequirements for the next 12 months. Actual excess and obsolete inventorycould differ from the write-down of excess and obsolete inventories of $7.0million recorded as of December 31, 2006.

*Goodwilland Other Intangible Assets.*   In accordance withSFAS No. 142, “*Goodwill and Other Intangible Assets*”(“SFAS No. 142”), goodwill is reviewed for impairment on an annual basis, ormore frequently if events or circumstances indicate that the carrying value maynot be recoverable. During 2006, we performed our annual test of goodwill todetermine if there was an impairment. These tests determined that eachreporting unit’s fair value exceeded the carrying value of the net assets ofeach respective reporting unit, using projected discounted cash flow modeling.No impairment was required to be recorded related to the annual impairmenttesting in 2006. Estimating future cash flows requires us to make projectionsthat can differ materially from actual results.

Also in accordance with SFAS No. 142, managementevaluated the useful lives assigned to other intangible assets, which resultedin no changes to such useful lives. Other intangible assets arose from theacquisition of Openera in February 2006, which are amortized over their respectiveeconomic useful lives proportionate to their expected cash flow.

*Long-livedAssets.**  *Inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,*Accounting for the Impairment or Disposal ofLong-lived Assets*, known as SFAS No. 144, we evaluate thecarrying value of our long-lived assets. SFAS No. 144 first requires anassessment of whether circumstances currently exist which suggest the carryingvalue of long-lived assets may not be recoverable. At December 31, 2006,we did not believe any such conditions existed. Had these conditions existed,we would assess the recoverability of the carrying value of our long-livedassets based on estimated undiscounted cash flows to be generated from suchassets. In assessing the recoverability of these assets, we would haveprojected estimated enterprise-level cash flows based on various operatingassumptions such as average revenue per unit, disconnect rates, and sales andworkforce productivity ratios. If the projection of undiscounted cash flows didnot exceed the carrying value of the long-lived assets, we would 

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be required to record animpairment charge to the extent the carrying value exceeded the fair value ofsuch assets.

*Stock-basedCompensation Expense.**  *OnJanuary 1, 2006, we implemented the provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 123 (revised 2004), *Share-Based Payment*(“SFAS 123R”) andrelated interpretations. SFAS 123R requires that all share-based paymentsto employees, including grants of stock options, be recognized in the financialstatements based on their fair value. We selected the modified prospectivetransition method for implementing SFAS 123R and began recognizingcompensation expense for stock-based awards granted on or after January 1,2006, plus any unvested awards granted prior to January 1, 2006. Underthis transition method, prior periods have not been restated. Stock-basedcompensation expense for awards granted on or after January 1, 2006, isbased on the grant date fair value calculated in accordance with the provisionsof SFAS 123R. Stock-based compensation related to any unvested awardsgranted prior to January 1, 2006, is based on the grant date fair valuecalculated in accordance with the original provisions of SFAS No. 123,*Accounting for Stock-Based Compensation.*Thefair value of our stock-based awards, less estimated forfeitures, is amortizedover the awards’ vesting periods on a straight-line basis. In March 2005,the Securities and Exchange Commission (“SEC”) issued Staff AccountingBulletin No. 107 (“SAB 107”) regarding the SEC Staff’sinterpretation of SFAS 123R. SAB 107 provides the Staff’s viewsregarding interactions between SFAS 123R and certain SEC rules andregulations and provides interpretations of the valuation of share-basedpayments for public companies. We have incorporated the provisions ofSAB 107 in our adoption of SFAS 123R.

Prior to the adoption of SFAS 123R on January 1,2006, we accounted for the costs of our stock-based employee compensation plansunder Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*(“APB 25”),and related interpretations. Under APB 25, compensation cost was notrecognized for substantially all options granted because the exercise price wasat least equal to the market value of the underlying common stock on the dateof grant.

The fair value of each option award on the grant dateis estimated using the Black-Scholes option-pricing model with the followingassumptions: expected dividend yield, expected stock price volatility, weightedaverage risk-free interest rate and weighted average expected life of theoptions. Under SFAS 123R, we establish the volatility assumption basedexclusively on historical volatility, and the expected life assumption isestablished based upon an analysis of historical option exercise behavior. Therisk-free interest rate is based on the implied yield currently available onU.S. Treasury zero-coupon issues with a remaining term equal to ourexpected term assumption. We have never declared or paid any cash dividends onour common stock and have no current plans to pay cash dividends on our commonstock. The payment of any future cash dividends will be determined by the ourboard of directors in light of conditions then existing, including ourearnings, financial condition and capital requirements, restrictions infinancing agreements, business conditions, tax laws, certain corporate lawrequirements and various other factors.

The choice of a valuation technique, and the approachutilized to develop the underlying assumptions for that technique, involvesignificant judgments. These judgments reflect our assessment of the mostaccurate method of valuing the stock options we issue, based on historicalexperience, knowledge of current conditions and beliefs of what could occur inthe future given available information. Our judgments could change over time asadditional information becomes available, or the facts underlying theassumptions change over time. Any change in judgments could have a materialimpact on our financial statements. We believe that these estimates incorporateall relevant information and represent a reasonable approximation in light ofthe difficulties involved in valuing non-traded stock options.

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*Severanceand Restructuring Accrued Liabilities.*   Wecontinually evaluate our staffing levels to meet our business objectives andour strategy to reduce our cost of operations. Severance costs are reviewedperiodically to determine whether a severance charge is required to be recordedin accordance with SFAS No. 112, *Employers’ Accounting forPost-employment Benefits*, (“SFAS No. 112”). The provisions of SFASNo. 112 require us to accrue post-employment benefits if certain specifiedcriteria are met. Post-employment benefits include salary continuation,severance benefits and continuation of benefits such as health and lifeinsurance.

From time to time, we announce reorganization plansthat may include eliminating positions within the Company. Each plan isreviewed to determine whether a restructuring charge is required to be recordedin accordance with SFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities*, (“SFAS No. 146”). Theprovisions of SFAS No. 146 require us to record an estimate of the fair valueof any termination costs based on certain facts, circumstances and assumptions,including specific provisions included in the underlying reorganization plan.

Also from time to time, we cease to use certainfacilities prior to expiration of the underlying lease agreements. Exit costsare reviewed in each of these circumstances on a case-by-case basis todetermine whether a restructuring charge is required to be recorded inaccordance with SFAS No. 146. The provisions of SFAS No. 146 require theCompany to record an estimate of the fair value of the exit costs based oncertain facts, circumstances and assumptions, including remaining minimum leasepayments, potential sublease income and specific provisions included in theunderlying lease agreements.

Subsequent to recording such accrued liabilities,changes in market or other conditions may result in changes to assumptions uponwhich the original liabilities were recorded that could result in an adjustmentto the liabilities and, depending on the circumstances, such adjustment could bematerial. 

*IncomeTaxes.**  *Thepreparation of our consolidated financial statements requires us to provide forincome taxes in each of the jurisdictions in which we operate, including thoseoutside the United States which may be subject to certain risks that ordinarilywould not be expected in the United States. A change in our income byjurisdiction could cause a change in our annual effective tax rate. The incometax accounting process involves estimating our actual current exposure togetherwith assessing temporary differences resulting from differing treatment ofcertain items for tax and accounting purposes. These differences result in therecognition of deferred tax assets and liabilities. We must then record avaluation allowance to reduce our deferred tax assets to the amount that ismore likely than not to be realized.

Management judgment is required in determining ourprovision for income taxes, our deferred tax assets and liabilities and anyvaluation allowance recorded against deferred tax assets. We have recordedvaluation allowance of $144.5 million as of December 31, 2006 due touncertainties related to our ability to utilize our deferred tax assets,primarily consisting of net operating loss carry forwards. We establishvaluation allowances based on historical levels of profitability and on ourestimates of future taxable income by jurisdiction in which we operate and theperiod over which our deferred tax assets will be recoverable. If actualresults differ from these estimates or we adjust these estimates in future periods,we may need to adjust our valuation allowance, which could materially impactour consolidated financial position and results of operations.

The provision for income taxes is computed based onpre-tax income included in the Consolidated Statements of Operations. Werecognize deferred tax assets and liabilities for the expected future taxconsequences of events that have been included in the financial statements.Under this method, deferred tax assets and liabilities are determined based onthe difference between the financial statement carrying amounts and tax basisof assets and liabilities using enacted tax rates in effect for the year inwhich the differences are expected to reverse.

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We determine our effective tax rate by dividing ourincome tax expense by our income before taxes as reported in its ConsolidatedStatement of Operations. For reporting periods prior to the end of the fiscalyear, we record income tax expense based upon an estimated annual effective taxrate. This rate is computed using the statutory tax rate and an estimate ofannual net income adjusted for an estimate of non-deductible expenses.

In July 2006, the Financial Accounting StandardsBoard (“FASB”) issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109*(“FIN 48”). FIN 48 clarifies theaccounting for income taxes by prescribing the minimum recognition threshold as“more-likely-than-not” that a tax position must meet before being recognized inthe financial statements. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting for income taxes in interimperiods, financial statement disclosure and transition rules.

The evaluation of a tax position in accordance withFIN 48 is a two-step process. The first step is recognition: Theenterprise determines whether it is more likely than not that a tax positionwill be sustained upon examination, including resolution of any litigation. Thesecond step is measurement: A tax position that meets the more-likely-than-notrecognition threshold is measured to determine the amount of benefit torecognize in the financial statements. The tax position is measured at thelargest amount of benefit that is greater than 50 percent likely of beingrealized upon ultimate resolution.

We are required to adopt the provisions of FIN 48related to all of our tax positions for the fiscal year beginning January 1,2007. The adoption of the provisions of FIN 48 is not expected to have amaterial impact on the Company’s financial position or results of operation.

*Restructuring and OtherRelated Charges.**  *During 2006, we reduced our workforce andceased use of two of our U.S. offices, in order to reduce operating expenses. Wecontinue to monitor and assess our facility obligations, real estate marketsand our operating expenses. These restructuring charges require us to makeestimates based upon real estate market conditions, rental rates, futurecorporate requirements, general economic conditions and estimated cash flows.We review exit costs in each of these circumstances on a case-by-case basis todetermine whether a restructuring charge is required to be recorded inaccordance with SFAS No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*. Theprovisions of SFAS No. 146 require us to record an estimate of the fairvalue of the exit costs based on certain facts, circumstances and assumptions,including remaining minimum lease payments, potential sublease income andspecific provisions included in the underlying lease agreements. We baseestimates related to anticipated sublease market rates for excess facilities onassumptions regarding the time period required to locate and contract withsuitable subtenants and base these assumptions on market trend informationanalysis. Subsequent to recording a reserve, changes in market or other conditionsmay result in changes to assumptions upon which the original reserve wasrecorded that could result in an adjustment to the reserve and, depending onthe circumstances, such adjustment could be material.

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**Results ofOperations**

The following table setsforth, for the periods indicated, certain items from our consolidatedstatements of operations as a percentage of revenues.

| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues                                |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                        |       | 36.2                                       |       | 36.0 |   | 37.5 |   |
| Gross profit                            |       | 63.8                                       |       | 64.0 |   | 62.5 |   |
| Operating expenses:                     |       |                                       |       |   |   |   |   |
| Selling, general and administrative     |       | 49.0                                       |       | 36.5 |   | 33.3 |   |
| Research and development                |       | 25.8                                       |       | 23.9 |   | 23.5 |   |
| Restructuring and other related charges |       | 5.5                                        |       | — |   | — |   |
| Total operating expenses                |       | 80.3                                       |       | 60.4 |   | 56.8 |   |
| Operating income  (loss)                |       | (16.5                                      | )          | 3.6 |   | 5.7 |   |
| Other income  (expense), net            |       | 0.9                                        |       | 1.2 |   | (1.6 | ) |
| Income (loss)  before income taxes      |       | (15.6                                      | )          | 4.8 |   | 4.1 |   |
| Income tax  expense                     |       | 0.2                                        |       | 0.3 |   | 0.1 |   |
| Net income (loss)                       |       | (15.8                                      | )%         | 4.5 | % | 4.0 | % |

 

*Revenues.*   Revenues consist primarily ofproduct sales and, to a lesser extent, sales of services provided to ourcustomers by our PS, MA and NI business units. The PS business unit revenuesconsist of sales of our building block products and services and video serverproducts and services as well as our voice quality enhancement and echocancellation products, systems and services. The MA business unit revenuesconsist of sales of our MyCaller and Openera products and related services. TheNI business unit revenues consist of sales of our wireless backhaul optimizerproduct, *AccessGate*, and related services.

*Costof revenues.**  *Costof revenues consists primarily of product cost, cost of services provided toour customers and overhead associated with testing and fulfillment operations.The Company’s manufacturing process is outsourced to a contract manufacturer.In 2006, the amortization of certain acquired intangible assets and stock-basedcompensation expense as a result of the adoption of SFAS 123R were included incost of revenues.

*Selling,general and administrative expenses.**  *Selling, general and administrativeexpenses consist primarily of salaries, commissions and related personnel andoverhead expenses for those engaged in our sales, marketing, promotional,public relations, executive, accounting and administrative activities. In 2006,the amortization of intangible assets related to acquired customerrelationships from Openera, stock-based compensation expense related to theOpenera acquisition and stock-based compensation expense as a result of theadoption of SFAS 123R were included in selling, general and administrativeexpenses.

*Researchand development expenses.**  *Research and development expenses consist primarilyof salaries, personnel expenses and prototype fees related to the design,development, testing and enhancement of our products. These costs are expensedas incurred. In 2006, stock-based compensation expense was included in researchand development expenses.

*Restructuringand other related charges.**  *Restructuring charges consist of involuntaryseverance related costs, facility closures or downsizing and disposal of excessor unused assets.

*Other income (expense),net.**  *Otherincome (expense), net consists primarily of interest income, interest expense,gains or losses realized on the repurchase of convertible debt and foreigncurrency translation gains and losses.

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**Year Ended December 31,2006 Compared to Year Ended December 31, 2005**

**Revenues**

| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2006**                                   | ** ** | **2005** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **Amount**                                 | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Change** | ** ** |
| ** **     | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| PS             |       |                                       | $          | 87.1 |   |   |   | 87.5 | % |   |   | $ | 101.8 |   |   |   | 93.0 | % |   |   | (14.4 | )% |   |
| MA             |       |                                       | 8.9        |   |   |   | 8.9 |   |   |   | 6.8 |   |   |   | 6.2 |   |   |   | 31.3 | % |   |
| NI             |       |                                       | 3.6        |   |   |   | 3.6 |   |   |   | 0.9 |   |   |   | 0.8 |   |   |   | 296.9 | % |   |
| Total revenues |       |                                       | $          | 99.6 |   |   |   | 100.0 | % |   |   | $ | 109.5 |   |   |   | 100.0 | % |   |   | (9.0 | )% |   |

 

We experienced a decrease in PS business unit revenuein the year ended December 31, 2006, as compared to the year ended December 31,2005. The change resulted primarily from a 47.5% decrease of sales of our VQSproducts and services as described below. This decrease was partially offset byincreases in revenues earned by our MA and NI business units. Sales of our VQSproducts and services decreased in 2006 compared to 2005 based primarily onfewer deployments of our products in the 3G network of a major Japaneseoperator. This deployment started in the second quarter of 2005 and diminishedthrough 2006. We do not expect to continue to earn any more revenues on suchdeployments in the future. Sales to this customer were made through a reselleragreement with Lucent Technologies Inc. (“Lucent”) which expired on December 31,2006. The functionality incorporated in our VQS products has become an embeddedrather than stand alone technology. The anticipated revenue stream, comprisedof component level product and service revenue from maintenance of theinstalled base, is expected to be modest in 2007.

In 2006, we continued to see growth in the MA businessunit through new operator deployments and expansions around the world. Weexpect our MA business to grow in 2007 with continued market adoption andintroduction of new applications and expanded service capabilities.

We experienced growth in the NI business unit for theyear ended December 31, 2006 as compared to the year ended December 31,2005, due to an increase in channel partner agreements. In 2007, we willcontinue to focus our sales efforts on emerging markets and execute agreementswith channel partners to assist with the execution of our strategy.

We experienced a 12.2%increase in service revenue from $8.1 million to $9.1 million in 2006 due to anincrease in service contracts, primarily related to the MyCaller productoffering.

| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                   | ** ** | **2005** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **Amount**                                 | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Change** | ** ** |
| ** **                      | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Americas                        |       |                                       | $          | 40.6 |   |   |   | 40.8 | % |   |   | $ | 41.2 |   |   |   | 37.6 | % |   |   | (1.3 | )% |   |
| Europe, Middle  East and Africa |       |                                       | 28.8       |   |   |   | 28.9 |   |   |   | 24.3 |   |   |   | 22.2 |   |   |   | 18.4 | % |   |
| Asia                            |       |                                       | 30.2       |   |   |   | 30.3 |   |   |   | 44.0 |   |   |   | 40.2 |   |   |   | (31.4 | )% |   |
| Total revenues                  |       |                                       | $          | 99.6 |   |   |   | 100.0 | % |   |   | $ | 109.5 |   |   |   | 100.0 | % |   |   | (9.0 | )% |   |

 

Revenues generated fromthe Americas in 2006 remained flat in comparison to 2005. Revenue from Europe,the Middle East and Africa increased in the year ended December 31, 2006due to growth in the sales of our Mobile Applications and NetworkInfrastructure products. The Asia market experienced decline in the year ended December 31,2006, as the Japanese mobile operator completed its deployment of our VQSproducts in its 3G network, as described more fully above.

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**Gross Profit and Cost of Revenues**

| ** **       | ** ** | **Year Ended December 31,** | ** ** |
|------------------|------------|--------------------------------------------|------------|
| ** **       | ** ** | **2006**                                   | ** ** | **2005** | ** ** | ** ** | ** ** |
| ** **       | ** ** | **Amount**                                 | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Change** | ** ** |
| ** **       | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues         |       |                                       | $          | 99.6 |   |   |   | 100.0 | % |   |   | $ | 109.5 |   |   |   | 100.0 | % |   |   | (9.0 | )% |   |
| Cost of revenues |       |                                       | 36.0       |   |   |   | 36.4 |   |   |   | 39.4 |   |   |   | 36.0 |   |   |   | (8.6 | )% |   |
| Gross profit     |       |                                       | $          | 63.6 |   |   |   | 63.6 | % |   |   | $ | 70.1 |   |   |   | 64.0 | % |   |   | (9.3 | )% |   |

 

| ** **             | ** ** | **Year Ended December 31,** | ** ** |
|------------------------|------------|--------------------------------------------|------------|
| ** **             | ** ** | **2006**                                   | ** ** | **2005** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Amount**                                 | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Change** | ** ** |
| ** **             | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| PS                     |       |                                       | $          | 27.5 |   |   |   | 27.7 | % |   |   | $ | 32.7 |   |   |   | 29.9 | % |   |   | (15.8 | )% |   |
| MA                     |       |                                       | 5.4        |   |   |   | 5.4 |   |   |   | 4.5 |   |   |   | 4.1 |   |   |   | 19.6 | % |   |
| NI                     |       |                                       | 3.1        |   |   |   | 3.1 |   |   |   | 2.2 |   |   |   | 2.0 |   |   |   | 41.4 | % |   |
| Total cost of revenues |       |                                       | $          | 36.0 |   |   |   | 36.2 | % |   |   | $ | 39.4 |   |   |   | 36.0 | % |   |   | (8.6 | )% |   |

 

We experienced a decreasein gross profit margin in the year ended December 31, 2006 as compared tothe year ended December 31, 2005 primarily due to a decrease in annualsales of our VQS products and services as described above. Although we incurreddecreased profit margins as compared to prior years in the MA and NI our costsassociated with these business units increased due to the labor effort requiredto put the products to use. In 2007, we expect gross profit as a percent ofrevenue to decline due to an increase in MyCaller and AccessGate sales, whichgenerate lower product margins than our PS products. During 2006, we wrote offapproximately $0.8 million of excess and obsolete inventory. This chargerelates to the purchase of NI related raw materials that could not be utilized.Service costs, which represent primarily sales technical support activities,decreased as a result of fewer employees. During 2006, we recognized $1.1million of amortization expense related to the core technology acquired fromOpenera, and $0.1 million of stock-based compensation expense due to theadoption of SFAS 123R.

**Selling, General and Administrative**

| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                   | ** ** | **2005** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Amount**                                 | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Change** | ** ** |
| ** **                           | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general  and administrative |       |                                       | $          | 48.8 |   |   |   | 49.0 | % |   |   | $ | 39.9 |   |   |   | 36.5 | % |   |   | 22.3 | % |   |
|                                      |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Selling, general andadministrative expenses increased during the year ended December 31, 2006compared to the year ended December 31, 2005. The increase for the yearended December 31, 2006 was primarily comprised of $5.0 million ofincreased payroll expense due to an increase in headcount, $1.8 million ofstock-based compensation expense due to the adoption of SFAS 123R and $2.5million of stock-based compensation expense associated with the Openeraacquisition, a $1.0 million increase of travel expenses primarily related toour international customers and Openera, and $0.1 million of amortizationrelated to acquired intangibles. These increases were partially offset by a$1.5 million decrease in sales commissions due to the decrease in 2006 annualsales. We expect selling, general and administrative spending to decreasethroughout 2007 due to the effect of the restructuring actions taken in 2006 asdescribed below and other initiatives to reduce operating costs.

30

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**Research and Development**

| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|
| ** **                | ** ** | **2006**                                   | ** ** | **2005** | ** ** | ** ** | ** ** |
| ** **                | ** ** | **Amount**                                 | ** ** | **% of  Revenues** | ** ** | **Amount** | ** ** | **% of  Revenues** | ** ** | **Change** | ** ** |
| ** **                | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research and  development |       |                                       | $          | 25.7 |   |   |   | 25.8 | % |   |   | $ | 26.2 |   |   |   | 23.9 | % |   |   | (1.7 | )% |   |
|                           |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our research anddevelopment spending decreased slightly in 2006 in comparison to 2005. Thisdecrease was primarily attributable to a decrease in personnel costs. Ourresearch and development activities are primarily focused on opportunitiesrelating to emerging wireless applications, radio access networks and emergingIP-based services, including VoIP. Our research and development spending iscurrently directed to enhance our existing board and software families, nextgeneration board and related software offerings incorporating for example,video capabilities, our Vision series of application ready media servers, andour newer product families, MyCaller and AccessGate. During the year ended December 31,2006 we invested approximately $7.6 million and $4.5 million, respectively, inthe MyCaller and AccessGate products. In 2006, we incurred $0.3 million ofstock-based compensation expense associated with the adoption of SFAS 123 R ,which is reflected in research and development. In 2007, we expect research anddevelopment spending to decrease due to decreases in payroll related costs dueto the restructuring actions taken in the third and fourth quarters of 2006 andto transferring a portion of our research and development activities to India.We expect to continue to invest in existing and new products.

**Restructuring andOther Related Charges**

During the third and fourth quarter of 2006, in orderto reduce operating costs, the Company terminated 57 employees, and  ceased using its Red Bank, New Jerseyfacility, and part of one of its facilities in Framingham, Massachusetts. Theseactions resulted in restructuring and other related charges of $5.5 million. Weexpect these actions to result in annual costs savings of approximately $8.0million from these restructuring actions.

Thefollowing table illustrates the components of the restructuring and otherrelated charges: 

| ** **                                     | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **2006**                               | ** ** |
| ** **                                     | ** ** | **(In millions)**                 | ** ** |
| Involuntary  severance related costs           |       |                                   | $          | 2.7 |   |   |
| Facility related  costs                        |       |                                   | 2.7        |   |   |
| Write-down of  fixed assets                    |       |                                   | 0.1        |   |   |
| Total restructuring and  other related charges |       |                                   | $          | 5.5 |   |   |

 

31

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**Other Income(Expense), Net**

Interestincome increased due to a rise in interest rates in 2006. The decrease ininterest expense was attributable to the repurchase and retirement ofoutstanding convertible debt in 2005. There was no third-party debt outstandingas of December 31, 2006. Included in “Other” in the year endedDecember 31, 2006, are $0.4 million of foreign exchange expense related tothe remeasurement of our inter-company debt.

| ** **                         | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|
| ** **                         | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(In millions)**                 | ** ** |
| Interest income                    |       | $                                      | 1.7        |   | $ | 1.6 |   |
| Interest expense                   |       | —                                 |       | (0.8 | ) |
| Other                              |       | (0.8                                   | )          | 0.6 |   |
| Total other income  (expense), net |       | $                                      | 0.9        |   | $ | 1.4 |   |

 

**Income Tax Expense**

| ** **          | ** ** | **Year Ended  December 31,** | ** ** |
|---------------------|------------|----------------------------------------|------------|
| ** **          | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| ** **          | ** ** | **(In millions)**                 | ** ** |
| Income tax  expense |       | $                                      | 0.2        |   | $ | 0.4 |   |
|                     |            |                                        |            |  |  |  |  |

 

Income tax expense is primarily due to foreign incometaxes incurred by foreign subsidiaries offset by tax credits earned related toour research and development activities performed at our Canadian facility.

For U.S. federal income tax purposes, we had netoperating loss carryforwards available to reduce taxable income ofapproximately $176.2 million at December 31, 2006. Of this amount$21.1 million relates to deductions from the exercise of stock options ofwhich approximately $1.5 million is tracked separately and not included inthe Company’s deferred tax asset (in accordance with FAS 123R). The futurebenefit from these deductions will be recorded as a credit to additionalpaid-in capital when realized. Under the provision of the Internal Revenue CodeSection 382, certain changes in the Company’s ownership structure mayresult in a limitation on the amount of net operating loss carryforwards andresearch and development credit carryforwards that may be used in future years.These carryforwards will begin to expire in 2007 if unutilized. We also hadforeign net operating loss carryforwards of approximately $28.4 million.As of December 31, 2006, we had approximately $6.4 million of tax creditsin the U.S. that are composed of federal research and development credits andstate and local credits. These credits will begin to expire in 2007 ifunutilized. In addition, we had Canadian investment tax credits ofapproximately $4.4 million. These credits begin to expire in 2014 if unutilized.

We have established a valuation allowance against netdeferred tax assets in certain jurisdictions including the United States,because we believe that it is more likely than not that the tax assets in thosejurisdictions will not be realized prior to their expiration. We will continueto assess the valuation allowance and to the extent it is determined that anyallowance is no longer required, the tax benefit of the remaining net deferredtax assets would be recognized in the future.

United States income taxeswere not provided on cumulative undistributed earnings for certain non-U.S.subsidiaries of approximately $3.2 million. We intend to reinvest theseearnings indefinitely in our operations outside the United States.

32

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**Year EndedDecember 31, 2005 Compared to Year Ended December 31, 2004**

**Revenues**

| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2005**                                   | ** ** | **2004** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **Amount**                                 | ** ** | **% of Revenues** | ** ** | **Amount** | ** ** | **% of Revenues** | ** ** | **Change** | ** ** |
| ** **     | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| PS             |       |                                       | $          | 101.8 |   |   |   | 93.0 | % |   |   | $ | 100.9 |   |   |   | 99.4 | % |   | 0.9 | % |
| MA             |       |                                       | 6.8        |   |   |   | 6.2 |   |   |   | 0.3 |   |   |   | 0.3 |   |   | 1857.0 | % |
| NI             |       |                                       | 0.9        |   |   |   | 0.8 |   |   |   | 0.3 |   |   |   | 0.3 |   |   | 192.4 | % |
| Total revenues |       |                                       | $          | 109.5 |   |   |   | 100.0 | % |   |   | $ | 101.5 |   |   |   | 100.0 | % |   | 7.8 | % |

 

We experienced a slight increase in PS business unitrevenue in the year ended December 31, 2005, as compared to the year endedDecember 31, 2004. The change resulted from a 15.4% decrease in sales ofour natural access products offset by an 85.1% increase in our voice qualityproducts. The decrease in natural access sales was a result of a decrease involume sales attributable to original equipment manufacturers (“OEMs”) andsolution provider customers, primarily in North America, and a slowdown in theChinese telecommunications equipment market during the first half of 2005. Thedecrease in sales to our customers is directly related to lower demand they experiencedfrom their operator, service provider and enterprise customers. We believe theenterprise sector had the largest impact on demand during this period. In 2005,demand from our customers increased during the third quarter of 2005 and wasstable through the remainder of the year. Sales of our voice quality productsand services were up significantly in 2005, based primarily on deployments ofour products in the 3G network of a major Japanese operator. This deploymentstarted in the second quarter and concluded in the second quarter of 2006, withthe fourth quarter of 2005 representing the volume peak. Sales to this customerare made through a reseller agreement with Lucent Technologies Inc. (“Lucent”)which expired on December 31, 2006. During 2004, we received royalty feesfrom Lucent in connection with our VQS technology of $2.4 million. Our royaltyagreement expired in late 2004.

During 2005 we recorded $6.8 million of revenue in ourMA business unit from sales of our MyCaller products and services. Orders andshipments of MyCaller systems were greater than total revenues recognized forthe fourth quarter and the year. As a result, the excess shipments resulted indeferred revenues until customer acceptance is completed. We introduced theMyCaller product late in 2004, and recognized our first revenues in the fourthquarter of 2004.

We experienced modest growth in the NI business unitduring the year ended December 31, 2005 as compared to the year endedDecember 31, 2004. Revenues associated with AccessGate were lower thanexpected. In 2005, we re-focused our sales efforts on emerging markets and havesigned agreements with channel partners to assist with the execution of ourstrategy.

Weexperienced a 9.2% decrease in service revenue from $8.9 million in 2004 to$8.1 million in 2005 due to a decrease in consulting projects in 2005.

| ** **                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **Amount**                                 | ** ** | **% of Revenues** | ** ** | **Amount** | ** ** | **% of Revenues** | ** ** | **Change** | ** ** |
| ** **                      | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Americas                        |       |                                       | $          | 41.2 |   |   |   | 37.6 | % |   |   | $ | 54.5 |   |   |   | 53.7 | % |   |   | (24.4 | )% |   |
| Europe, Middle  East and Africa |       |                                       | 24.3       |   |   |   | 22.2 |   |   |   | 20.4 |   |   |   | 20.1 |   |   |   | 18.8 | % |   |
| Asia                            |       |                                       | 44.0       |   |   |   | 40.2 |   |   |   | 26.6 |   |   |   | 26.2 |   |   |   | 65.5 | % |   |
| Total revenues                  |       |                                       | $          | 109.5 |   |   |   | 100.0 | % |   |   | $ | 101.5 |   |   |   | 100.0 | % |   |   | 7.8 | % |   |

 

33

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We experienced growth inthe year ended December 31, 2005 as compared to the year endedDecember 31, 2004 in our international markets due primarily to growth inthe Asian market. The Asian market experienced the strongest growth during thelatter half of 2005, due in large part to the deployment of our VQS products bya major Japanese mobile operator, as described above. The increase in Asia waspartially offset by lower sales of PS products in Europe and the Americas. TheAmericas market declined when compared to the previous year due primarily tolower sales of our PS products as described in the preceding section.

**Gross Profit and Cost of Revenues**

| ** **       | ** ** | **Year Ended December 31,** | ** ** |
|------------------|------------|--------------------------------------------|------------|
| ** **       | ** ** | **2005**                                   | ** ** | **2004** | ** ** | ** ** | ** ** |
| ** **       | ** ** | **Amount**                                 | ** ** | **% of Revenues** | ** ** | **Amount** | ** ** | **% of Revenues** | ** ** | **Change** | ** ** |
| ** **       | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues         |       |                                       | $          | 109.5 |   |   |   | 100.0 | % |   |   | $ | 101.5 |   |   |   | 100.0 | % |   |   | 7.8 | % |   |
| Cost of revenues |       |                                       | 39.4       |   |   |   | 36.0 |   |   |   | 38.0 |   |   |   | 37.5 |   |   |   | 3.6 | % |   |
| Gross profit     |       |                                       | $          | 70.1 |   |   |   | 64.0 | % |   |   | $ | 63.5 |   |   |   | 62.5 | % |   |   | 10.4 | % |   |

 

Weexperienced an improvement in gross profit margin for the year ended December 31,2005 as compared to the year ended December 31, 2004, due to higherproduct margins and product volume increases in our VQS products which werepartially attributable to the sale of approximately $0.7 million of previouslywritten-down inventory. 

| ** **             | ** ** | **Year Ended December 31,** | ** ** |
|------------------------|------------|--------------------------------------------|------------|
| ** **             | ** ** | **2005**                                   | ** ** | **2004** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Amount**                                 | ** ** | **% of Revenues** | ** ** | **Amount** | ** ** | **% of Revenues** | ** ** | **Change** | ** ** |
| ** **             | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product                |       |                                       | $          | 28.3 |   |   |   | 25.9 | % |   |   | $ | 26.0 |   |   |   | 25.6 | % |   |   | 8.9 | % |   |
| Service                |       |                                       | 6.7        |   |   |   | 6.1 |   |   |   | 7.1 |   |   |   | 7.0 |   |   |   | (6.2 | )% |   |
| Overhead               |       |                                       | 4.4        |   |   |   | 4.0 |   |   |   | 4.9 |   |   |   | 4.9 |   |   |   | (10.5 | )% |   |
| Total cost of revenues |       |                                       | $          | 39.4 |   |   |   | 36.0 | % |   |   | $ | 38.0 |   |   |   | 37.5 | % |   |   | 3.6 | % |   |

 

Product costs vary withrevenues and to a lesser extent due to fluctuations in product mix as discussedin the previous paragraph. Service costs which represent primarily pre and postsales technical support activities did not change significantly during 2005.Substantially all manufacturing activities are outsourced to a contractmanufacturer.

**Selling, General and Administrative**

| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                   | ** ** | **2004** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Amount**                                 | ** ** | **% of Revenues** | ** ** | **Amount** | ** ** | **% of Revenues** | ** ** | **Change** | ** ** |
| ** **                           | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general  and administrative |       |                                       | $          | 39.9 |   |   |   | 36.5 | % |   |   | $ | 33.8 |   |   |   | 33.3 | % |   |   | 18.2 | % |   |
|                                      |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Selling, general andadministrative expenses increased 18.2% during the year ended December 31,2005 compared to 2004. The primary components of the increase in 2005 were $2.6million related to increased headcount, $1.5 million related to salescommissions associated with sales to Lucent and $1.7 million in professionalservice fees of which $0.7 million  oflegal and auditing costs was incurred in connection with an independentinvestigation completed by the Audit Committee of our Board of Directors and ofwhich $0.3 million related to our compliance with Sarbanes Oxley, and $0.3million in miscellaneous expenses.

34

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**Research and Development**

| ** **               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|
| ** **               | ** ** | **2005**                                   | ** ** | **2004** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Amount**                                 | ** ** | **% of Revenues** | ** ** | **Amount** | ** ** | **% of Revenues** | ** ** | **Change** | ** ** |
| ** **               | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research and development |       |                                       | $          | 26.2 |   |   |   | 23.9 | % |   |   | $ | 23.9 |   |   |   | 23.5 | % |   |   | 9.4 | % |   |
|                          |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our research anddevelopment spending and headcount increased 9.4% during the year endedDecember 31, 2005 in comparison to the year ended December 31, 2004.Our research and development activities in 2005 were primarily focused onopportunities relating to emerging wireless applications, radio access networksand emerging IP-based services, including VoIP. Our research and developmentspending is currently directed to product extensions to our CG and TX boardfamilies, next generation board and related software offerings incorporatingfor example, video capabilities, our recently announced Vision series ofapplication ready media servers, and our more recent product families, MyCallerand AccessGate. During 2005 we invested approximately $10.7 million in theMyCaller and AccessGate products.

**Restructuring andOther Related Charges**

There were norestructuring and other related charges in either 2004 or 2005.

**Other Income (Expense), Net**

| ** **                             | ** ** | **Year Ended  December 31,** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                             | ** ** | **(In millions)**                 | ** ** |
| Interest income                        |       | $                                      | 1.6        |   | $ | 1.2 |   |
| Interest expense                       |       | (0.8                                   | )          | (2.2 | ) |
| Gain (loss) on  extinguishment of debt |       | —                                 |       | (0.3 | ) |
| Other                                  |       | 0.6                                    |       | (0.3 | ) |
| Total other income  (expense), net     |       | $                                      | 1.4        |   | $ | (1.6 | ) |

 

The increase in interestincome earned for the year ended December 31, 2005 compared to that earnedduring the year ended December 31, 2004 were primarily due to an increasein our cash, cash equivalents and marketable securities as a result of proceedsof $49.5 million from our underwritten public offering in March 2004. Thedecrease in interest expense in the year ended December 31, 2005 comparedto the year ended December 31, 2004 is attributable to the repurchase andretirement of outstanding convertible debt throughout 2005 and 2004. Includedin “Other” in the year ended December 31, 2005 is a $0.2 million franchisetax refund and a $0.2 million gain related to net foreign currency translation.

**Income Tax Expense**

| ** **          | ** ** | **Year Ended  December 31,** | ** ** |
|---------------------|------------|----------------------------------------|------------|
| ** **          | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **          | ** ** | **(In millions)**                 | ** ** |
| Income tax  expense |       | $                                      | 0.4        |   | $ | 0.1 |   |
|                     |            |                                        |            |  |  |  |  |

 

Income tax expense for the years endedDecember 31, 2005 and 2004 was $368,000 and $66,000, respectively. Incometax expense is primarily due to foreign taxes incurred by foreign subsidiaries.

35

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For U.S. federal income tax purposes, we had netoperating loss carryforwards available to reduce taxable income ofapproximately $149.4 million at December 31, 2005. Under the provision ofthe Internal Revenue Code Section 382, certain changes in the Company’sownership structure may result in a limitation on the amount of net operatingloss carryforwards and research and development credit carryforwards which maybe used in future years. These carryforwards began to expire in 2006. We alsohad foreign net operating loss carryforwards of approximately $36.9 million. Asof December 31, 2005, we had approximately $6.9 million of tax credits inthe U.S. that are composed of federal research and development credits, foreigntax credits and state and local credits. These credits began to expire in 2006.In addition, we had Canadian investment tax credits of approximately $3.5million. These credits begin to expire in 2014.

We have established a valuation allowance against netdeferred tax assets, in certain jurisdictions including the United States,because we believe that it is more likely than not that the tax assets in thosejurisdictions will not be realized prior to their expiration. During fiscalyear 2005, the deferred tax asset valuation allowance decreased byapproximately $6.2 million, primarily as the result of net operating losses andcredits that expired during 2005. We will continue to assess the valuationallowance and, to the extent it is determined that such allowance is no longerrequired, the tax benefit of the remaining net deferred tax assets will berecognized in the future. Approximately $7.5 million of the valuation allowancefor deferred tax assets relates to the tax benefit from stock optiondeductions, which, if realized, will be allocated directly to additionalpaid-in capital.

In the years ended December 31,2005 and 2004, United States income taxes were not provided on cumulativeundistributed earnings for certain non-U.S. subsidiaries of approximately $1.9million. We will reinvest these earnings indefinitely in our operations outsidethe United States.

**Liquidity and Capital Resources**

| ** **                                        | ** ** | **December 31,**  | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **2006**               | ** ** | **2005** | ** ** |
| ** **                                        | ** ** | **(In millions)** | ** ** |
| Cash, cash  equivalents and marketable securities |       | $                      | 32.3       |   | $ | 62.2 |   |
| Working capital                                   |       | $                      | 35.8       |   | $ | 67.0 |   |

 

As of December 31, 2006, our liquid assetsincluded cash, cash equivalents and marketable securities of $32.3 million. Weintend to use our cash for general corporate purposes, which may includeworking capital, capital expenditures, share repurchases and potentialacquisitions. As of December 31, 2006, we had no significant capitalspending or purchase commitments other than facility leases and purchase ordersin the ordinary course of business.

During the third and fourth quarter of 2006, in orderto reduce operating costs, the Company terminated 57 employees and ceased usingits Red Bank, New Jersey facility, and part of one of its facilities inFramingham, Massachusetts. These actions resulted in restructuring and otherrelated charges of $5.5 million. We expect these actions to result inannual costs savings of approximately $8.0 million.

In December, 2006, the Company entered into a subleaseagreement to sublease headquarters office space located in Framingham,Massachusetts, which was formerly used as supplementary conference, trainingand corporate office space. The Company exited this facility as of December 31,2006. In 2001 and 2002, the Company recorded restructuring charges related tothe difference between committed lease payments and the estimated subleaserental income for other exited space in this facility. During the fourthquarter of 2006, the Company updated its estimates of the sublease rentalincome based on the signing of the Sublease and the current and expected marketconditions. As a result, the Company recorded additional pre-tax restructuringcosts of approximately $900,000. The total pre-tax restructuring charges 

36

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that the Companyrecognized in the fourth quarter of fiscal year 2006 related to these actionswere $2.3 million.

During 2006, the Company’s Board of Directorsauthorized stock repurchase programs to buy back shares of the Company’s commonstock. The programs were completed in September 2006. We used $23.3 millionof cash to repurchase 7,888,985 shares of the Company’s common stock during theyear ended December 31, 2006.

We believe that ouravailable liquid assets and working capital are sufficient to meet ouroperating expenses, capital requirements and contractual obligations for atleast the next 12 months. Material risks to cash flow from operations includedelayed cash receipts accompanying sales of product. There can be no assurancethat changes in our plans or other events affecting our operations will notresult in materially accelerated or unexpected expenditures. Our futureliquidity and cash requirements will depend on numerous factors, including, butnot limited to, the level of revenue we will be able to achieve in the future,the successful introduction of new products and potential acquisitions ofrelated businesses and/or technologies. Long-term cash requirements other thannormal operating expenses are anticipated for the continued development of newproducts, financing anticipated growth and the possible acquisition ofbusinesses or technologies complementary to our business. We may requireadditional external financing through the sales of additional equity or otherfinancing vehicles. There is no assurance that such financing can be obtainedon favorable terms, if at all.

**Cash Flow**

Sources and uses of cashfor the 2006, 2005 and 2004 years are summarized in the table below.

| ** **                                           | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(In millions)**                     | ** ** |
| Net cash provided  by (used in) operating activities |       | $                                          | (5.5       | ) | $ | 3.6 |   | $ | 7.1 |   |
| Net cash provided  by (used in) investing activities |       | $                                          | 1.4        |   | $ | 32.8 |   | $ | (49.6 | ) |
| Net cash provided by  (used in) financing activities |       | $                                          | (22.4      | ) | $ | (18.0 | ) | $ | 16.1 |   |

 

The principal driver in the change in cash flows usedin operations is net income (loss) adjusted by certain non-cash items such asamortization  and stock-basedcompensation. Net income (loss), decreased $20.7 million from net income of$5.0 million for the year ended December 31, 2005 to a net loss of $15.8 millionfor the year ended December 31, 2006. Amortization, a non-cash item usedto reconcile cash flows to net loss, was higher in the year ended December 31,2006, in comparison to the years ended December 31, 2005 and 2004, as aresult of the acquisition of Openera. We also incurred stock-basedcompensation expense of $1.9 million with the adoption of SFAS 123R on January 1,2006. We incurred additional stock-based compensation expense of $2.9 millionrelated to the restricted stock and common stock consideration used to purchaseOpenera in February 2006. There was no stock-based compensation expense in2005 and $0.1 million in 2004.

As of December 31, 2006, 2005 and 2004 days salesoutstanding (DSO) were 54 days, 48 days and 49 days, respectively. DSO issignificantly affected by the timing of customer invoicing which for most ofour products takes place at the time of shipment. For some of our products, wepartially invoice our customers at the time of order receipt, with theremainder of the order being invoiced at certain milestones. Deferred revenues representproducts shipped to customers or services billed where revenue is not yetrecognized. These shipments relate to the inventory at customer sites in 2006.As MyCaller and AccessGate revenues become a larger proportion of overallrevenues, both the deferred revenue and the inventory at customer sites isexpected to grow and affect cash flows accordingly. In 2006, cash flowsutilized by inventory activity and deferred revenue activity were $0.8 millionand $1.2 million, respectively.

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In connection with the acquisition of Openera weacquired debt of $0.7 million which was repaid in 2006. During the years ended December 31,2005 and 2004 we used $20.4 million and $38.5 million, respectively, torepurchase debt obligations which were fully retired in October, 2005.

As part of the Company’sBoard of Director’s plan to repurchase the Company’s common stock, we used$23.3 million during 2006 to repurchase 7,888,985 shares of our common stock.The stock repurchase programs were completed in September, 2006.

**Off-Balance SheetArrangements**

We do not have anyoff-balance sheet financing arrangements, other than property and equipmentoperating leases that are disclosed in the contractual obligations table belowand in our consolidated financial statements, nor do we have any transactions,arrangements or other relationships with any special purpose entitiesestablished by us, at our direction or for our benefit. The following tabledetails our future contractual payment obligations.

**Contractual Obligations**

| ** **                               | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------------|------------|-------------------------------------------|------------|
| ** **                               | ** ** | **2007**                                  | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| ** **                               | ** ** | **(In thousands)**                   | ** ** |
| Property and  equipment operating leases |       | $                                         | 4,745      |   | $ | 3,921 |   | $ | 3,513 |   | $ | 3,178 |   | $ | 3,229 |   |   | $ | 2,207 |   |   | $ | 20,793 |   |
| Open purchase  orders                    |       | 6,288                                     |       | — |   | — |   | — |   | — |   |   | — |   |   | 6,288 |   |
| Total contractual  obligations           |       | $                                         | 11,033     |   | $ | 3,921 |   | $ | 3,513 |   | $ | 3,178 |   | $ | 3,229 |   |   | $ | 2,207 |   |   | $ | 27,081 |   |

 

Property and equipment operating lease contractualobligations do not include estimated sublease income of $2.8 million which willbe earned in the next five years. Open purchase orders are defined asagreements to purchase goods or services that are enforceable and legallybinding and that specify all significant terms, including: fixed or minimumquantities to be purchased; fixed, minimum or variable pricing provisions; andthe approximate timing of the transactions. These obligations primarily relateto components, software licenses and services and equipment maintenanceservices. The amounts are based on our contractual commitments; however, it is possiblewe may be able to negotiate lower payments if we choose to exit these contractsearlier.

The Company’s agreementwith Plexus requires that Plexus turn its NMS-related inventory at least eighttimes per year. If this condition is not met, the Company must purchase enoughinventory to bring Plexus up to eight turns. During 2006, the Company satisfiedthe eight turn goal in all interim periods. As such, we have not included anyamounts in the table of contractual obligations related to our commitment withPlexus at December 31, 2006. The Company can only ascribe value to suchcommitment when the Company has not met the condition as determined at aspecific point in time, based on facts and circumstances. The Company has nosuch arrangements with its other third-party contract manufacturer.

**Recent AccountingPronouncements**

Effective January 1, 2006, the Company adoptedthe provisions of Statement of Financial Accounting Standards 123R, *“Share-Based Payment,”* (“SFAS 123R”),which establishes accounting for equity instruments exchanged for employeeservices. Under the provisions of SFAS 123R, stock-based compensation costis measured at the grant date, based on the fair value of the award, and isrecognized as an expense over the employee’s requisite service period(generally the vesting period of the equity award). Prior to January 1,2006, the Company accounted for stock-based compensation to employees inaccordance with Accounting Principles Board Opinion No. 25, *“Accounting for Stock Issued to Employees,”*(“APB 25”) and related interpretations. The Company also followed thedisclosure requirements of Statement of Financial Accounting Standards No. 123,*“Accounting for Stock-Based Compensation”*

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(“SFAS 123”). TheCompany elected to adopt the modified prospective transition method as providedby SFAS 123R and, accordingly, financial statement amounts for the priorperiods presented in this Annual Report on Form 10-K have not beenrestated to reflect the fair value method of expensing stock-basedcompensation.

In November 2004, the FASB issued SFAS No. 151,*Inventory Costs, an amendment of ARB No. 43,Chapter 4* (“SFAS 151”). SFAS 151 amends the guidance inAccounting Research Bulletin (“ARB 43”), Chapter 4, “Inventory Pricing,” toclarify the accounting for abnormal amounts of idle facility expense, freight,handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter4, previously stated that “... under some circumstances, items such as idlefacility expense, excessive spoilage, double freight, and rehandling costs maybe so abnormal as to require treatment as current period charges”. ThisStatement requires that those items be recognized as current-period chargesregardless of whether they meet the criterion of “so abnormal”. In addition,SFAS 151 requires allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facilities. Theadoption of SFAS 151, effective January 1, 2006, did not have a materialimpact on the Company’s financial position, results of operations and cashflows.

In June 2006, the FASB ratified the consensusreached by the EITF on Issue No. 06-3, *How TaxesCollected from Customers and Remitted to Governmental Authorities Should bePresented in the Income Statement (That Is, Gross Versus Net Presentation)*(“EITF 06-3). EITF 06-3 includes any tax assessed by a governmentalauthority that is directly imposed on a revenue-producing transaction between aseller and a customer and may include, but is not limited to, sales, use, valueadded, and some excise taxes. EITF 06-3 concludes that the presentationof taxes on either a gross (included in revenues and costs) or a net (excludedfrom revenues) basis is an accounting policy decision that should be disclosed.In addition, for any such taxes that are reported on a gross basis, a companyshould disclose the amounts of those taxes in interim and annual financialstatements for each period for which an income statement is presented if thoseamounts are significant. The provisions of EITF 06-3 should be applied tofinancial reports for interim and annual reporting periods beginning after December 15,2006, with earlier adoption permitted. The adoption of the provisions of EITF 06-3in 2007 is not expected to have a material impact on the Company’s financialposition or results of operations.

In July 2006, the FASB issued Interpretation No. 48,*Accounting for Uncertainty in Income Taxes*(“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s financial statements in accordance with FASBStatement No. 109, *Accounting forIncome Taxes*. FIN 48 prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. ThisInterpretation also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure, andtransition. This Interpretation is effective for fiscal years beginning after December 15,2006, with earlier adoption permitted. The adoption of the provisions of FIN 48in 2007 is not expected to have a material impact on the Company’s financialposition or results of operations.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements* (“SFAS157”). SFAS 157 defines fair value, establishes a framework for measuringfair value in generally accepted accounting principles (“GAAP”) and expandsdisclosures about fair value measurements. SFAS 157 applies under other accountingpronouncements that require or permit fair value measurements, the FASB havingpreviously concluded in those accounting pronouncements that fair value is therelevant measurement attribute. Accordingly, SFAS 157 does not require any newfair value measurements. SFAS 157 is effective for fiscal years beginningafter November 15, 2007, and interim periods within those fiscal years,with earlier adoption permitted. The provisions of SFAS 157 should be appliedprospectively as of the beginning of the fiscal year in which it is initiallyapplied, with limited exceptions. The Company is currently evaluating theprovisions of SFAS 157.

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In September 2006, the SEC issued StaffAccounting Bulletin No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements* (“SAB 108”) expressing the Staff’sviews regarding the process of quantifying financial statement misstatements.There have been two widely-recognized methods for quantifying the effects of financialstatement errors: the “roll-over” method and the “iron curtain” method. Theroll-over method focuses primarily on the impact of a misstatement on theincome statement—including the reversing effect of prior year misstatements—butits use can lead to the accumulation of misstatements in the balance sheet. Theiron-curtain method, on the other hand, focuses primarily on the effect ofcorrecting the period-end balance sheet with less emphasis on the reversingeffects of prior year errors on the income statement. SAB 108 establishes anapproach that requires quantification of financial statement errors based onthe effects of the error on each of the company’s financial statements and therelated financial statement disclosures. This model is commonly referred to asa “dual approach” because it essentially requires quantification of errorsunder both the iron-curtain and the roll-over methods. The provisions of SAB108 should be applied to annual financial statements covering the first fiscalyear ending after November 15, 2006. The adoption of the provisions of SAB108 had no material impact on the Company’s financial position, results ofoperations and cash flows.

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities, including an amendment of FASB Statement No. 115.”  SFAS No. 159 permits entities to chooseto measure many financial instruments and certain other items at fair valuethat are not currently required to be measured at fair value. Unrealized gainsand losses on items for which the fair value option has been elected arereported in earnings. SFAS No. 159 does not affect any existing accountingliterature that requires certain assets and liabilities to be carried at fairvalue. SFAS No. 159 is effective for fiscal years beginning after November 15,2007. We do not expect our adoption of this new standard to have a materialimpact on our financial position, results of operations or cash flows.

**Quarterly Information (Unaudited)**

| ** **                                             | ** ** | **Quarter Ended**                                                | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **Dec. 31,  2006**                                               | ** ** | **Sept. 30,  2006** | ** ** | **June 30,  2006** | ** ** | **Mar. 31,  2006** | ** ** | **Dec. 31,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **June 30,  2005** | ** ** | **Mar. 31,  2005** | ** ** |
| ** **                                             | ** ** | **(Unaudited)**                                                       | ** ** |
| ** **                                             | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenues                                               |       |                                                                  | $          | 21,685 |   |   |   | $ | 20,783 |   |   |   | $ | 26,440 |   |   |   | $ | 30,698 |   |   |   | $ | 31,684 |   |   |   | $ | 30,271 |   |   |   | $ | 24,919 |   |   |   | $ | 22,600 |   |   |
| Cost of revenues                                       |       |                                                                  | 8,511      |   |   |   | 8,358 |   |   |   | 9,335 |   |   |   | 9,841 |   |   |   | 10,425 |   |   |   | 10,083 |   |   |   | 9,394 |   |   |   | 9,518 |   |   |
| Gross profit                                           |       |                                                                  | 13,174     |   |   |   | 12,425 |   |   |   | 17,105 |   |   |   | 20,857 |   |   |   | 21,259 |   |   |   | 20,188 |   |   |   | 15,525 |   |   |   | 13,082 |   |   |
| Operating expenses:                                    |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and   administrative                  |       |                                                                  | 11,779     |   |   |   | 11,124 |   |   |   | 13,114 |   |   |   | 12,833 |   |   |   | 11,565 |   |   |   | 10,078 |   |   |   | 9,344 |   |   |   | 8,942 |   |   |
| Research and development                               |       |                                                                  | 6,023      |   |   |   | 6,317 |   |   |   | 6,799 |   |   |   | 6,559 |   |   |   | 6,788 |   |   |   | 6,837 |   |   |   | 6,323 |   |   |   | 6,192 |   |   |
| Restructuring and other  related charges               |       |                                                                  | 4,161      |   |   |   | 1,308 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total operating expenses                               |       |                                                                  | 21,963     |   |   |   | 18,749 |   |   |   | 19,913 |   |   |   | 19,392 |   |   |   | 18,353 |   |   |   | 16,915 |   |   |   | 15,667 |   |   |   | 15,134 |   |   |
| Operating income (loss)                                |       |                                                                  | (8,789     | ) |   |   | (6,324 | ) |   |   | (2,808 | ) |   |   | 1,465 |   |   |   | 2,906 |   |   |   | 3,273 |   |   |   | (142 | ) |   |   | (2,052 | ) |   |
| Other income (expense), net                            |       |                                                                  | 25         |   |   |   | 336 |   |   |   | 313 |   |   |   | 270 |   |   |   | 603 |   |   |   | 117 |   |   |   | 485 |   |   |   | 150 |   |   |
| Income  (loss) before income taxes                     |       |                                                                  | (8,764     | ) |   |   | (5,988 | ) |   |   | (2,495 | ) |   |   | 1,735 |   |   |   | 3,509 |   |   |   | 3,390 |   |   |   | 343 |   |   |   | (1,902 | ) |   |
| Income tax expense  (benefit)                          |       |                                                                  | 171        |   |   |   | (113 | ) |   |   | 130 |   |   |   | 51 |   |   |   | (180 | ) |   |   | 63 |   |   |   | 285 |   |   |   | 200 |   |   |
| Net income (loss)                                      |       |                                                                  | (8,935     | ) |   |   | (5,875 | ) |   |   | $ | (2,625 | ) |   |   | 1,684 |   |   |   | 3,689 |   |   |   | 3,327 |   |   |   | $ | 58 |   |   |   | (2,102 | ) |   |
| Basic and diluted net earnings (loss) per common share |       |                                                                  | $          | (0.21 | ) |   |   | $ | (0.12 | ) |   |   | $ | (0.05 | ) |   |   | $ | 0.03 |   |   |   | $ | 0.08 |   |   |   | $ | 0.07 |   |   |   | $ | 0.00 |   |   |   | $ | (0.04 | ) |   |

 

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| ** **                                         | ** ** | **Quarter Ended** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| **(As a percent of revenues)** | ** ** | ** **             | ** ** | **Dec. 31,  2006** | ** ** | **Sept. 30,  2006** | ** ** | **June 30,  2006** | ** ** | **Mar. 31,  2006** | ** ** | **Dec. 31,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **June 30,  2005** | ** ** | **Mar. 31,  2005** | ** ** |
| ** **                                         | ** ** | **(Unaudited)**        | ** ** |
| Revenues                                           |       |                   | 100.0      | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |
| Cost of revenues                                   |       |                   | 39.2       |   |   |   | 40.2 |   |   |   | 35.3 |   |   |   | 32.1 |   |   |   | 32.9 |   |   |   | 33.3 |   |   |   | 37.7 |   |   |   | 42.1 |   |   |
| Gross profit                                       |       |                   | 60.8       |   |   |   | 59.8 |   |   |   | 64.7 |   |   |   | 67.9 |   |   |   | 67.1 |   |   |   | 66.7 |   |   |   | 62.3 |   |   |   | 57.9 |   |   |
| Operating expenses:                                |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and  administrative               |       |                   | 54.3       |   |   |   | 53.5 |   |   |   | 49.6 |   |   |   | 41.8 |   |   |   | 36.5 |   |   |   | 33.3 |   |   |   | 37.5 |   |   |   | 39.6 |   |   |
| Research and development                           |       |                   | 27.8       |   |   |   | 30.4 |   |   |   | 25.7 |   |   |   | 21.4 |   |   |   | 21.4 |   |   |   | 22.6 |   |   |   | 25.4 |   |   |   | 27.4 |   |   |
| Restructuring and other  related charges           |       |                   | 19.2       |   |   |   | 6.3 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total operating expenses                           |       |                   | 101.3      |   |   |   | 90.2 |   |   |   | 75.3 |   |   |   | 63.2 |   |   |   | 57.9 |   |   |   | 55.9 |   |   |   | 62.9 |   |   |   | 67.0 |   |   |
| Operating income (loss)                            |       |                   | (40.5      | ) |   |   | (30.4 | ) |   |   | (10.6 | ) |   |   | 4.7 |   |   |   | 9.2 |   |   |   | 10.8 |   |   |   | (0.6 | ) |   |   | (9.1 | ) |   |
| Other income (expense), net                        |       |                   | 0.1        |   |   |   | 1.6 |   |   |   | 1.2 |   |   |   | 0.9 |   |   |   | 1.9 |   |   |   | 0.4 |   |   |   | 1.9 |   |   |   | 0.1 |   |   |
| Income (loss) before income  taxes                 |       |                   | (40.4      | ) |   |   | (28.8 | ) |   |   | (9.4 | ) |   |   | 5.6 |   |   |   | 11.1 |   |   |   | 11.2 |   |   |   | 1.3 |   |   |   | (9.0 | ) |   |
| Income taxes expense  (benefit)                    |       |                   | 0.8        |   |   |   | (0.5 | ) |   |   | 0.5 |   |   |   | 0.2 |   |   |   | (0.5 | ) |   |   | 0.2 |   |   |   | 1.1 |   |   |   | 0.1 |   |   |
| Net income (loss)                                  |       |                   | (41.2      | )% |   |   | (28.3 | )% |   |   | (9.9 | ) |   |   | 5.4 |   |   |   | 11.6 | % |   |   | 11.0 | % |   |   | 0.2 | % |   |   | (9.1 | )% |   |
|                                                    |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

During 2006, weexperienced a decrease in quarterly revenue in comparison to prior quarters of2005. We attribute this decrease to a decline in our PS business unit and to adecrease in VQS sales to Lucent. During 2006 revenue and gross margin relatedto  MyCaller and AccessGate products andservices increased over 2005.

Selling, general andadministrative expenses have generally increased during 2006 and 2005 primarilydue to increases in payroll and related expenses and stock-based compensationexpense related to the adoption of SFAS 123R on January 1, 2006 andamortization expense related to intangible assets acquired from Openera in thefirst quarter of 2006.

Research and developmentexpenses increased throughout 2005 and the first half of 2006. For theremainder of 2006 decreases in research and development expense wereattributable to workforce reductions and increased leverage of lower costdevelopment resources, which includes our Bangalore India engineering resourcesassociated with our acquisition of Openera. As noted earlier, our research anddevelopment spending is currently directed to product extensions to certainboard families, next generation board and related software offeringsincorporating, for example, video capabilities, and our more recent productfamilies, Vision, MyCaller, MobilePlace and AccessGate.

During the third andfourth quarters of 2006, in order to reduce operating costs, the Companyterminated 57 employees, ceased using its Red Bank, New Jersey facility, andpart of its headquarter facility in Framingham, Massachusetts. These actionsresulted in restructuring and other related charges of $5.5 million.

Our quarterly operatingresults may fluctuate as a result of a number of factors, some of which arebeyond our control, including, but not limited to: fluctuations in ourcustomers’ businesses; demand for our customers’ products incorporating ourproducts; timing and market acceptance of new products or enhancementsintroduced by us or our competitors; availability of components from oursuppliers and the manufacturing capacity of our subcontractors; timing andlevel of expenditures for sales, marketing and product development; and changesin the prices of our products or of our competitors’ products.

We believe that ourrevenues and results of operations have not been significantly impacted byinflation.

**ITEM7A.**        QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

Our primary market riskexposures are in the areas of interest rate risk and foreign currency exchangerate risk. Our investment portfolio of cash equivalents, marketable securitiesand non-marketable securities are subject to interest rate fluctuations, but webelieve this risk is immaterial due to the short-term nature of theseinvestments. Our exposure to currency exchange rate fluctuations has beenmoderate due to the fact that the revenues are billed primarily in U.S.dollars.

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**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.

**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholders of NMSCommunications:

We have completedintegrated audits of NMS Communications Corporation’s consolidated financialstatements and of its internal control over financial reporting as of December31, 2006, in accordance with the standards of the Public Company AccountingOversight Board (United States). Our opinions, based on our audits, arepresented below.

*Consolidatedfinancial statements and financial statement schedules*

In our opinion, the consolidated financial statementslisted in the index appearing under Item 15(a)(1) present fairly, in allmaterial respects, the financial position of NMS Communications Corporation andits subsidiaries at December 31, 2006 and December 31, 2005, and the results oftheir operations and their cash flows for each of the three years in the periodended December 31, 2006 in conformity with accounting principles generallyaccepted in the United States of America. In addition, in our opinion, thefinancial statement schedules listed in the index under Item 15(a)(2) presentfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements. Thesefinancial statements and financial statement schedules are the responsibilityof the Company’s management. Our responsibility is to express an opinion onthese financial statements and financial statement schedules based on ouraudits. We conducted our audits of these statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit of financial statements includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

As discussed in Note 2 tothe consolidated financial statements, the Company changed the manner in whichit accounts for share-based compensation in 2006.

*Internal controlover financial reporting*

Also, in our opinion, management’s assessment,included in Management's Report on Internal Control Over Financial Reporting appearingunder Item 9A, that the Company maintained effective internal control overfinancial reporting as of December 31, 2006 based on criteria established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO), isfairly stated, in all material respects, based on those criteria. Furthermore,in our opinion, the Company maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2006, based oncriteria established in *Internal Control—IntegratedFramework* issued by the COSO. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express opinions on management’s assessmentand on the effectiveness of the Company’s internal control over financialreporting based on our audit. We conducted our audit of internal control over financialreporting in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. An audit of internal control over financial reporting includesobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such other 

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procedures as we considernecessary in the circumstances. We believe that our audit provides a reasonablebasis for our opinions. 

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Acompany’s internal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements. 

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

As described inManagement's Report on Internal Control Over Financial Reporting, managementhas excluded Openera Technologies, Inc. from its assessment of internal controlover financial reporting as of December 31, 2006 because it was acquiredby the Company in a purchase business combination during 2006. We have alsoexcluded Openera Technologies, Inc. from our audit of internal control overfinancial reporting. Openera Technologies, Inc. is a wholly-owned subsidiarywhose total assets and total revenues represent 2% and 1%, respectively, of therelated consolidated financial statement amounts as of and for the year endedDecember 31, 2006.

/s/ PricewaterhouseCoopers LLPBoston, MassachusettsMarch 16, 2007

43

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**NMS Communications CorporationConsolidated Balance Sheets**

| ** **                                                                                                                                                                                                                    | ** ** | **December 31,**                                                              | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                    | ** ** | **2006**                                                                           | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                                                                                    | ** ** | **(In thousands, except  share and per share data)** | ** ** |
| **Assets**                                                                                                                                                                                                                    |       |                                                                               |       |   |   |
| Current assets:                                                                                                                                                                                                               |       |                                                                               |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                                     |       | $                                                                                  | 25,176     |   | $ | 51,212 |   |
| Marketable securities                                                                                                                                                                                                         |       | 7,082                                                                              |       | 11,002 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $829 and $794, respectively                                                                                                                                   |       | 13,270                                                                             |       | 16,895 |   |
| Inventories                                                                                                                                                                                                                   |       | 3,649                                                                              |       | 2,844 |   |
| Prepaid expenses and other assets                                                                                                                                                                                             |       | 3,100                                                                              |       | 4,092 |   |
| Total current assets                                                                                                                                                                                                          |       | 52,277                                                                             |       | 86,045 |   |
| Property and equipment,  net                                                                                                                                                                                                  |       | 6,625                                                                              |       | 6,535 |   |
| Goodwill                                                                                                                                                                                                                      |       | 5,469                                                                              |       | — |   |
| Other intangible  assets, net                                                                                                                                                                                                 |       | 3,782                                                                              |       | — |   |
| Other assets                                                                                                                                                                                                                  |       | 1,177                                                                              |       | 723 |   |
| Total assets                                                                                                                                                                                                                  |       | $                                                                                  | 69,330     |   | $ | 93,303 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                 |       |                                                                               |       |   |   |
| Current liabilities:                                                                                                                                                                                                          |       |                                                                               |       |   |   |
| Accounts payable                                                                                                                                                                                                              |       | $                                                                                  | 3,849      |   | $ | 4,855 |   |
| Accrued expenses and other liabilities                                                                                                                                                                                        |       | 5,952                                                                              |       | 9,319 |   |
| Accrued restructuring                                                                                                                                                                                                         |       | 2,228                                                                              |       | 916 |   |
| Deferred revenue                                                                                                                                                                                                              |       | 4,431                                                                              |       | 3,959 |   |
| Total current liabilities                                                                                                                                                                                                     |       | 16,460                                                                             |       | 19,049 |   |
| Accrued  restructuring                                                                                                                                                                                                        |       | 2,104                                                                              |       | — |   |
| Accrued warranty  expense                                                                                                                                                                                                     |       | 122                                                                                |       | 159 |   |
| Total liabilities                                                                                                                                                                                                             |       | 18,686                                                                             |       | 19,208 |   |
| Commitments and  contingencies (note 16)                                                                                                                                                                                      |       |                                                                               |       |   |   |
| Stockholders’  equity:                                                                                                                                                                                                   |       |                                                                               |       |   |   |
| Preferred stock, $0.05 par value, 3,000,000 shares  authorized at December 31, 2006 and 2005, respectively, no shares issued  and outstanding                                                                            |       | —                                                                             |       | — |   |
| Common stock, $0.01 par value, 125,000,000 shares  authorized; 52,991,435 shares issued and 45,441,183 shares outstanding at  December 31, 2006 and 48,412,589 shares issued and outstanding at  December 31, 2005. |       | 530                                                                                |       | 484 |   |
| Additional paid-in capital                                                                                                                                                                                                    |       | 428,717                                                                            |       | 414,939 |   |
| Accumulated deficit                                                                                                                                                                                                           |       | (353,511                                                                           | )          | (337,760 | ) |
| Accumulated other comprehensive loss                                                                                                                                                                                          |       | (2,762                                                                             | )          | (3,568 | ) |
| Treasury stock, at cost, 7,550,252 shares at  December 31, 2006 and 0 shares at December 31, 2005                                                                                                                   |       | (22,330                                                                            | )          | — |   |
| Total stockholders’ equity                                                                                                                                                                                               |       | 50,644                                                                             |       | 74,095 |   |
| Total liabilities  and stockholders’ equity                                                                                                                                                                              |       | $                                                                                  | 69,330     |   | $ | 93,303 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

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**NMS Communications CorporationConsolidated Statements of Operations**

| ** **                                   | ** ** | **Year Ended December 31,**                                 | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | **(In thousands except for per share data)** | ** ** |
| Revenues                                     |       | $                                                                          | 99,606     |   | $ | 109,474 |   | $ | 101,512 |   |
| Cost of revenues                             |       | 36,046                                                                     |       | 39,420 |   | 38,052 |   |
| Gross profit                                 |       | 63,560                                                                     |       | 70,054 |   | 63,460 |   |
| Operating expenses:                          |       |                                                                       |       |   |   |   |   |
| Selling, general and administrative          |       | 48,849                                                                     |       | 39,929 |   | 33,776 |   |
| Research and development                     |       | 25,699                                                                     |       | 26,140 |   | 23,884 |   |
| Restructuring and other related charges      |       | 5,469                                                                      |       | — |   | — |   |
| Total operating expenses                     |       | 80,017                                                                     |       | 66,069 |   | 57,660 |   |
| Operating income  (loss)                     |       | (16,457                                                                    | )          | 3,985 |   | 5,800 |   |
| Other income (expense):                      |       |                                                                       |       |   |   |   |   |
| Interest income                              |       | 1,730                                                                      |       | 1,643 |   | 1,223 |   |
| Interest expense                             |       | —                                                                     |       | (878 | ) | (2,186 | ) |
| Loss on extinguishment of debt               |       | —                                                                     |       | — |   | (369 | ) |
| Other                                        |       | (786                                                                       | )          | 590 |   | (300 | ) |
| Other income (expense), net                  |       | 944                                                                        |       | 1,355 |   | (1,632 | ) |
| Income (loss)  before income taxes           |       | (15,513                                                                    | )          | 5,340 |   | 4,168 |   |
| Income tax expense                           |       | 238                                                                        |       | 368 |   | 66 |   |
| Net income (loss)                            |       | $                                                                          | (15,751    | ) | $ | 4,972 |   | $ | 4,102 |   |
| Basic earnings (loss) per common share       |       | $                                                                          | (0.33      | ) | $ | 0.10 |   | $ | 0.09 |   |
| Weighted average basic shares outstanding    |       | 48,467                                                                     |       | 47,884 |   | 44,709 |   |
| Diluted earnings (loss) per common share     |       | $                                                                          | (0.33      | ) | $ | 0.10 |   | $ | 0.09 |   |
| Weighted average  diluted shares outstanding |       | 48,467                                                                     |       | 48,285 |   | 46,894 |   |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

45

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**NMS Communications CorporationConsolidated Statements of Stockholders’ Equity**

| ** **                                                               | ** ** | ** **            | ** ** | ** **     | ** ** | ** **      | ** ** | **Accumulated**   | ** ** | ** **              | ** ** | ** **             | ** ** | ** **             | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-----------------|------------|-------------------|------------|-------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                               | ** ** | ** **            | ** ** | **Additional** | ** ** | ** **      | ** ** | **other**         | ** ** | **Treasury stock** | ** ** | **Total**              | ** ** | ** **             | ** ** |
| ** **                                                               | ** ** | **Common Stock** | ** ** | **paid-in**    | ** ** | **Accumulated** | ** ** | **comprehensive** | ** ** | ** **              | ** ** | **Amount**             | ** ** | **stockholders’** | ** ** | **Comprehensive** | ** ** |
| **(In thousands)**                                                  | ** ** | ** **            | ** ** | **Shares**     | ** ** | **Amount**      | ** ** | **capital**       | ** ** | **deficit**             | ** ** | **income (loss)** | ** ** | **Shares**             | ** ** | **(at cost)** | ** ** | **equity** | ** ** | **Income (loss)** | ** ** |
| Balance, December 31, 2003                                          |       |                  | 36,738     |           |       |            | $          | 367               |       |                    |       | $                      | 359,316    |                   |       |   | $ | (346,834 | ) |   |   | $ | (2,326 | ) |   | 52,444 |   | $ | (285 | ) |   | $ | 10,238 |   |   |   | $ | (55,628 | ) |   |
| Issuance of common stock under employee purchase plan                    |       |                  | 149        |           |       |            | 2          |              |       |                    | 535        |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   | 537 |   |   |   |   |   |   |
| Amortization of deferred compensation                                    |       |                  |       |           |       |            |       |              |       |                    | 102        |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   | 102 |   |   |   |   |   |   |
| Exercise of common stock options                                         |       |                  | 1,282      |           |       |            | 13         |              |       |                    | 3,620      |                   |       |                   |       |   |   |   |   |   |   | (52,444 | ) | 285 |   |   | 3,918 |   |   |   |   |   |   |
| Issuance of common stock under secondary offering                        |       |                  | 9,200      |           |       |            | 92         |              |       |                    | 49,416     |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   | 49,508 |   |   |   |   |   |   |
| Change in market value of securities available for  sale                 |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   |       |   |   |   | (108 | ) |   |   |   |   |   |   | (108 | ) |   |   | (108 | ) |   |
| Foreign currency translation adjustment                                  |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   |       |   |   |   | 134 |   |   |   |   |   |   |   | 134 |   |   |   | 134 |   |   |
| Net income                                                               |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   | 4,102      |   |   |   |   |   |   |   |   |   |   |   | 4,102 |   |   |   | 4,102 |   |   |
| Balance, December 31, 2004                                          |       |                  | 47,369     |           |       |            | $          | 474               |       |                    |       | $                      | 412,989    |                   |       |   | $ | (342,732 | ) |   |   | $ | (2,300 | ) |   | — |   | $ | — |   |   | $ | 68,431 |   |   |   | $ | 4,128 |   |   |
| Exercise of common stock options                                         |       |                  | 898        |           |       |            | 8          |              |       |                    | 1,560      |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   | 1,568 |   |   |   |   |   |   |
| Issuance of common stock under employee purchase plan                    |       |                  | 145        |           |       |            | 2          |              |       |                    | 390        |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   | 392 |   |   |   |   |   |   |
| Change in market value of securities available for  sale                 |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   |       |   |   |   | 95 |   |   |   |   |   |   |   | 95 |   |   |   | 95 |   |   |
| Foreign currency translation adjustment                                  |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   |       |   |   |   | (1,363 | ) |   |   |   |   |   |   | (1,363 | ) |   |   | (1,363 | ) |   |
| Net income                                                               |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   | 4,972      |   |   |   |   |   |   |   |   |   |   |   | 4,972 |   |   |   | 4,972 |   |   |
| Balance, December 31, 2005                                          |       |                  | 48,412     |           |       |            | $          | 484               |       |                    |       | $                      | 414,939    |                   |       |   | $ | (337,760 | ) |   |   | $ | (3,568 | ) |   | — |   | $ | — |   |   | $ | 74,095 |   |   |   | $ | 3,704 |   |   |
| Repurchase of common stock                                               |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   |       |   |   |   |   |   |   | 7,889 |   | (23,332 | ) |   | (23,332 | ) |   |   |   |   |   |
| Exercise of common stock options                                         |       |                  | 534        |           |       |            | 5          |              |       |                    | 518        |                   |       |                   |       |   |   |   |   |   |   | (275 | ) | 812 |   |   | 1,335 |   |   |   |   |   |   |
| Issuance of common stock under employee purchase plan                    |       |                  | 67         |           |       |            | 1          |              |       |                    | 141        |                   |       |                   |       |   |   |   |   |   |   | (64 | ) | 190 |   |   | 332 |   |   |   |   |   |   |
| Issuance of common stock and restricted stock under  Openera acquisition |       |                  | 3,978      |           |       |            | 40         |              |       |                    | 7,774      |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   | 7,814 |   |   |   |   |   |   |
| Issuance of vested common stock options under Openera  acquisition       |       |                  |       |           |       |            |       |              |       |                    | 577        |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   | 577 |   |   |   |   |   |   |
| Stock based compensation                                                 |       |                  |       |           |       |            |       |              |       |                    | 4,768      |                   |       |                   |       |   |   |   |   |   |   |   |   |   |   |   | 4,768 |   |   |   |   |   |   |
| Change in market value of securities available for  sale                 |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   |       |   |   |   | 15 |   |   |   |   |   |   |   | 15 |   |   |   | 15 |   |   |
| Foreign currency translation adjustment                                  |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   |       |   |   |   | 791 |   |   |   |   |   |   |   | 791 |   |   |   | 791 |   |   |
| Net loss                                                                 |       |                  |       |           |       |            |       |              |       |                    |       |                   |       |                   | (15,751    | ) |   |   |   |   |   |   |   |   |   |   | (15,751 | ) |   |   | (15,751 | ) |   |
| Balance,  December 31, 2006                                         |       |                  | 52,991     |           |       |            | $          | 530               |       |                    |       | $                      | 428,717    |                   |       |   | $ | (353,511 | ) |   |   | $ | (2,762 | ) |   | 7,550 |   | $ | (22,330 | ) |   | $ | 50,644 |   |   |   | $ | (14,945 | ) |   |
|                                                                          |            |                       |            |                |            |                 |            |                   |            |                         |            |                        |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of the consolidatedfinancial statements

46

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**NMS Communications CorporationConsolidated Statements of Cash Flows**

| ** **                                                                                      | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                      | ** ** | **(In thousands)**                     | ** ** |
| Cash flow from operating activities:                                                            |       |                                        |       |   |   |   |   |
| Net income (loss)                                                                               |       | $                                           | (15,751    | ) | $ | 4,972 |   | $ | 4,102 |   |
| Adjustments to reconcile net income (loss) to cash  provided by (used in) operating activities: |       |                                        |       |   |   |   |   |
| Depreciation of property  and equipment                                                         |       | 2,832                                       |       | 2,774 |   | 3,578 |   |
| Amortization (accretion)  of marketable securities                                              |       | (484                                        | )          | (210 | ) | 320 |   |
| Amortization of other  intangibles                                                              |       | 1,218                                       |       | — |   | — |   |
| Stock based compensation  expense                                                               |       | 4,768                                       |       | — |   | 102 |   |
| Loss on disposal of  property and equipment                                                     |       | 367                                         |       | 164 |   | 137 |   |
| Foreign exchange  translation loss (gain)                                                       |       | 433                                         |       | (378 | ) | (180 | ) |
| Loss on extinguishment  of long-term debt                                                       |       | —                                      |       | — |   | 369 |   |
| Write-off and amortization  of debt issuance costs                                              |       | —                                      |       | 131 |   | 320 |   |
| Changes in operating assets and liabilities, net of  effects of acquisitions:                   |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                             |       | 4,218                                       |       | (2,580 | ) | (5,046 | ) |
| Inventories                                                                                     |       | (805                                        | )          | 602 |   | (254 | ) |
| Prepaid expenses and  other assets                                                              |       | 907                                         |       | (1,160 | ) | 2,454 |   |
| Accounts payable                                                                                |       | (285                                        | )          | 514 |   | (371 | ) |
| Accrued expenses and  other liabilities                                                         |       | (5,117                                      | )          | (129 | ) | 558 |   |
| Accrued restructuring                                                                           |       | 3,416                                       |       | (393 | ) | (2,019 | ) |
| Deferred revenue                                                                                |       | (1,170                                      | )          | (661 | ) | 2,982 |   |
| Cash (used in) provided  by operating activities                                                |       | (5,453                                      | )          | 3,646 |   | 7,052 |   |
| Cash flow from investing activities:                                                            |       |                                        |       |   |   |   |   |
| Purchases of property  and equipment                                                            |       | (3,088                                      | )          | (3,337 | ) | (2,368 | ) |
| Purchases of marketable  securities                                                             |       | (23,580                                     | )          | (42,321 | ) | (61,492 | ) |
| Proceeds from the  maturity of marketable securities                                            |       | 28,000                                      |       | 78,440 |   | 14,250 |   |
| Cash acquired through  acquisition of a business                                                |       | 42                                          |       | — |   | — |   |
| Cash provided by (used  in) investing activities                                                |       | 1,374                                       |       | 32,782 |   | (49,610 | ) |
| Cash flow from financing activities:                                                            |       |                                        |       |   |   |   |   |
| Repayment of debt                                                                               |       | (715                                        | )          | (19,942 | ) | (37,849 | ) |
| Repurchase of common  stock                                                                     |       | (23,332                                     | )          | — |   | — |   |
| Proceeds from issuance  of common stock                                                         |       | 1,667                                       |       | 1,960 |   | 53,963 |   |
| Cash (used in) provided  by financing activities                                                |       | (22,380                                     | )          | (17,982 | ) | 16,114 |   |
| Effect of exchange rate  changes on cash                                                        |       | 423                                         |       | (1,038 | ) | 331 |   |
| Net increase (decrease)  in cash and cash equivalents                                           |       | (26,036                                     | )          | 17,408 |   | (26,113 | ) |
| Cash and cash  equivalents, beginning of year                                                   |       | 51,212                                      |       | 33,804 |   | 59,917 |   |
| Cash and cash  equivalents, end of year                                                         |       | $                                           | 25,176     |   | $ | 51,212 |   | $ | 33,804 |   |
| Supplemental cash flow information:                                                             |       |                                        |       |   |   |   |   |
| Interest paid                                                                                   |       | $                                           | —     |   | $ | 997 |   | $ | 2,304 |   |
| Taxes paid                                                                                      |       | $                                           | 276        |   | $ | 251 |   | $ | 332 |   |
| Acquisition of Openera:                                                                         |       |                                        |       |   |   |   |   |
| Fair value of assets acquired, net of cash acquired                                             |       | $                                           | 11,485     |   | $ | — |   | $ | — |   |
| Fair value of liabilities acquired                                                              |       | $                                           | 2,775      |   | $ | — |   | $ | — |   |

 

The accompanying notes are an integralpart of the consolidated financial statements.

47

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**Notes toConsolidated Financial Statements**

**1—Summary ofSignificant Accounting Policies**

**BusinessDescription**

NMS CommunicationsCorporation is a provider of enabling technologies, platforms and systems towireless and wireline telecommunications operators and network equipment andapplication providers. The Company’s products, which include systems buildingblocks, service delivery systems and personalized mobile entertainmentapplications, voice quality systems and a wireless backhaul optimizer, andservices address a wide range of customers’ needs as they seek to develop anddeploy enhanced voice and data services and applications, and improve thequality and efficiency of communications networks. Telecommunications operatorsuse the Company’s products to improve customer acquisition and retention,diversify revenue streams and reduce operating costs and capital expenditures.Network equipment and application providers use the Company’s products to helpdeploy leading technology solutions for their telecommunication operators andenterprise customers in a timely and cost-effective manner. The Company sellsits products worldwide through its direct sales force as well as throughchannel partners and system integrator partners. The Company’s customersinclude leading telecommunications operators and network equipment andapplication providers.

**Principles ofConsolidation**

The consolidated financialstatements include the accounts of the Company and its wholly ownedsubsidiaries. Intercompany balances and transactions have been eliminated inconsolidation.

**Use of Estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand judgments that affect the reported amounts of assets, liabilities, revenuesand expenses, and related disclosure of contingent assets and liabilities. Onan on-going basis, management evaluates estimates related to the allowance fordoubtful accounts, write-down of excess and obsolete inventories to the lowerof cost or market value, the realizability of long-lived assets and goodwill,income taxes, restructuring and other related charges, and accounting foracquisitions. Management established these estimates based on historicalexperience and various assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates underdifferent assumptions or conditions.

**Foreign CurrencyTranslation**

Assets and liabilities ofthe Company’s subsidiaries operating outside the United States, which operatein a functional currency other than U.S. dollars, are translated into U.S.dollars using year-end exchange rates. Revenues and expenses are translated atthe average exchange rates effective during the year. Foreign currencytranslation gains and losses are included as a component of accumulated othercomprehensive income (loss) within stockholders’ equity. Gains and lossesresulting from foreign currency transactions are included in other income(expense), net. The foreign currency translation gain or loss generated by theremeasurement of our intercompany debt at each reporting period is recorded asa component of accumulated other comprehensive income (loss) withinstockholders’ equity, since the Company expects those loans to be permanentlyreinvested.

48

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**Revenue Recognition**

The Company derives its revenue from two sources:sales of products, including hardware and software licenses, and services,including maintenance, support and professional services. Maintenance andsupport services consist of on-site support, telephone support, system hostingand training. Professional services consist of multiple-elements of hardwareand/or software customization projects provided to customers. The Company sellsits products and services through direct sales and through channel partners,which include resellers, distributors and system integrators. The Company’sproducts are sold as bundled hardware and software solution. When the softwareis essential to the functionality of the hardware the Company recognizesrevenue in accordance with the provisions of the American Institute ofCertified Public Accountants Statement of Position (SOP) 97-2, *Software Revenue Recognition*, and relatedinterpretations. The Company recognizes revenue from the sale of products whenpersuasive evidence of an arrangement exists, delivery has occurred, the fee isfixed or determinable, and collection is considered probable.

When selling to resellers, distributors and systemsintegrators, the Company defers revenue until collectibility is probable. Whenrevenue is deferred, if reliable reporting from the reseller or distributorexists, the Company will recognize revenue when the reseller or distributorsells the product to an end-user (“sell through”). Where reliable reportingdoes not exist, revenue will be recognized upon our receipt of payment, or inlimited circumstances receipt of a letter of credit.

For arrangements with customers that includeacceptance provisions, the Company recognizes revenue upon the customer’sacceptance of the product, which occurs upon the earlier of receipt of awritten customer acceptance or expiration of the contractual acceptance period.

In accordance with Statement of Financial AccountingStandards (“SFAS”) No. 48, “*Revenue Recognition whenRight of Return Exists*,” the Company recognizes revenue uponshipment of product to its stocking distributors, net of estimated returns. TheCompany offers quarterly return rights to a limited number of channel partnersthat allow the channel partner to exchange a percentage of their inventorybased on its prior quarter purchases. The Company provides for these returnrights each quarter in an amount equal to estimated returns. The Company doesnot offer rights of return on sales made through its direct sales force.

When an arrangement involves multiple elements, suchas hardware and software products, maintenance and/or professional services,the Company allocates the entire sale price to each respective element based onvendor specific objective evidence (“VSOE”) of fair value for each element.When arrangements contain multiple elements and VSOE of fair value exists forall undelivered elements, the Company recognizes revenue for the deliveredelements using the residual method. The Company bases its determination of VSOEof fair value of the undelivered elements based on either substantial renewalrates of maintenance and support agreements, the price the Company charges whenthe same element is sold separately or the price established by management, whohave the relevant authority to set prices, for an element not yet soldseparately. For arrangements containing multiple elements where VSOE of fairvalue does not exist for all undelivered elements, the Company defers revenuefor the delivered and undelivered elements until VSOE of fair value exists orall elements have been delivered.

The Company defers maintenance and support servicesrevenue, whether sold separately or as part of a multiple element arrangement,and recognizes it ratably over the term of the maintenance contract, generallytwelve months. When maintenance and support services are not sold separatelythe Company determines VSOE on maintenance and support services by establishinga substantive renewal price in the multiple element arrangements.

The Company recognizes revenue allocated toprofessional service elements as the services are performed. When thecustomization is essential to the functionality of the licensed software, boththe 

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software license andprofessional services revenue are recognized under the percentage of completionmethod, which requires revenue to be recognized as services are performed. TheCompany recognizes revenue and gross profit using labor hours as an inputmeasure of progress to completion on these arrangements.

Maintenance and support services and professionalservice revenue represents 9.1%, 7.4% and 8.8% of revenue for the years ended December 31,2006, 2005 and 2004, respectively

When there are shippingand handling fees, the Company invoices customers for such fees and  recognizes the invoiced amounts as revenueand the related costs as costs of revenue.

**Cash Equivalents**

Cash equivalents includeshort-term investments with remaining maturities of three months or less atdate of purchase.

**Accounts Receivable**

The Company’s accounts receivable balances arecomposed of trade receivables. The Company has recorded receivables associatedwith product and services that have been delivered but not yet accepted.

The Company establishes allowances against doubtfulaccounts for potential credit losses when it determines receivables are at riskfor collection based upon the length of time the receivables are outstanding,as well as various other criteria. Receivables are written off against theseallowances in the period they are determined to be uncollectible.

The Company does notrequire collateral on accounts receivable or letters of credit on all foreignexport sales. The Company evaluates its customers’ creditworthiness beforeextending credit and performs periodic credit reviews on existing customers.

**Investments**

The Company classifies allof its investments in marketable securities as available-for-sale securities.These securities are stated at market value, with unrealized gains and lossesreflected in other comprehensive income (loss) in stockholders’ equity. Theamortized cost of debt securities is adjusted for amortization of premiums andaccretion of discounts to maturity. Such amortization and accretion areincluded in interest income. Realized gains and losses on marketable securitiesare included in earnings and are derived using the specific identificationmethod for determining the cost of securities. The Company periodicallyevaluates the carrying value of its investments for other than temporaryimpairment.

**Advertising**

Advertising costs areexpensed in the period when incurred and were immaterial for each of the yearspresented.

**Inventories**

Inventories are stated atthe lower of cost (first-in, first-out method) or market. Inventories consistof raw materials, work in process, finished goods and inventory at customersites. Inventory at customer sites represents inventory associated with productthat has not yet been accepted by the customer. Write-downs of inventory tolower of cost or market value are based primarily on estimated forecast ofproduct demand and production requirements over the next twelve months.

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**Property andEquipment**

Propertyand equipment are recorded at cost. Depreciation is based on the followingestimated useful lives of the assets using the straight-line method:

| Machinery and equipment                |   | 3 years                                    |
|----------------------------------------|--------|--------------------------------------------|
| Computer software and  equipment       |   | 3-5 years                                  |
| Furniture and fixtures                 |   | 5 years                                    |
| Telecommunications  computer equipment |   | 5 years                                    |
| Leasehold improvements                 |   | Shorter of the lease term or economic life |

 

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

**Goodwill and Other Intangible Assets**

In accordance with SFAS No. 142, “*Goodwill andOther Intangible Assets*” (“SFAS No. 142”), goodwill is reviewed forimpairment on an annual basis, or more frequently if events or circumstancesindicate that the carrying value may not be recoverable. During 2006, theCompany performed its annual test of goodwill to determine if there was animpairment. These tests determined that each reporting unit’s fair valueexceeded the carrying value of the net assets of each respective reportingunit, using projected discounted cash flow modeling. No impairment was requiredto be recorded related to the Company’s annual impairment testing in 2006.Estimating future cash flows requires management to make projections that candiffer materially from actual results. 

Also in accordance withSFAS No. 142, the Company evaluated the useful lives assigned to its otherintangible assets, which resulted in no changes to such useful lives. Otherintangible assets arose from the acquisition of Openera in February 2006, whichare amortized over their respective estimated economic useful livesproportionate to their expected cash flows.

**Long-Lived Assets**

The Company performs reviews for the impairment oflong-lived assets whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. An impairment loss isrecognized when estimated undiscounted future cash flows expected to resultfrom the use of the asset and its eventual disposition are less than itscarrying amount. If future expected undiscounted cash flows are insufficient torecover the carrying value of the assets, then an impairment loss is recognizedbased upon the excess of the carrying value of the asset over the anticipatedcash flows on a discounted basis.

The Company also reviewsany legal and contractual obligations associated with the retirement of itslong-lived assets and records assets and liabilities, as necessary, related tothe cost of such obligations. Costs associated with such obligations that arereasonably estimable and probable are accrued and expensed, or capitalized asappropriate. The asset recorded shall be recorded during the period in which itoccurs and shall be amortized over the useful life of the related long-livedtangible asset. The liability recorded is relieved when the costs are incurredto retire the related long-lived tangible asset.

**Research andDevelopment**

Research and developmentexpenses consist primarily of salaries, personnel expenses and prototype feesrelated to the design, development, testing and enhancement of the Company’sproducts. All research and development costs are expensed as incurred.

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**CapitalizedSoftware Development Costs**

The Company capitalizessoftware development costs incurred after a product’s technological feasibilityhas been established and before it is available for general release tocustomers. Amortization of capitalized software costs is computed on anindividual product basis and is the greater of a) the ratio that currentgross revenues for a product bear to the total of current and anticipatedfuture gross revenues of that product or b) the straight-line method overthe estimated economic life of the product. Costs qualifying for capitalizationhave been immaterial for all periods presented and, accordingly, have not beencapitalized.

**FinancialInstruments**

The Company’s financialinstruments include cash, marketable securities, accounts receivable, debt andaccounts payable. The fair value of marketable securities, accounts receivableand accounts payable are equal to their carrying value at December 31,2006 and 2005. Debt obligations were repaid in 2006 and 2005. Debt is recordedat its face value.

***Severanceand Restructuring Accrued Liabilities***

**The Company continually evaluatesits staffing levels to meet its business objectives and its strategy to reduceits cost of operations. Severance costs are reviewed periodically to determinewhether a severance charge is required to be recorded in accordance with SFASNo. 112, *Employers’ Accounting for Post-employment Benefits*,(“SFAS No. 112”). The provisions of SFAS No. 112 require the Company to accruepost-employment benefits if certain specified criteria are met. Post-employmentbenefits include salary continuation, severance benefits and continuation ofbenefits such as health and life insurance.**

**From time to time, the Company willannounce reorganization plans that may include eliminating positions within theCompany. Each plan is reviewed to determine whether a restructuring charge isrequired to be recorded in accordance with SFAS No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*, (“SFAS No.146”). The provisions of SFAS No. 146 require the Company to record an estimateof the fair value of any termination costs based on certain facts,circumstances and assumptions, including specific provisions included in theunderlying reorganization plan.**

**Also from time to time, the Companyceases to use certain facilities prior to expiration of the underlying leaseagreements. Exit costs are reviewed in each of these circumstances on acase-by-case basis to determine whether a restructuring charge is required tobe recorded in accordance with SFAS No. 146. The provisions of SFAS No. 146require the Company to record an estimate of the fair value of the exit costsbased on certain facts, circumstances and assumptions, including remainingminimum lease payments, potential sublease income and specific provisionsincluded in the underlying lease agreements.**

**Subsequentto recording such accrued liabilities, changes in market or other conditionsmay result in changes to assumptions upon which the original liabilities wererecorded that could result in an adjustment to the liabilities and, dependingon the circumstances, such adjustment could be material.**

**Income Taxes**

The provision for income taxes is computed based onpre-tax income included in the Consolidated Statements of Operations. TheCompany recognizes deferred tax assets and liabilities for the expected futuretax consequences of events that have been included in the financial statements.Under this method, deferred tax assets and liabilities are determined based onthe difference between the financial statement carrying amounts and tax basisof assets and liabilities using enacted tax rates in effect for the year inwhich the differences are expected to reverse. A valuation allowance againstnet deferred tax assets is required if, 

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based upon availableevidence, it is more likely than not that some or all of the deferred taxassets will not be realized.

The Company determines its effective tax rate bydividing its income tax expense by its income before taxes as reported in itsConsolidated Statement of Operations. For reporting periods prior to the end ofthe Company’s fiscal year, the Company records income tax expense based upon anestimated annual effective tax rate. This rate is computed using the statutorytax rate and an estimate of annual net income adjusted for an estimate ofnon-deductible expenses.

In July 2006, the Financial Accounting StandardsBoard (“FASB”) issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109*(“FIN 48”). FIN 48 clarifies theaccounting for income taxes by prescribing the minimum recognition threshold as“more-likely-than-not” that a tax position must meet before being recognized inthe financial statements. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting for income taxes in interimperiods, financial statement disclosure and transition rules.

The evaluation of a tax position in accordance withFIN 48 is a two-step process. The first step is recognition: Theenterprise determines whether it is more likely than not that a tax positionwill be sustained upon examination, including resolution of any litigation. Thesecond step is measurement: A tax position that meets the more-likely-than-notrecognition threshold is measured to determine the amount of benefit torecognize in the financial statements. The tax position is measured at thelargest amount of benefit that is greater than 50 percent likely of beingrealized upon ultimate resolution.

TheCompany is required to adopt the provisions of FIN 48 related to all ofthe Company’s tax positions for the fiscal year beginning January 1, 2007.The cumulative effect of applying the provisions of FIN 48 will bereported as an adjustment to the opening balance of retained earnings. Theadoption of the provisions of FIN 48 is not expected to have a material impacton the Company’s financial position or results of operation.

**Stock Option andStock Purchase Plans**

Effective January 1, 2006, the Companyimplemented the provisions of SFAS No. 123 (revised 2004), *Share-Based Payment*(“SFAS 123R”) andrelated interpretations. (See Note 4 of Notes to Consolidated FinancialStatements). SFAS 123R requires that all share-based payments toemployees, including grants of stock options, be recognized in the financialstatements based on their fair value. The Company selected the modifiedprospective transition method for implementing SFAS 123R, and beganrecognizing compensation expense for stock-based awards granted on or after January 1,2006, plus any unvested awards granted prior to January 1, 2006. Underthis transition method, prior periods have not been restated. Stock-basedcompensation expense for awards granted on or after January 1, 2006, isbased on the grant date fair value calculated in accordance with the provisionsof SFAS 123R. Stock-based compensation related to any unvested awardsgranted prior to January 1, 2006, is based on the grant date fair valuecalculated in accordance with the original provisions of SFAS No. 123,*Accounting for Stock-Based Compensation.*The fair value of the Company’s stock-based awards, less estimated forfeitures,is amortized over the awards’ vesting periods on a straight-line basis. In March 2005,the Securities and Exchange Commission (“SEC”) issued Staff AccountingBulletin No. 107 (“SAB 107”) regarding the SEC Staff’sinterpretation of SFAS 123R. SAB 107 provides the Staff’s views regardinginteractions between SFAS 123R and certain SEC rules and regulationsand provides interpretations of the valuation of share-based payments forpublic companies. The Company has incorporated the provisions of SAB 107in its adoption of SFAS 123R.

Prior to the adoption of SFAS 123R on January 1,2006, the Company accounted for the costs of its stock-based employeecompensation plans under Accounting Principles Board (“APB”) Opinion No. 25,*Accounting for Stock Issued to Employees*(“APB 25”),and related interpretations. Under APB 25, 

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compensation cost was notrecognized for substantially all options granted because the exercise price wasat least equal to the market value of the underlying common stock on the dateof grant.

The fair value of each option award on the grant datewas estimated using the Black-Scholes option-pricing model with the followingassumptions: expected dividend yield, expected stock price volatility, weightedaverage risk-free interest rate and weighted average expected life of theoptions. Under SFAS 123R, the Company’s expected volatility assumptionused in the Black-Scholes option-pricing model was based exclusively onhistorical volatility and the expected life assumption was established basedupon an analysis of historical option exercise behavior. The risk-free interestrate used in the Black-Scholes model was based on the implied yield currentlyavailable on U.S. Treasury zero-coupon issues with a remaining term equalto the Company’s expected term assumption. The Company has never declared orpaid any cash dividends on the Common Stock and has no current plans to paycash dividends on the Common Stock. The payment of any future cash dividendswill be determined by the Company’s board of directors in light of conditionsthen existing, including the Company’s earnings, financial condition andcapital requirements, restrictions in financing agreements, businessconditions, tax laws, certain corporate law requirements and various otherfactors.

The choice of a valuationtechnique, and the approach utilized to develop the underlying assumptions forthat technique, involve significant judgments. These judgments reflectmanagement’s assessment of the most accurate method of valuing the stockoptions the Company issues, based on historical experience, knowledge ofcurrent conditions and beliefs of what could occur in the future givenavailable information. The Company’s judgments could change over time asadditional information becomes available, or the facts underlying theassumptions change over time. Any change in judgments could have a materialimpact on the Company’s financial statements. The Company believes that theseestimates incorporate all relevant information and represent a reasonableapproximation in light of the difficulties involved in valuing non-traded stockoptions.

**Basic and DilutedNet Earnings (Loss) Per Common Share**

Basic net earnings (loss)per common share are computed by dividing net income (loss) by the weighted-averagenumber of common shares outstanding during the period. Diluted net earnings(loss) per common share is computed by dividing the net income (loss) by thesum of the weighted-average number of common shares outstanding plus alladditional common shares that would have been outstanding if potentiallydilutive common stock equivalents had been issued. Outstanding treasury stockis excluded from the computations of basic and diluted net earnings (loss) pershare.

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**Recent AccountingPronouncements**

As noted in Note 2, effectiveJanuary 1, 2006, the Company adopted the provisions of Statement ofFinancial Accounting Standards 123R, *“Share-BasedPayment,”* (“SFAS 123R”), which establishes accounting forequity instruments exchanged for employee services. Under the provisions ofSFAS 123R, stock-based compensation cost is measured at the grant date,based on the fair value of the award, and is recognized as an expense over theemployee’s requisite service period (generally the vesting period of the equityaward).

In November 2004, the FASB issued SFASNo. 151, *Inventory Costs, an amendmentof ARB No. 43, Chapter 4* (“SFAS 151”). SFAS 151 amends theguidance in Accounting Research Bulletin (“ARB 43”), Chapter 4, “Inventory Pricing,”to clarify the accounting for abnormal amounts of idle facility expense,freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43,Chapter 4, previously stated that “... under some circumstances, items such asidle facility expense, excessive spoilage, double freight, and rehandling costsmay be so abnormal as to require treatment as current period charges”. ThisStatement requires that those items be recognized as current-period chargesregardless of whether they meet the criterion of: so abnormal. In addition,SFAS 151 requires allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facilities. Theadoption of SFAS 151, effective January 1, 2006, did not have a materialimpact on the Company’s financial position, results of operations and cashflows.

In June 2006, the FASB ratified the consensusreached by the EITF on Issue No. 06-3, *How TaxesCollected from Customers and Remitted to Governmental Authorities Should be Presentedin the Income Statement (That Is, Gross Versus Net Presentation)*(“EITF 06-3). EITF 06-3 includes any tax assessed by a governmentalauthority that is directly imposed on a revenue-producing transaction between aseller and a customer and may include, but is not limited to, sales, use, valueadded, and some excise taxes. EITF 06-3 concludes that the presentationof taxes on either a gross (included in revenues and costs) or a net (excludedfrom revenues) basis is an accounting policy decision that should be disclosed.In addition, for any such taxes that are reported on a gross basis, a companyshould disclose the amounts of those taxes in interim and annual financialstatements for each period for which an income statement is presented if those amountsare significant. The provisions of EITF 06-3 should be applied tofinancial reports for interim and annual reporting periods beginning afterDecember 15, 2006, with earlier adoption permitted. The adoption of theprovisions of EITF 06-3 in 2007 is not expected to have a material impacton the Company’s financial position or results of operations.

In July 2006, the FASB issued InterpretationNo. 48, *Accounting for Uncertainty inIncome Taxes* (“FIN 48”). FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FASB Statement No. 109, *Accounting for Income Taxes*. FIN 48 prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.This Interpretation also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure, andtransition. This Interpretation is effective for fiscal years beginning afterDecember 15, 2006, with earlier adoption permitted. The adoption of theprovisions of FIN 48 in 2007 is not expected to have a material impact on theCompany’s financial position or results of operations.

In September 2006, the FASB issued SFASNo. 157, *Fair Value Measurements*(“SFAS 157”). SFAS 157 defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles (‘GAAP”) andexpands disclosures about fair value measurements. SFAS 157 applies under otheraccounting pronouncements that require or permit fair value measurements, theFASB having previously concluded in those accounting pronouncements that fairvalue is the relevant measurement attribute. Accordingly, SFAS 157 does notrequire any new fair value measurements. SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears, with earlier adoption permitted. The provisions of SFAS 157 should beapplied prospectively as of the 

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beginning of the fiscalyear in which it is initially applied, with limited exceptions. The Company iscurrently evaluating the provisions of SFAS 157.

In September 2006, the SEC issued StaffAccounting Bulletin No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements* (“SAB 108”) expressing the Staff’sviews regarding the process of quantifying financial statement misstatements.There have been two widely-recognized methods for quantifying the effects offinancial statement errors: the “roll-over” method and the “iron curtain”method. The roll-over method focuses primarily on the impact of a misstatementon the income statement—including the reversing effect of prior yearmisstatements—but its use can lead to the accumulation of misstatements in thebalance sheet. The iron-curtain method, on the other hand, focuses primarily onthe effect of correcting the period-end balance sheet with less emphasis on thereversing effects of prior year errors on the income statement. SAB 108establishes an approach that requires quantification of financial statementerrors based on the effects of the error on each of the company’s financialstatements and the related financial statement disclosures. This model iscommonly referred to as a “dual approach” because it essentially requiresquantification of errors under both the iron-curtain and the roll-over methods.The provisions of SAB 108 should be applied to annual financial statementscovering the first fiscal year ending after November 15, 2006. Theadoption of the provisions of SAB 108, effective January 1, 2006, had nomaterial impact on the Company’s financial position, results of operations andcash flows.

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities, including an amendment of FASB Statement No. 115.”  SFAS No. 159 permits entities to chooseto measure many financial instruments and certain other items at fair valuethat are not currently required to be measured at fair value. Unrealized gainsand losses on items for which the fair value option has been elected arereported in earnings. SFAS No. 159 does not affect any existing accountingliterature that requires certain assets and liabilities to be carried at fairvalue. SFAS No. 159 is effective for fiscal years beginning after November 15,2007. The Company does not expect the adoption of this new standard to have amaterial impact on the Company’s financial position, results of operations orcash flows.

**2—Stock-BasedCompensation**

Thefollowing table presents the effect of recording stock-based compensationexpense under SFAS 123R:

| ** **                                                  | ** ** | **Year ended  December 31,  2006**               | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(In thousands,  except per  share data)** | ** ** |
| Stock-based  compensation expense by type of award:         |       |                                                       |       |   |   |
| Stock options                                               |       |                                                       | $          | 1,939 |   |   |
| Restricted stock                                            |       |                                                       | 2,548      |   |   |
| Employee stock purchase plan                                |       |                                                       | 307        |   |   |
| Total stock-based  compensation                             |       |                                                       | $          | 4,794 |   |   |
| Effect on  earnings per share                               |       |                                                       |       |   |   |
| Increase to basic and diluted loss per share                |       |                                                       | $          | 0.10 |   |   |
| Effect of  stock-based compensation on income by line item: |       |                                                       |       |   |   |
| Cost of revenues                                            |       |                                                       | $          | 98 |   |   |
| Selling, general and administrative                         |       |                                                       | 4,393      |   |   |
| Research and development                                    |       |                                                       | 303        |   |   |
| Stock-based  compensation expense                           |       |                                                       | $          | 4,794 |   |   |

 

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As a result of adopting SFAS 123R, the Company’snet loss increased $4.8 million for the year ended December 31, 2006.Basic and diluted loss per share for the year ended December 31, 2006 was$0.10 greater due to the adoption of SFAS 123R. The adoption of SFAS 123Rdid not have a material impact on the Company’s cash flows.

The Company estimates the fair value of each awardusing the Black-Scholes valuation model. This valuation model uses the exerciseprice of the award, and the following significant assumptions:  the expected term, the expected volatility ofthe Company’s stock over the expected term, the risk-free interest rate overthe expected term, and the Company’s expected annual dividend yield. TheCompany believes that the valuation method and the approach utilized to developthe underlying assumptions are appropriate in calculating the fair values ofthe Company’s equity awards on respective grant dates during the year ended December 31,2006. Estimates of fair value are not intended to predict actual future eventsor the value ultimately realized by persons who receive equity awards.

Assumptionsused to determine the fair value of stock options granted during the year endedDecember 31, 2006, using a Black-Scholes valuation model were:

| ** **                           | ** ** | **Year Ended   December 31,  2006** | ** ** |
|--------------------------------------|------------|----------------------------------------------------|------------|
| Expected term(1)                     |       | 3.25  to 3.5 years                                 |       |
| Expected stock  price volatility (2) |       | 69  to 73%                                         |       |
| Risk-free  interest rate(3)          |       | 4.4%  to 5.2%                                      |       |
| Expected dividend yield              |       | 0%                                                 |       |

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(1)          The expected term foreach grant is estimated based on the midpoint between the vesting date and theend of the contractual term, also known as the “simplified method” forestimating expected term described by Staff Accounting Bulletin No. 107 (“SAB107”).

(2)          The expected stock pricevolatility for each grant is estimated based on an average of historical dailyprice changes of the Company’s common stock over the periods that match theexpected term of the stock option.

(3)          The risk-free interestrate for each grant is based on the interest rates of zero coupon U.S. TreasuryNotes in effect at the time of grant for a period equal to the expected term ofthe stock option.

Stock-based compensation expense related to theCompany’s Employee Stock Purchase Plan was determined using the Black-Scholesvaluation model. The compensation expense is recorded over the period in whichthe awards are earned. During the year ended December 31, 2006 the Companyrecorded stock-based compensation expense based on actual shares issued and anestimate of 23,000 shares to be issued under the Company’s Employee StockPurchase Plan in the second fiscal quarter of 2007.

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Proformainformation for periods prior to adopting SFAS 123R:

Priorto January 1, 2006, the Company accounted for stock-based compensation toemployees in accordance with APB 25 and disclosed the pro-forma stock-basedcompensation and its impact on net loss and net loss per share in accordancewith SFAS 123. The following table illustrates the effects on net loss and netloss per share for the years ended December 31, 2005 and 2004 if theCompany had applied the fair value recognition provisions of SFAS 123 tostock-based employee awards.

| ** **                                                                                    | ** ** | **Year ended  December 31,  2005**                   | ** ** | **Year ended  December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                    | ** ** | **(In thousands,  except per share data)** | ** ** |
| Net income as  reported                                                                       |       |                                                           | $          | 4,972                                        |       |   |   | $ | 4,102 |   |   |
| Add: Stock-based employee compensation expense  included in net income                        |       |                                                           | —     |                                         |       |   | 102 |   |   |
| Less: Total stock-based employee compensation  expense determined under the fair value method |       |                                                           | (8,449     | )                                            |       |   | (5,625 | ) |   |
| Pro forma net loss                                                                            |       |                                                           | $          | (3,477                                       | )          |   |   | $ | (1,421 | ) |   |
| Net income (loss) per  share:                                                                 |       |                                                           |       |                                         |       |   |   |   |   |
| Basic and Diluted net income per common  share—as reported                          |       |                                                           | $          | 0.10                                         |       |   |   | $ | 0.09 |   |   |
| Basic and  Diluted net loss per common share—pro-forma                              |       |                                                           | $          | (0.07                                        | )          |   |   | $ | (0.03 | ) |   |

 

Indetermining the stock-based compensation expense to be disclosed under SFAS123, the Company estimated the fair value of each stock option award using theBlack-Scholes valuation model. Assumptions used to determine the fair value ofoptions granted under SFAS 123 during the years ended December 31, 2005and 2004 were:

| ** **                       | ** ** | **Year ended  December 31,  2005** | ** ** | **Year ended  December 31,  2004** | ** ** |
|----------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| Expected term                    |       |                                         | 3.5  years |                                         |       |   | 5.0  years |   |   |
| Expected stock  price volatility |       |                                         | 82%        |                                         |       |   | 115% |   |   |
| Risk-free  interest rate         |       |                                         | 4.0%       |                                         |       |   | 3.4% |   |   |
| Expected dividend yield          |       |                                         | 0%         |                                         |       |   | 0% |   |   |

 

In the fourth quarter of2005, the Company accelerated the vesting of options to purchase 589,499 sharesof common stock with exercise prices greater than or equal to $4.03 per sharethat were awarded to employees, officers and other eligible participants underthe Company’s various stock option plans. The acceleration of the vesting ofthese options did not result in a charge based on generally accepted accountingprinciples. The Company disclosed $2.9 million of pro-forma stock-based compensationfor those modifications during the year ended December 31, 2005. Thesemodifications were made in anticipation of adopting SFAS No. 123R to avoidstock-based compensation expense.

**Stock IncentivePlans**

The Company has stockoption and stock purchase plans authorizing various types of stock optionawards that may be granted to officers and employees. The following is asummary of all of the plans of the Company:

**1993 Stock OptionPlan**

In October 1993, theCompany’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 toemployees, 

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directorsand consultants. Options granted under the 1993 Plan generally vest overfour years. The terms of options granted under the 1993 Plan do not exceedten years. In March 1998, the Board of Directors adopted, and in April 1998the Company’s stockholders approved, (i) an increase in the number ofshares available under the 1993 Plan from 3,000,000 to 3,800,000 and (ii) arequirement that the exercise price of options granted under the 1993 Plan beat least equal to the fair market value of the Company’s common stock on thedate of grant. In March 2000, the Board of Directors superseded the 1993Plan with the Company’s 2000 Equity Incentive Plan (the “2000 Plan”) and nofurther grants under the 1993 Plan will be made. Options granted previouslyunder the 1993 Plan will continue to be governed by the terms of the 1993 Plan.As of December 31, 2006 there were 384,000 options outstanding under the1993 Plan. The outstanding options under the 1993 Plan were fully vested as of December 31,2006. As of December 31, 2006, 384,000 shares of common stock have beenreserved for issuance upon the exercise of stock options under the 1993 Plan.

**1993 Non-EmployeeDirectors Stock Option Plan**

In October 1993, theCompany’s Board of Directors adopted the 1993 Non-Employee Directors StockOption Plan (the “Directors Plan”) which provides for the purchase of up to240,000 shares of common stock pursuant to the grant of non-statutory stockoptions to directors who are not employees of the Company. Options grantedunder the Directors Plan generally vest over four years. The terms ofoptions granted under the Directors Plan do not exceed ten years. In March 1996the Board of Directors adopted, and in May 1996 the Company’s stockholdersapproved, (i) an increase in the number of shares for which options shallbe granted to newly elected non-employee directors from 20,000 to 30,000 and (ii) anincrease in the number of shares for which options shall be granted annually toincumbent non-employee directors from 4,000 to 10,000. In March 1999, theBoard of Directors adopted, and in April 1999 the Company’s stockholdersapproved, an increase in the number of shares available under the DirectorsPlan from 240,000 to 480,000 shares. The exercise price of the options may notbe less than 100% of the fair market value of the Company’s common stock on thedate of the grant. In March 2000, the Board of Directors superseded theDirectors Plan with the 2000 Equity Incentive Plan and no further grants underthe Directors Plan will be made. As of December 31, 2006, there were105,000 options outstanding under the Directors Plan. The outstanding optionsunder the Directors Plan were fully vested as of December 31, 2006.Options granted previously under the Directors Plan will continue to begoverned by the terms of the Directors Plan. As of December 31, 2006,105,000 shares of common stock have been reserved for issuance upon theexercise of stock options under the Directors Plan.

**1995 Non-StatutoryStock Option Plan**

In October 1995, theCompany’s Board of Directors adopted the 1995 Non-Statutory Stock Option Plan(the “1995 Plan”). The 1995 Plan expired in October 2005. The exerciseprice of options outstanding under the 1995 Plan is not less than 100% of thefair market value of the Company’s common stock on the date of grant. Optionsoutstanding under the 1995 Plan generally vest over two years. The termsof options granted under the 1995 Plan do not exceed ten years. As of December 31,2006, there were 1,725,734 options outstanding under the 1995 Plan. As of December 31,2006, there were 1,693,134 options vested under the 1995 Plan. As of December 31,2006, 1,725,734 shares of common stock have been reserved for issuance upon theexercise of stock options under the 1995 Plan.

**2000 EquityIncentive Plan**

In March 2000, theCompany’s Board of Directors adopted, and in April 2000 the Company’sstockholders approved, the 2000 Equity Incentive Plan (the “2000 Plan”). The2000 Plan provides for the grant of incentive stock options and stockappreciation rights to employees and non-statutory stock options, stockbonuses, rights to purchase restricted stock and other awards based on theCompany’s 

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commonstock (collectively, “Stock Awards”) to employees, non-employee directors andconsultants. On April 28, 2005, the Company’s stockholders approvedamendments to the 2000 Plan to (i) increase the number of shares which maybe issued under the 2000 Plan by 2,050,000 shares, (ii) eliminate theCompany’s ability to grant non-statutory stock options at an exercise priceless than fair market value of the Company’s common stock on the date of grantand (iii) amend certain other terms and conditions of the 2000 Plan. Theaggregate number of shares which may be issued under the 2000 Plan, as amended,is 7,050,000 plus any shares of the Company’s common stock covered by optionsgranted under the 1993 Plan and the Directors Plan (both of which are supersededby the 2000 Plan) which are forfeited, expire or are canceled. The exerciseprice of options granted pursuant to the 2000 Plan may not be less than thefair market value of the Company’s common stock on the date of grant. Optionsgranted under the 2000 Plan generally vest over two years except that,options granted to new hires generally vest over three years. The terms ofoptions granted under the 2000 Plan do not exceed ten years. The terms ofoptions granted during 2006 do not exceed 5 years. As of December 31,2006, there were 5,370,560 options outstanding under the 2000 Plan. As of December 31,2006, there were 2,456,744 options vested under the 2000 Plan. As of December 31,2006, 7,398,353 shares of common stock have been reserved for issuance upon theexercise of stock options under the 2000 Plan.

**2003 Employee StockPurchase Plan**

In March 2003, theBoard of Directors adopted, and in April 2003 the Company’s stockholdersapproved, the 2003 Employee Stock Purchase Plan (the “Purchase Plan”). ThePurchase Plan permits employees and officers of the Company to participate inperiodic plan offerings, in which payroll deductions may be used to purchaseshares of common stock. The purchase price is 85% of the lower of the fairmarket value at the date the offering commences or terminates. In May 2006,the Board of Directors adopted the Indian Supplement to the Purchase Plan. As aresult, the Company allocated 150,000 shares from the Purchase Plan to be usedfor the Indian Supplement. The Company has reserved a total of 750,000 sharesfor the Purchase Plan. The Company issued 130,639 shares under the PurchasePlan during the year ended December 31, 2006. As of December 31,2006, 233,458 shares of common stock have been reserved for issuance upon theexercise of stock options under the Purchase Plan.

**2005 Openera Plan**

In connection with theacquisition of Openera Technologies, Inc. (“Openera”) on February 24,2006, the Company assumed the Openera 2005 Equity Incentive Plan (the “OpeneraPlan”). The Openera Plan provides for the grant of incentive stock options toemployees and non-statutory stock options to employees, non-employee directorsand advisors and consultants. A total of 762,065 shares may be issued under theOpenera Plan. The exercise price of incentive stock options granted pursuant tothe Openera Plan may not be less than the fair market value of the company’scommon stock on the date of grant. Options granted under the Openera Plangenerally vest over two years except that, options granted to new hiresgenerally vest over three years. The terms of options granted under the OpeneraPlan do not exceed ten years. The terms of options granted during 2006 do notexceed five years. As of December 31, 2006, there were 401,823options outstanding under the Openera Plan. As of December 31, 2006, therewere 3,184 options vested under the Openera Plan. As of December 31, 2006,406,808 shares of common stock have been reserved for issuance upon theexercise of stock options under the Openera Plan.

**2006 India StockOption Plan**

In May 2006,the Company’s Board of Directors adopted the 2006 India Stock Option Plan (the “2006India Plan”). The 2006 India Plan provides for the grant of non-statutory stockoptions to purchase shares of the Company’s common stock to India resident,non-executive office employees of and consultants to the Company or any of itssubsidiaries. A total of 600,000 options may be issued under the 2006 IndiaPlan. 

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Options granted under the 2006 India Plan generallyvest over two years except that, options granted to new hires generally vestover three years. The terms of options granted under the 2006 India Plan do notexceed five years. As of December 31, 2006, there were 74,450 optionsoutstanding under the 2006 India Plan. As of December 31, 2006, there wereno options vested under the 2006 India Plan. As of December 31, 2006,600,000 shares of common stock have been reserved for issuance upon theexercise of stock options under the India Plan.

Asummary of the Company’s stock option activity for the years endedDecember 31, 2006, 2005 and 2004 is as follows:

| ** **                          | ** ** | **Year Ended  December 31, 2006** | ** ** | **Year Ended  December 31, 2005** | ** ** | **Year Ended  December 31, 2004** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **Options**                                      | ** ** | **Weighted  Average  Exercise  Price**           | ** ** | **Options**                                      | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding at  beginning of period |       | 7,679,308                                        |       |                                             | $          | 4.90                                             |       |   | 8,626,392 |   |   | $ | 8.03 |   |   | 8,901,814 |   |   | $ | 8.54 |   |   |
| Granted                             |       | 3,467,476                                        |       |                                             | 2.55       |                                             |       | 2,401,202 |   |   | 3.49 |   |   | 1,818,944 |   |   | 6.30 |   |   |
| Exercised                           |       | (808,922                                         | )          |                                             | 1.64       |                                             |       | (908,086 | ) |   | 1.74 |   |   | (1,337,299 | ) |   | 2.91 |   |   |
| Forfeited and  cancelled            |       | (2,276,295                                       | )          |                                             | 5.44       |                                             |       | (2,440,200 | ) |   | 15.74 |   |   | (757,067 | ) |   | 19.10 |   |   |
| Outstanding at end of period        |       | 8,061,567                                        |       |                                             | 4.06       |                                             |       | 7,679,308 |   |   | 4.90 |   |   | 8,626,392 |   |   | 8.03 |   |   |
| Exercisable at  end of period       |       | 4,642,062                                        |       |                                             | 5.07       |                                             |       | 5,551,917 |   |   | 5.52 |   |   | 6,016,546 |   |   | 9.37 |   |   |

 

Thefollowing table summarizes outstanding stock options as of December 31,2006:

| **Range of Exercise Prices** | ** ** | ** ** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Average  Exercise Price** | ** ** |
|---------------------------------------------|------------|------------|------------|-------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------|------------|-------------------------|------------|----------------------------------|------------|
| $0.01—$5.00                            |       |       | 6,613,335  |                    |       |                                                | 3.5        |                                       |       |                    | $          | 2.91                             |       |   | 3,198,555 |   |   | $ | 3.15 |   |   |
| $5.01—$10.00                           |       |       | 1,185,294  |                    |       |                                                | 2.0        |                                       |       |                    | 6.71       |                             |       | 1,180,569 |   |   | 6.71 |   |   |
| $10.01—$20.00                          |       |       | 151,508    |                    |       |                                                | 1.0        |                                       |       |                    | 15.18      |                             |       | 151,508 |   |   | 15.18 |   |   |
| $20.01—$30.00                          |       |       | 63,000     |                    |       |                                                | 1.3        |                                       |       |                    | 25.08      |                             |       | 63,000 |   |   | 25.08 |   |   |
| $30.01—$40.00                          |       |       | 43,330     |                    |       |                                                | 0.6        |                                       |       |                    | 33.12      |                             |       | 43,330 |   |   | 33.12 |   |   |
| $40.01—$50.00                          |       |       | 5,100      |                    |       |                                                | 0.8        |                                       |       |                    | 45.19      |                             |       | 5,100 |   |   | 45.19 |   |   |
|                                        |       |       | 8,061,567  |                    |       |                                                | 3.2        |                                       |       |                    | $          | 4.06                             |       |   | 4,642,062 |   |   | $ | 5.07 |   |   |

 

As of December 31, 2006, a total of 10,619,895shares of common stock have been reserved for issuance upon the exercise ofstock options. As of December 31, 2006, a total of 2,558,328 shares ofcommon stock have been reserved for grants of stock options.

During the year ended December 31, 2006, theCompany granted 3,098,301 options with exercise prices equal to the fair marketvalue of the Company’s common stock on the grant date. In connection with theacquisition of Openera, the Company issued 369,175 options with exercise pricesless than fair market value of the Company’s common stock on the grant date(the “Openera Options”). The Openera Options vest 40% at the time ofacquisition and 20% at the 12, 24 and 30 month anniversaries of theacquisition date (February 24, 2006). Openera Options to purchase 147,670shares were vested at the acquisition date. The exercise prices of such optionsranged from $0.01 to $0.03 per option. Options granted during the year endedDecember 31, 2006 had a weighted average grant date fair value of $2.55.

At December 31, 2006, the aggregate intrinsicvalues of options outstanding and options exercisable were $1.0 million and$0.5 million, respectively. The intrinsic value of a stock option is the amountby 

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which the market value ofthe underlying stock exceeds the exercise price of the option. The aggregateintrinsic value of options exercised during the year ended December 31,2006 was $1.7 million.

AtDecember 31, 2006, unrecognized compensation expense related to non-vestedstock options, net of estimated forfeitures, was $2.6 million, which isexpected to be recognized over a weighted average period of 2.9 years.

TheCompany’s non-vested stock option activity for the year ended December 31,2006 was as follows:

| ** **                                    | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|--------------------------------------------|------------|
| Non-vested options  at December 31, 2005 |       | 2,127,391                   |       |                                       | $          | 3.27 |   |   |
| Granted                                       |       | 3,319,806                   |       |                                       | 2.55       |   |   |
| Vested                                        |       | (1,214,064                  | )          |                                       | 3.21       |   |   |
| Forfeited                                     |       | (813,628                    | )          |                                       | 3.33       |   |   |
| Non-vested options at  December 31, 2006 |       | 3,419,505                   |       |                                       | $          | 2.69 |   |   |

 

Asdescribed in Note 4, the Company issued 3,977,518 restricted shares of commonstock in connection with the acquisition of Openera. The shares vest 40% at thetime of acquisition and 20% at the 12, 24 and 30 month anniversaries ofthe acquisition date (February 24, 2006). A total of 1,591,007 sharesvested at the acquisition date. The following table summarizes the activityassociated with the unvested restricted shares of common stock issued inconnection with the Openera acquisition for the year ended December 31,2006:

| ** **                                              | ** ** | **Number of  Shares** | ** ** | **Weighted  Average Issuance  Fair Value** | ** ** |
|---------------------------------------------------------|------------|----------------------------|------------|------------------------------------------------------|------------|
| Non-vested  restricted shares at December 31, 2005 |       | —                     |       |                                                 | $          | — |   |   |
| Issued in  connection with the Openera acquisition      |       | 2,386,511                  |       |                                                 | 3.48       |   |   |
| Vested                                                  |       | —                     |       |                                                 | —     |   |   |
| Forfeited or  cancelled                                 |       | (2,212                     | )          |                                                 | 3.48       |   |   |
| Non-vested restricted  shares at December 31, 2006 |       | 2,384,299                  |       |                                                 | $          | 3.48 |   |   |

 

At December 31, 2006,unrecognized compensation expense, net of estimated forfeitures, related tonon-vested restricted stock was $4.6 million, which is expected to berecognized over a weighted average period of 1.7 years.

**3—Earnings (Loss)per Share**

Thefollowing table provides the basic and diluted income (loss) per sharecomputations:

| ** **                                   | ** ** | **Year Ended December 31,**                        | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | **(In thousands except per share data)** | ** ** |
| Numerator:                                   |       |                                                              |       |   |   |   |   |
| Net income (loss)                            |       | $                                                                 | (15,751    | ) | $ | 4,972 |   | $ | 4,102 |   |
| Denominator:                                 |       |                                                              |       |   |   |   |   |
| Weighted average  basic shares outstanding   |       | 48,467                                                            |       | 47,884 |   | 44,709 |   |
| Dilutive stock  options                      |       | —                                                            |       | 401 |   | 2,185 |   |
| Weighted average diluted shares outstanding  |       | 48,467                                                            |       | 48,285 |   | 46,894 |   |
| Basic and diluted  earnings (loss) per share |       | $                                                                 | (0.33      | ) | $ | 0.10 |   | $ | 0.09 |   |

 

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The number of options thatwere excluded from the calculation of diluted earnings (loss) per common share,as their inclusion would have been anti-dilutive, for the years endedDecember 31, 2006, 2005 and 2004 were 5,869,098, 4,547,354 and 4,294,968,respectively. All of the Company’s outstanding options were anti-dilutive forthe year ended December 31, 2006 due to the net loss position of theCompany. Additional common stock equivalents related to the Company’sConvertible Notes of 315,289 at December 31, 2004 have been excluded fromthe calculation of diluted earnings per common share as their inclusion wouldhave been anti-dilutive. There was no outstanding debt at December 31,2006 and 2005.

**4—Acquisitions**

Effective February 24, 2006, the Company acquiredOpenera Technologies, Inc. a Delaware corporation with operations basedprimarily in Bangalore, India (“Openera”), for a total purchase price of $11.5million, including transaction costs of approximately $0.4 million andliabilities assumed of $2.8 million.

Openera is a provider of mobile application handsetsolutions for converged mobile networks. Openera has developed a set ofapplications aimed at Internet Protocol Multimedia Subsystems (IMS) andpeer-to-peer communications services. These applications include peer-to-peervideo, push-to-talk over cellular, active phonebook, instant message andlocation-based services. Openera was allocated into the Mobile Applications(MA) business unit of the Company.

Inconnection with the acquisition of Openera, the Company issued 3,977,518 sharesof its common stock to both employee and non-employee stockholders of Openera,subject to certain restrictions. The shares vest 40% at the effective date ofthe acquisition and 20% at the 12, 24 and 30 month anniversaries of such date.A total of 1,981,047 shares issued to employees are subject to their continuedemployment over the 30-month period following the effective date of theacquisition, and therefore have been excluded from the purchase price of theacquisition. The fair value of the shares issued was determined based on afive-day average market price of the Company’s common stock for the two daysbefore and ending two days after the acquisition was publicly announced. Thetable below summarizes the allocations of the shares issued:

| ** **                                                     | ** ** | **Shares** | ** ** | **Fair Value**     | ** ** |
|----------------------------------------------------------------|------------|------------|------------|-------------------------|------------|
| ** **                                                     | ** ** | ** ** | ** ** | **(In thousands)** | ** ** |
| Shares issued to  employees                                    |       | 3,301,747  |       |                    | $          | 12,923 |   |   |
| Shares issued to  non-employees                                |       | 675,771    |       |                    | 2,645      |   |   |
| Total shares  issued                                           |       | 3,977,518  |       |                    | $          | 15,568 |   |   |
| Shares issued and  included in the purchase price of Openera   |       | 1,996,471  |       |                    | $          | 7,814 |   |   |
| Shares issued and  excluded from the purchase price of Openera |       | 1,981,047  |       |                    | 7,754      |   |   |
| Total shares issued                                            |       | 3,977,518  |       |                    | $          | 15,568 |   |   |

 

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Inaddition, the Company granted options to purchase 369,175 shares of its commonstock to certain employees of Openera. The options vest 40% at the effectivedate of the acquisition and 20% at the 12, 24 and 30 month anniversaries ofsuch date. Options to purchase 221,505 shares are subject to the employees’continued employment with the Company over the 30-month period followingthe acquisition, and therefore have been excluded from the purchase price ofthe acquisition. The fair value of the options was determined using theBlack-Scholes valuation model. The table below summarizes the allocation of theoptions granted in the purchase price:

| ** **                                                       | ** ** | **Options** | ** ** | **Fair Value**     | ** ** |
|------------------------------------------------------------------|------------|-------------|------------|-------------------------|------------|
| ** **                                                       | ** ** | ** **  | ** ** | **(In thousands)** | ** ** |
| Options granted  and included in the purchase price of Openera   |       | 147,670     |       |                    | $          | 577 |   |   |
| Options granted  and excluded from the purchase price of Openera |       | 221,505     |       |                    | 865        |   |   |
| Total options granted                                            |       | 369,175     |       |                    | $          | 1,442 |   |   |

 

The value of the vested portion of the shares andoptions issued in connection with the acquisition was recorded as part of thepurchase price. The unvested portion is being amortized as compensation expenseratably over the 30-month period following the date of acquisition.

The acquisition was accounted for as a purchasebusiness combination. Accordingly, the results of the operations of Openerawere included with those of the Company for periods subsequent to the date ofacquisition. Pro forma results of operations are not presented as theacquisition of Openera was determined not to be significant to the Company’scondensed consolidated financial statements at the time of the transaction. TheCompany has preliminarily allocated the purchase price based upon the fairvalues of the assets acquired and liabilities assumed on February 24,2006. The allocation of the purchase price is preliminary because finalanalysis of the deferred revenue is not yet complete. The final allocation willbe complete in the first quarter of 2007 when a sales contract is expected tobe amended in order to clarify the obligations the Company assumed in theOpenera acquisition.

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Thefollowing table presents the allocation of the purchase price and the lives ofthe acquired intangible assets.

| ** **                                                  | ** ** | **Amount**              | ** ** | **Estimated Life** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                  | ** ** | **(In thousands)** | ** ** | **(In years)**     | ** ** |
| Consideration  exchanged:                                   |       |                    |       |                    |       |   |   |   |   |
| Fair value of restricted shares issued                      |       |                    | $          | 7,814                   |       |   |   |   |   |   |
| Fair value of stock options issued                          |       |                    | 577        |                    |       |   |   |   |   |
| Transaction costs                                           |       |                    | 361        |                    |       |   |   |   |   |
|                                                        |       |                    | 8,752      |                    |       |   |   |   |   |
| Liabilities  assumed                                        |       |                    | 2,775      |                    |       |   |   |   |   |
| Total purchase  price                                       |       |                    | $11,527    |                    |       |   |   |   |   |
| Less estimated fair value of identifiable assets  acquired: |       |                    |       |                    |       |   |   |   |   |
| Cash and cash equivalents                                   |       |                    | 42         |                    |       |   |   |   |   |
| Accounts receivable                                         |       |                    | 592        |                    |       |   |   |   |   |
| Prepaid expenses and other current assets                   |       |                    | 217        |                    |       |   |   |   |   |
| Fixed assets                                                |       |                    | 198        |                    |       |   |   |   |   |
| Core technology                                             |       |                    | 4,000      |                    |       |   | 1.8—4.8 |   |   |
| Customer relationships                                      |       |                    | 1,000      |                    |       |   | 6.8 |   |   |
| Goodwill                                                    |       |                    | 5,469      |                    |       |   |   |   |   |
| Other assets                                                |       |                    | 9          |                    |       |   |   |   |   |
| Total assets acquired                                       |       |                    | $          | 11,527                  |       |   |   |   |   |   |

 

In connection with theOpenera acquisition, the Company assumed short-term debt of $0.7 million andrepaid the obligation in March 2006. There were no expenses associatedwith the retirement of the debt for the year ended December 31, 2006.

**5—Goodwill andOther Intangible Assets**

Thefollowing table sets forth activity related to goodwill during 2006:

| ** **                          | ** ** | **(In thousands)** | ** ** |
|-------------------------------------|------------|-------------------------|------------|
| Goodwill at  December 31, 2005 |       |                    | $          | — |   |   |
| Goodwill from  purchase of Openera  |       |                    | 5,561      |   |   |
| Additions  (reductions) to goodwill |       |                    | (93        | ) |   |
| Effect of foreign  exchange         |       |                    | 1          |   |   |
| Goodwill at  December 31, 2006 |       |                    | $          | 5,469 |   |   |

 

The Company reduced goodwill subsequent to theacquisition date due to the collection of an account receivable where paymentwas not expected as of the acquisition date. Goodwill is deductible for taxpurposes.

Thecomponents of other intangible assets are as follows as of December 31,2006:

| ** **                | ** ** | **Estimated  Useful Life** | ** **   | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Amount** | ** ** |
|---------------------------|------------|---------------------------------|--------------|-----------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                | ** ** | **(In years)**             | ** **   | ** **                  | ** ** | **(In thousands)**       | ** ** | ** **                    | ** ** |
| Other intangible  assets: |       |                            |         |                        |       |                          |       |                          |       |   |   |   |   |   |   |   |   |
| Core technology           |       |                            | 1.8—4.8 |                        |       |                          | $          | 4,000                         |       |   |   | $ | (1,118 | ) |   |   | $ | 2,882 |   |   |
| Customer  relationships   |       |                            | 6.8          |                        |       |                          | 1,000      |                          |       |   | (100 | ) |   |   | 900 |   |   |
| Other intangible assets   |       |                            |         |                        |       |                          | $          | 5,000                         |       |   |   | $ | (1,218 | ) |   |   | $ | 3,782 |   |   |

 

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Thefollowing table presents amortization expense of the intangible assets for theyear ended December 31, 2006:

| ** **                           | ** ** | **(In thousands)** | ** ** |
|--------------------------------------|------------|-------------------------|------------|
| Cost of revenues                     |       |                    | $          | 1,118 |   |   |
| Selling, general  and administrative |       |                    | 100        |   |   |
|                                 |       |                    | $          | 1,218 |   |   |

 

Therewas no intangible asset amortization for the years ended December 31, 2005and 2004. The following table summarizes the expected remaining amortization ofacquired other intangible assets as of December 31, 2006:

| **Fiscal Year** | ** ** | ** **              | ** ** | **Expected  Amortization  Expense** | ** ** |
|----------------------|------------|-------------------------|------------|-------------------------------------|------------|
| ** **           | ** ** | **(In thousands)** | ** ** |
| 2007                 |       |                    | $          | 1,168                               |       |   |
| 2008                 |       |                    | 1,044      |                                |       |
| 2009                 |       |                    | 778        |                                |       |
| 2010                 |       |                    | 522        |                                |       |
| 2011                 |       |                    | 150        |                                |       |
| Thereafter           |       |                    | 120        |                                |       |
|                 |       |                    | $          | 3,782                               |       |   |

 

At December 31, 2006,the Company’s goodwill of $5.5 million and other intangible assets of$3.8 million were allocated to the Mobile Applications business unit.

**6—Restructuring andOther Related Charges Accruals**

In September, 2006, in order to reduce operatingcosts, the Company eliminated 17 employee positions and closed its engineeringfacility in Red Bank, New Jersey, which resulted in the recording ofrestructuring and other related charges of $1.3 million. These charges consistof $0.8 million of involuntary employee severance related costs, $0.4 millionof lease termination and $0.1 million of fixed asset write-offs.

In November, 2006, in order to further reduceoperating costs, the Company eliminated 40 employee positions, which resultedin the recording of restructuring charges of $2.1 million. These chargesconsist of $1.9 million of involuntary severance related costs.

In December 2006, the Company entered into anagreement to sublease headquarter office space located in Framingham,Massachusetts, which was formerly used as supplementary conference, trainingand corporate office space.The Company exited this facility as of December 31,2006. In 2001 and 2002, the Company recorded restructuring charges related tothe difference between committed lease payments and the estimated subleaserental income for other exited space in this facility. During the fourthquarter of 2006, the Company updated its estimates of the sublease rentalincome based on the signing of the Sublease and the current and expected marketconditions. As a result, the Company recorded additional pre-tax restructuringcosts of approximately $900,000. The total pre-tax restructuring charges thatthe Company recognized in the fourth quarter of fiscal year 2006 related tothese actions were $2.3 million.

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Thefollowing table sets forth activity during the years ended December 31,2004, 2005 and 2006, related to restructuring and other action taken in fiscalyears 2002, 2003 and 2006:

| ** **                                               | ** ** | **Employee  Related**   | ** ** | **Facility  Related** | ** ** | **Fixed Asset  Write-offs** | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|----------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                               | ** ** | **(In thousands)** | ** ** |
| Restructuring  accrual balance at December 31, 2003 |       |                    | $          | 1,515                 |       |                             | $          | 1,692     |       |      | $          | — |   |   | $ | 121 |   | $ | 3,328 |   |
| Cash payments                                            |       |                    | (1,413     | )                     |       | (496                             | )          |      | —     |      |       | (110 | ) | (2,019 | ) |
| Restructuring  accrual balance at December 31, 2004 |       |                    | $          | 102                   |       |                             | $          | 1,196     |       |      | $          | — |   |   | $ | 11 |   | $ | 1,309 |   |
| Cash payments                                            |       |                    | (102       | )                     |       | (280                             | )          |      | —     |      |       | (11 | ) | (393 | ) |
| Restructuring  accrual balance at December 31, 2005 |       |                    | $          | —                |       |                             | $          | 916       |       |      | $          | — |   |   | $ | — |   | $ | 916 |   |
| Restructuring and  other related charges                 |       |                    | 2,653      |                  |       | 2,710                            |       |      | 106        |      |       | — |   | 5,469 |   |
| Cash payments                                            |       |                    | (1,862     | )                     |       | (702                             | )          |      | —     |      |       | — |   | (2,564 | ) |
| Reclassification  of deferred rent                       |       |                    | —     |                  |       | 617                              |       |      | —     |      |       | — |   | 617 |   |
| Write-off of  property and equipment                     |       |                    | —     |                  |       | —                           |       |      | (106       | )         |       | — |   | (106 | ) |
| Restructuring accrual  balance at December 31, 2006 |       |                    | $          | 791                   |       |                             | $          | 3,541     |       |      | $          | — |   |   | $ | — |   | $ | 4,332 |   |

 

The remaining accrualbalance includes employee related charges, which are expected to be settled incash during the first quarter of 2007, and facility related charges, which areexpected to be settled in cash over the next five years.

**7—Business and CreditConcentration**

At December 31, 2006, Ericsson represented 17.2 %of the Company’s outstanding net accounts receivable balance. AtDecember 31, 2005, Lucent Technologies Inc. (“Lucent”) and Ericssonrepresented 26.2 % and 17.0%, respectively, of the Company’s outstanding netaccounts receivable balance.

During 2006, 2005 and2004, Lucent represented 13.2%, 22.6% and 11.7%, respectively, of the Company’stotal revenues.

**8—MarketableSecurities**

Investmentsin marketable securities categorized as available for sale are carried at fairvalue and consist of the following:

| ** **                             | ** ** | **December 31, 2006** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Amortized  Cost**             | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| ** **                             | ** ** | **(In thousands)**         | ** ** |
| Money market fund                      |       |                            | $          | 5,268 |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 5,268 |   |
| Certificate of  deposit                |       |                            | 2,000      |   |   |   | — |   |   |   | — |   |   | 2,000 |   |
| U.S. government  and agency bonds      |       |                            | 12,060     |   |   |   | 3 |   |   |   | — |   |   | 12,063 |   |
|                                   |       |                            | $          | 19,328 |   |   |   | $ | 3 |   |   |   | $ | — |   |   | $ | 19,331 |   |
| Included in cash  and cash equivalents |       |                            | 12,247     |   |   |   | 2 |   |   |   | — |   |   | 12,249 |   |
| Marketable securities                  |       |                            | $          | 7,081 |   |   |   | $ | 1 |   |   |   | $ | — |   |   | $ | 7,082 |   |

 

67

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| ** **                             | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Amortized  Cost**             | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| ** **                             | ** ** | **(In thousands)**         | ** ** |
| Money market  mutual funds             |       |                            | $          | 5,063 |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 5,063 |   |
| U.S. government  and agency bonds      |       |                            | 36,688     |   |   |   | 3 |   |   |   | (15 | ) |   | 36,676 |   |
|                                   |       |                            | $          | 41,751 |   |   |   | $ | 3 |   |   |   | $ | (15 | ) |   | $ | 41,739 |   |
| Included in cash  and cash equivalents |       |                            | 30,734     |   |   |   | 3 |   |   |   | — |   |   | 30,737 |   |
| Marketable securities                  |       |                            | $          | 11,017 |   |   |   | $ | — |   |   |   | $ | (15 | ) |   | $ | 11,002 |   |

 

At December 31, 2006 and 2005, all marketablesecurities were due to mature within one year. Proceeds from maturity ofsecurities for the years ended December 31, 2006, 2005 and 2004 were$28.0 million, $78.4 million and $14.3 million, respectively. There wereno gross realized gains or losses from sale of securities for the years ended December 31,2006, 2005 and 2004.

The Company has madeequity investments in certain privately held entities. The Company accounts forthese investments under the cost method of accounting since the Company doesnot have the ability to exercise significant influence over these entities andthere is not a readily determinable market value for these investments. TheCompany periodically evaluates the carrying value of these investments forother than temporary impairment. The Company did not realize any gains orlosses related to equity investments for the years ended December 31, 2006and 2005. In 2004, the Company realized a gain of $0.1 million associatedwith an equity investment whose carrying value had been reduced to zero inprior years.

**9—Inventories**

| ** **                     | ** ** | **December 31,**   | ** ** |
|--------------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                     | ** ** | **(In thousands)** | ** ** |
| Raw materials                  |       | $                       | 1,474      |   | $ | 490 |   |
| Work in process                |       | 127                     |       | 228 |   |
| Finished goods                 |       | 739                     |       | 658 |   |
| Inventories at  customer sites |       | 1,309                   |       | 1,468 |   |
| Inventory                      |       | $                       | 3,649      |   | $ | 2,844 |   |

 

**10—Property andEquipment**

Propertyand equipment consist of the following:

| ** **                     | ** ** | **December 31,**   | ** ** |
|--------------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                     | ** ** | **(In thousands)** | ** ** |
| Computer  equipment            |       | $                       | 20,735     |   | $ | 19,123 |   |
| Computer software              |       | 10,653                  |       | 10,405 |   |
| Furniture and  fixtures        |       | 2,954                   |       | 2,652 |   |
| Machinery and  equipment       |       | 2,456                   |       | 2,211 |   |
| Leasehold  improvements        |       | 6,250                   |       | 5,547 |   |
| Software in  process           |       | —                  |       | 509 |   |
| Property and  equipment, gross |       | 43,048                  |       | 40,447 |   |
| Less accumulated  depreciation |       | (36,423                 | )          | (33,912 | ) |
| Property and equipment,  net   |       | $                       | 6,625      |   | 6,535 |   |
|                                |            |                         |            |  |  |  |  |

 

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Depreciation andamortization expense related to property and equipment was $2.8 million,$2.8 million and $3.6 million for the years ended December 31, 2006,2005 and 2004, respectively.

**11—Income Taxes**

Thecomponents of income tax expense (benefit) consist of the following:

| ** **                                                   | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                   | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**                    | ** ** |
| Current income  tax expense (benefit):                       |       |                                       |       |   |   |   |   |
| Federal                                                      |       | $                                          | —     |   | $ | — |   | $ | — |   |
| State                                                        |       | 22                                         |       | 20 |   | — |   |
| Foreign                                                      |       | 216                                        |       | 348 |   | 66 |   |
|                                                         |       | 238                                        |       | 368 |   | 66 |   |
| Deferred income  tax expense (benefit):                      |       |                                       |       |   |   |   |   |
| Federal                                                      |       | —                                     |       | — |   | — |   |
| State                                                        |       | —                                     |       | — |   | — |   |
| Foreign                                                      |       | —                                     |       | — |   | — |   |
| Total income tax provision                                   |       | $                                          | 238        |   | $ | 368 |   | $ | 66 |   |
| Deferred tax  assets (liabilities) consist of the following: |       |                                       |       |   |   |   |   |
| Net operating loss carryforwards                             |       | $                                          | 75,227     |   | $ | 71,411 |   | $ | 75,103 |   |
| Research and development tax credit carryforwards            |       | 9,772                                      |       | 9,330 |   | 5,340 |   |
| Capital loss carryforwards                                   |       | 2,966                                      |       | 2,885 |   | 2,657 |   |
| Inventories                                                  |       | 512                                        |       | 505 |   | 514 |   |
| Fixed assets                                                 |       | 854                                        |       | 845 |   | — |   |
| Intangible assets                                            |       | 52,886                                     |       | 60,522 |   | 67,136 |   |
| Accrued expenses                                             |       | 1,942                                      |       | 400 |   | 362 |   |
| Other                                                        |       | 292                                        |       | 299 |   | 320 |   |
| Acquisition costs                                            |       | 2,121                                      |       | 1,681 |   | 2,684 |   |
|                                                         |       | $                                          | 146,572    |   | $ | 147,878 |   | $ | 154,116 |   |
| Acquired  intangible assets                                  |       | (1,419                                     | )          | — |   | — |   |
| Fixed assets                                                 |       | (644                                       | )          | (592 | ) | (635 | ) |
| Less: valuation  allowance:                                  |       | (144,509                                   | )          | (147,286 | ) | (153,481 | ) |
| Net deferred taxes                                           |       | $                                          | —     |   | $ | — |   | $ | — |   |

 

For U.S. federal income tax purposes, the Company hasnet operating loss carryforwards available to reduce taxable income ofapproximately $176.2 million at December 31, 2006. Of this amount$21.1 million relates to deductions from the exercise of stock options of whichapproximately $1.5 million is tracked separately and not included in theCompany’s deferred tax asset (in accordance with FAS 123R). The futurebenefit from these deductions will be recorded as a credit to additionalpaid-in capital when realized. Under the provisions of the Internal RevenueCode Section 382, certain changes in the Company’s ownership structure mayresult in a limitation on the amount of net operating loss carryforwards andresearch and development tax credit carryforwards that may be used in futureyears. These carryforwards will begin to expire in 2007 if unutilized. TheCompany also had foreign net operating loss carryforwards of approximately$28.4 million expire. As of December 31, 2006, the Company hadapproximately $6.4 million of tax credits in the U.S. that are composed offederal research and development credits and state and local credits. Thesecredits begin to expire in 2007 if unutilized. In 

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addition, the Company hasCanadian investment tax credits of approximately $4.4 million. These creditsbegin to expire in 2014.

The Company has established valuation allowancesagainst net deferred tax assets, in certain jurisdictions including the UnitedStates, because it believes that it is more likely than not that the tax assetsin those jurisdictions will not be realized prior to their expiration. TheCompany will continue to assess the valuation allowance and to the extent it isdetermined that such allowance is no longer required, the tax benefit of the remainingnet deferred tax assets would be recognized in the future.

UnitedStates income taxes were not provided on permanently reinvested undistributedearnings for certain non-U.S. subsidiaries of approximately $3.2 million. TheCompany will reinvest these earnings indefinitely outside the United States inits operations.

| ** **                                                     | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Computed expected  tax expense at U.S. federal statutory rate  |       | 34.0                                       | %          | 34.0 | % | 34.0 | % |
| State income  taxes, net of U.S. federal tax expense (benefit) |       | (12.7                                      | )          | (19.1 | ) | (30.2 | ) |
| Tax rate and tax  law differential of foreign operations       |       | 8.3                                        |       | (22.6 | ) | (38.1 | ) |
| U.S. federal  research and development credits                 |       | —                                     |       | 5.6 |   | (12.0 | ) |
| Foreign tax  deductions                                        |       | (0.4                                       | )          | (7.0 | ) | (5.7 | ) |
| Other tax credits                                              |       | 7.2                                        |       | (11.2 | ) | (7.6 | ) |
| Change in  valuation allowance                                 |       | (23.9                                      | )          | 26.8 |   | 51.2 |   |
| Foreign loss  disallowance                                     |       | (12.9                                      | )          | — |   | — |   |
| Nondeductible  expenses                                        |       | (1.0                                       | )          | (0.3 | ) | 4.4 |   |
| Other                                                          |       | (0.1                                       | )          | 0.7 |   | 5.6 |   |
| Effective tax rate                                             |       | (1.5                                       | )%         | 6.9 | % | 1.6 | % |

 

Thedomestic and foreign components of income (loss) before income taxes were:

| ** ** | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** ** | ** ** | **(In thousands)**                    | ** ** |
| Domestic   |       | $                                          | (13,376    | ) | $ | 8,106 |   | $ | 5,741 |   |
| Foreign    |       | (2,137                                     | )          | (2,766 | ) | (1,573 | ) |
|       |       | $                                          | (15,513    | ) | $ | 5,340 |   | $ | 4,168 |   |

 

**12—Accrued Expensesand Other Liabilities**

Componentsof accrued expenses and other liabilities consist of the following:

| ** **                                 | ** ** | **December 31,**   | ** ** |
|--------------------------------------------|------------|-------------------------|------------|
| ** **                                 | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| Accrued  compensation and related expenses |       | $                       | 2,664      |   | $ | 5,153 |   |
| Income taxes  payable                      |       | 309                     |       | 556 |   |
| Deferred rent                              |       | 754                     |       | 1,927 |   |
| Other liabilities                          |       | 2,225                   |       | 1,683 |   |
|                                       |       | $                       | 5,952      |   | $ | 9,319 |   |

 

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**13—Indebtedness**

**Convertible Notes**

Effective October 11, 2000, the Company issued$175.0 million of convertible subordinated notes (the “Notes”). The Noteswere convertible into shares of the Company’s common stock at any time after90 days following the last day of the original issuance of the notes andbefore the close of business on the business day immediately preceding thematurity date, at a conversion price of $63.125 per share, subject to specifiedadjustments. The Notes bore interest at a rate of 5% per year which was payablesemiannually on April 15 and October 15 of each year, commencing on April 15,2001. The Notes, which were unsecured obligations of the Company, matured on October 15,2005 and were repaid in full. The Company was subject to certain covenantsunder the related indenture. During 2005, the Company was in compliance withsuch covenants. In 2000, the Company incurred debt issuance costs aggregating$5.7 million, which were deferred and amortized using the effectiveinterest rate method as a component of interest expense over the term of theNotes.

For the years ended December 31,2005 and 2004, the Company paid $20.9 million and $38.5 million,respectively, to extinguish $19.9 million and $37.8 million, respectively,of face value of the Notes. As a result, in the years ended December 31,2005 and 2004, the Company wrote off $0.1 million and $0.9 million,respectively, of unamortized debt issuance costs and recorded a related loss of$0.3 million in other income and expense on the income statement in 2004. In2005, the Company did not incur any related losses or gains associated with therepayment of its debt.

**Short-Term Debt**

In connection with theOpenera acquisition, the Company assumed short-term debt of $0.7 million andrepaid the obligation in March 2006.

**14—Profit SharingPlans**

The Company hasestablished a 401(k) cash or deferred profit sharing plan covering alleligible full-time employees of the Company. Contributionsto the 401(k) plan are made by the participants to their individualaccounts through payroll withholding. Additionally, the plan provides for theCompany to make profit sharing contributions to the plan in amounts at thediscretion of management. The Company currently matches contributions each payperiod at 50% of the employee’s contributions up to 6% of employee’scompensation, not to exceed the federal limit of $15,000 per calendar year. Theemployer contribution for the years ended December 31, 2006, 2005 and 2004was $0.7 million, $0.6 million and $0.5 million,respectively.

**15—Equity**

**Common StockOffering**

On March 17, 2004,the Company completed the sale of 9,200,000 shares of common stock through anunderwritten public offering at $5.75 per share. The net proceeds of the offeringwere $49.5 million. In April 2004, the Company invested the netproceeds of this offering in interest-bearing, investment-grade securities.

**Stock RepurchaseProgram**

During 2001, the Company’s Board of Directors approveda stock repurchase program authorizing the Company to repurchase up to2,500,000 shares of its outstanding common stock for an aggregate purchaseprice not to exceed $5.0 million. As of December 31, 2006, theCompany had repurchased 915,000 shares for an aggregate purchase price of $4.7 million.The Company made no repurchases during 2004 or 2005.

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In July, 2006, the Company’sBoard of Directors authorized the repurchase of up to $20,000,000 of theCompany’s common stock by March 31, 2007 (the “July Program”). The July Programsuperseded the stock repurchase program previously authorized by the Board ofDirectors in April, 2006, for the repurchase of up to 1,100,000 shares of theCompany’s common stock by December 31, 2006 (the “April Program”).All repurchases under the July Program and the April Program weremade in open-market transactions. As of December 31, 2006 the Company hadrepurchased 7,613,773 shares of its outstanding common stock for an aggregatepurchase price of $22.5 million, which included $0.2 million of broker fees.

**Other StockRepurchases**

In May, 2006, the Company repurchased 275,212 sharesof the Company’s common stock in a private negotiated transaction for $0.8million from an entity that had acquired those shares at fair value inconnection with the Company’s acquisition of Openera. This transaction was notpursuant to the publicly announced stock repurchase program described above.

During 2006, the Companyissued 338,733 treasury shares in conjunction with the exercise of stockoptions and issuance of stock under the employee stock purchase plan.

**Preferred Stock**

Under its restatedcertificate of incorporation the Company has authorized 3,000,000 shares ofpreferred stock, par value $0.05 per share. As of December 31, 2006 and2005, the Company had no shares of preferred stock issued and outstanding. Inconnection with its stockholder rights plan, 15,000 of such shares have beendesignated “Series A Junior Preferred Stock”, none of which are issued andoutstanding. The Company’s board of directors has the authority to issuepreferred stock in one or more classes or series and to fix the rights,preferences, privileges and restrictions thereof, including dividend rights,dividend rates, conversion rights, exchange rights, voting rights, terms ofredemption, redemption prices, liquidation preferences and the number of sharesconstituting any class or series or the designation of such class or series,without any further action by the stockholders.

**Stockholders RightsPlan**

The Company’s Board ofDirectors adopted a Stockholders Rights Plan (“the Rights Plan”) on December 23,1998, under which a dividend of one Common Stock Purchase Right (each a “Right”)was declared for and attached to each outstanding share of the Company’s CommonStock, $0.01 par value per share (“Common Stock”) held by stockholders ofrecord as of January 4, 1999. The Rights Plan was amended on April 22,1999. Shares of Common Stock issued after December 23, 1998 also containsuch Rights. The Rights become exercisable following the tenth day after aperson or group (a) acquires beneficial ownership of 15% or more of theCompany’s outstanding shares of Common Stock; or (b) announces a tender ofexchange offer or exchange offer, the consummation of which would result inownership by a person or group of 30% or more of the Company’s Common Stock (an“Acquiring Person”). The plan entitles Right holders to purchase a one-onethousandth of a share of the Company’s Series A Junior Preferred Stock for$60 (the “Purchase Price”). Under some circumstances, the Plan entitles Rightholders (other than an Acquiring Person) to purchase Common Stock having avalue equal to two times the Purchase Price of the Right for the PurchasePrice, once the Rights become exercisable. Under some circumstances, the Boardof Directors of the Company may exchange the Rights at an exchange rate of oneShare of Common Stock per Right. Rights are redeemable at the Company’s optionfor $0.01 per Right at any time after the acquisition of 15% or more of theCompany’s Common Stock. As of December 31, 2006, none of the Rightsare exercisable. The Rights expire on the earliest of (a) December 23,2008, (b) exchange or redemption of the Rights as described above, or (c) consummationof a merger or consolidation or sale of assets resulting in termination of theRights.

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**16—Commitments andContingencies**

**Leases**

The Company leases its current corporate headquartersoffice facilities under non-cancelable leases extending to May 31, 2012.The Company occupies other facilities, which serve as sales offices throughoutNorth America, Europe and Asia, under leases that expire within one to fouryears. Rental expenses under all operating lease agreements during the yearsended December 31, 2006, 2005 and 2004 were approximately$3.1 million, $4.5 million and $5.2 million, respectively.

At December 31,2006, commitments under operating leases for minimum future payments consist ofthe following, of which $3.5 million of these future operating leasepayments have been accrued as part of the Company’s restructuring charges andwill not impact the Company’s results of operations in future periods:

| **Year ending December 31,** | ** ** | ** ** | ** ** | **(In thousands)** | ** ** |
|---------------------------------------------|------------|------------|------------|-------------------------|------------|
| 2007                                        |       |       | $          | 4,745                   |       |   |
| 2008                                        |       |       | 3,921      |                    |       |
| 2009                                        |       |       | 3,513      |                    |       |
| 2010                                        |       |       | 3,178      |                    |       |
| 2011                                        |       |       | 3,229      |                    |       |
| Thereafter                                  |       |       | 2,207      |                    |       |
|                                        |       |       | $          | 20,793                  |       |   |

 

The amounts presented inthe table above do not include future sublease income of $2.8 million whichwill be earned in the next five years.

**Litigation**

The Company is party tovarious legal proceedings incidental to its business. However, the Company hasno material legal proceedings currently pending.

**PurchaseCommitments**

The Company’s agreementwith Plexus requires that Plexus turn its NMS-related inventory eight times peryear. If this condition is not met, the Company must purchase enough materialto bring Plexus up to eight turns. This is assessed on a quarterly basis.During 2006, 2005 and 2004, the Company had met the eight turn goal.. As such,the Company does not have any contractual obligations related to a commitmentwith Plexus at December 31, 2006. The Company can only ascribe value tosuch commitment when the Company has not met the condition as determined at aspecific point in time, based on future facts and circumstances. The Companyhas no such arrangements with its other third-party manufacturers.

**Guarantees**

The Company’s products are generally sold with a 18-24 monthwarranty period. Parts and labor are covered under the terms of the warrantyagreement. The warranty provision is based on historical experience by product,configuration and geographic region. Current warranty provisions are related tothe past one and a half to two years’ revenues and warranty consumption isassociated with current and prior year’s revenues.

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Changesin the aggregate warranty liability were as follows:

| ** **               | ** ** | **December 31,**   | ** ** |
|--------------------------|------------|-------------------------|------------|
| ** **               | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **               | ** ** | **(In thousands)** | ** ** |
| Beginning balance        |       | $                       | 370        |   | $ | 342 |   |
| Provisions for  warranty |       | 44                      |       | 196 |   |
| Expenditures             |       | (129                    | )          | (168 | ) |
| Ending balance           |       | $                       | 285        |   | $ | 370 |   |

 

**Indemnification**

The Company enters into indemnification agreementswith certain of its customers in its ordinary course of business. Pursuant tothese agreements the Company agrees that in the event its products infringeupon any proprietary right of a third party, the Company will indemnify itscustomer against any loss, expense or liability from any damages that may beawarded against the customer. As described in FASB Statement of Position No. FIN45-1, indemnifications related to infringement on intellectual property,such as the ones the Company has entered into, are considered guarantees andtherefore within the scope of FIN 45. These arrangements have been recorded ata fair value of zero as there have been no claims brought against the Companyunder such arrangements in the past five years.

The Company provides anindemnification, to the extent permitted by law, to its officers, directors,employees and agents for liabilities arising from certain events or occurrenceswhile the officer, director, employee, or agent, is or was serving, at theCompany’s request in such capacity. As a matter of practice, the Companymaintains directors and officer liability insurance coverage.

**17—Segment andGeographic Information**

The Company has organized the Company’s productmanagement and development activities around specific target markets. TheCompany’s Platform Solutions (PS) business unit focuses on systems buildingblocks or enabling technology solutions that are targeted toward communicationssolution providers such as network equipment providers, application developersand systems integrators. The PS business unit also manages the Company’s voicequality systems (VQS) product lines, as the Company increasingly sees thesetechnologies being delivered to customers as systems building blocks orenabling technologies. The Mobile Applications (MA) business unit is aimed atdelivering mobile solutions and related services to mobile operators and the NIbusiness unit is focused on solutions targeted at the radio access network(RAN) portion of mobile operators’ infrastructure. Corporate and unallocatedcosts include corporate marketing and general and administrative functions ofthe Company and all charges and expenses related to amortization of intangibleassets and restructuring actions.

As of December 31, 2006 the Company hadoperations established in 11 countries outside the United States and itsproducts are sold throughout the world. The Company is exposed to the risk ofchanges in social, political and economic conditions inherent in foreignoperations and the Company’s results of operations and the value of its foreignassets are affected by fluctuations in foreign currency exchange rates.

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Thefollowing table presents the Company’s revenues, operating loss and long-livedassets by business unit and geographic region. Revenues by geographic regionare presented by attributing revenues from external customers on the basis ofwhere products are sold. For the years ended December 31, 2006, 2005 and2004 the income (loss) from operations for the Mobile Applications business unitand “Americas” includes all acquisition related amortization expenses.

| ** **                                 | ** ** | **For the year ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                                      | ** ** |
| Revenues                                   |       |                                                         |       |   |   |   |   |
| Platform Solutions                         |       | $                                                            | 87,077     |   | $ | 101,790 |   | $ | 100,830 |   |
| Mobile Applications                        |       | 8,897                                                        |       | 6,769 |   | 369 |   |
| Network Infrastructure                     |       | 3,632                                                        |       | 915 |   | 313 |   |
| Total revenues                             |       | $                                                            | 99,606     |   | $ | 109,474 |   | $ | 101,512 |   |
| Operating income (loss)                    |       |                                                         |       |   |   |   |   |
| Platform Solutions                         |       | $                                                            | 31,557     |   | $ | 37,232 |   | $ | 32,267 |   |
| Mobile Applications                        |       | (13,522                                                      | )          | (8,303 | ) | (9,438 | ) |
| Network Infrastructure                     |       | (8,927                                                       | )          | (11,243 | ) | (9,663 | ) |
| Corporate and unallocated costs            |       | (25,926                                                      | )          | (13,701 | ) | (7,366 | ) |
| Total operating income (loss)              |       | $                                                            | (16,818    | ) | $ | 3,985 |   | $ | 5,800 |   |
| Long-lived assets                          |       |                                                         |       |   |   |   |   |
| Platform Solutions                         |       | $                                                            | 882        |   | $ | 1,211 |   | $ | 1,223 |   |
| Mobile Applications                        |       | 9,691                                                        |       | 256 |   | 12 |   |
| Network Infrastructure                     |       | 379                                                          |       | 648 |   | 657 |   |
| Corporate and unallocated assets           |       | 4,923                                                        |       | 4,420 |   | 4,255 |   |
| Total long-lived assets                    |       | $                                                            | 15,875     |   | $ | 6,535 |   | $ | 6,147 |   |
| Revenues by geographic area                |       |                                                         |       |   |   |   |   |
| Americas                                   |       | $                                                            | 40,634     |   | $ | 41,156 |   | $ | 54,464 |   |
| Europe, Middle East and Africa             |       | 28,773                                                       |       | 24,295 |   | 20,446 |   |
| Asia                                       |       | 30,199                                                       |       | 44,023 |   | 26,602 |   |
| Total revenues                             |       | $                                                            | 99,606     |   | $ | 109,474 |   | $ | 101,512 |   |
| Operating income (loss) by geographic area |       |                                                         |       |   |   |   |   |
| Americas                                   |       | $                                                            | (18,809    | ) | $ | (20,989 | ) | $ | (20,477 | ) |
| Europe, Middle East and Africa             |       | 1,237                                                        |       | (510 | ) | 9,055 |   |
| Asia                                       |       | 754                                                          |       | 25,484 |   | 17,222 |   |
| Total operating income (loss)              |       | $                                                            | (16,818    | ) | $ | 3,985 |   | $ | 5,800 |   |
| Long-lived assets by geographic area       |       |                                                         |       |   |   |   |   |
| Americas                                   |       | $                                                            | 5,585      |   | $ | 6,317 |   | $ | 6,018 |   |
| Europe, Middle East and Africa             |       | 709                                                          |       | 79 |   | 110 |   |
| Asia                                       |       | 331                                                          |       | 139 |   | 19 |   |
| Total long-lived  assets                   |       | $                                                            | 6,625      |   | $ | 6,535 |   | $ | 6,147 |   |

 

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**18—Quarterly Information (Unaudited)**

| ** **                                              | ** ** | **Quarter Ended**                                                | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Dec. 31,  2006**                                               | ** ** | **Sept. 30,  2006** | ** ** | **June 30,  2006** | ** ** | **Mar. 31,  2006** | ** ** | **Dec. 31,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **June 30,  2005** | ** ** | **Mar. 31,  2005** | ** ** |
| ** **                                              | ** ** | **(Unaudited)**                                                       | ** ** |
| ** **                                              | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenues                                                |       |                                                                  | $          | 21,685 |   |   |   | $ | 20,783 |   |   |   | $ | 26,440 |   |   |   | $ | 30,698 |   |   |   | $ | 31,684 |   |   |   | $ | 30,271 |   |   |   | $ | 24,919 |   |   |   | $ | 22,600 |   |   |
| Cost of revenues                                        |       |                                                                  | 8,511      |   |   |   | 8,358 |   |   |   | 9,335 |   |   |   | 9,841 |   |   |   | 10,425 |   |   |   | 10,083 |   |   |   | 9,394 |   |   |   | 9,518 |   |   |
| Gross profit                                            |       |                                                                  | 13,174     |   |   |   | 12,425 |   |   |   | 17,105 |   |   |   | 20,857 |   |   |   | 21,259 |   |   |   | 20,188 |   |   |   | 15,525 |   |   |   | 13,082 |   |   |
| Operating expenses:                                     |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative                     |       |                                                                  | 11,779     |   |   |   | 11,124 |   |   |   | 13,114 |   |   |   | 12,833 |   |   |   | 11,565 |   |   |   | 10,078 |   |   |   | 9,344 |   |   |   | 8,942 |   |   |
| Research and development                                |       |                                                                  | 6,023      |   |   |   | 6,317 |   |   |   | 6,799 |   |   |   | 6,559 |   |   |   | 6,788 |   |   |   | 6,837 |   |   |   | 6,323 |   |   |   | 6,192 |   |   |
| Restructuring and other related charges                 |       |                                                                  | 4,161      |   |   |   | 1,308 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total operating expenses                                |       |                                                                  | 21,963     |   |   |   | 18,749 |   |   |   | 19,913 |   |   |   | 19,392 |   |   |   | 18,353 |   |   |   | 16,915 |   |   |   | 15,667 |   |   |   | 15,134 |   |   |
| Operating income (loss)                                 |       |                                                                  | (8,789     | ) |   |   | (6,324 | ) |   |   | (2,808 | ) |   |   | 1,465 |   |   |   | 2,906 |   |   |   | 3,273 |   |   |   | (142 | ) |   |   | (2,052 | ) |   |
| Other income (expense), net                             |       |                                                                  | 25         |   |   |   | 336 |   |   |   | 313 |   |   |   | 270 |   |   |   | 603 |   |   |   | 117 |   |   |   | 485 |   |   |   | 150 |   |   |
| Income (loss) before income taxes                       |       |                                                                  | (8,764     | ) |   |   | (5,988 | ) |   |   | (2,495 | ) |   |   | 1,735 |   |   |   | 3,509 |   |   |   | 3,390 |   |   |   | 343 |   |   |   | (1,902 | ) |   |
| Income tax expense (benefit)                            |       |                                                                  | 171        |   |   |   | (113 | ) |   |   | 130 |   |   |   | 51 |   |   |   | (180 | ) |   |   | 63 |   |   |   | 285 |   |   |   | 200 |   |   |
| Net income (loss)                                       |       |                                                                  | (8,935     | ) |   |   | (5,875 | ) |   |   | $ | (2,625 | ) |   |   | 1,684 |   |   |   | 3,689 |   |   |   | 3,327 |   |   |   | $ | 58 |   |   |   | (2,102 | ) |   |
| Basic and diluted  net earnings (loss) per common share |       |                                                                  | $          | (0.21 | ) |   |   | $ | (0.12 | ) |   |   | $ | (0.05 | ) |   |   | $ | 0.03 |   |   |   | $ | 0.08 |   |   |   | $ | 0.07 |   |   |   | $ | 0.00 |   |   |   | $ | (0.04 | ) |   |

 

 

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**VALUATION ANDQUALIFYING ACCOUNTS**

***Schedule II(In thousands)***

**Allowance for Doubtful Accounts**

| ** ** | ** ** | **Balance at  Beginning of Year** | ** ** | **Additions** | ** ** | **Deductions(1)** | ** ** | **Balance at  End of Year** | ** ** |
|------------|------------|--------------------------------------------------|------------|---------------|------------|-------------------|------------|--------------------------------------------|------------|
| 12/31/06   |       |                                             | $          | 794           |       |              |       | $                                          | 64         |   |   |   | $ | (29 | ) |   |   | $ | 829 |   |   |
| 12/31/05   |       |                                             | $          | 1,004         |       |              |       | $                                          | 23         |   |   |   | $ | (233 | ) |   |   | $ | 794 |   |   |
| 12/31/04   |       |                                             | $          | 995           |       |              |       | $                                          | 151        |   |   |   | $ | (142 | ) |   |   | $ | 1,004 |   |   |

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(1)          Amountsinclude write-offs of accounts receivable deemed to be uncollectible.

**Deferred Tax Asset Valuation Allowance**

| ** ** | ** ** | **Balance at  Beginning of Year** | ** ** | **Additions** | ** ** | **Deductions** | ** ** | **Balance at  End of Year** | ** ** |
|------------|------------|--------------------------------------------------|------------|---------------|------------|----------------|------------|--------------------------------------------|------------|
| 12/31/06   |       |                                             | $          | (147,286      | )          |           |       | $                                          | —     |   |   |   | $ | 2,777 |   |   | $ | (144,509 | ) |
| 12/31/05   |       |                                             | $          | (153,481      | )          |           |       | $                                          | —     |   |   |   | $ | 6,195 |   |   | $ | (147,286 | ) |
| 12/31/04   |       |                                             | $          | (148,442      | )          |           |       | $                                          | (5,039     | ) |   |   | $ | — |   |   | $ | (153,481 | ) |

 

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

**A.**                Evaluationof Disclosure Controls and Procedures

Based on the evaluation ofour disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the“Exchange Act”)) required by Exchange Act Rules 13a-15(b) or15d-15(b), our Chief Executive Officer and our Chief Financial Officerhave concluded that as of December 31, 2006, the end of the period coveredby this report, our disclosure controls and procedures were effective.

**B.     Management’s Report on Internal ControlOver Financial Reporting**

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting. Our internalcontrol system was designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples. 

In accordance with SEC responses to frequently askedquestions regarding the evaluation of internal controls of entities subject toa business combination (SEC Release No. 34-47986), our evaluation excludesOpenera Technologies, Inc. (“Openera”), of which we acquired all issued andoutstanding capital stock on February 24, 2006, from our assessment of internalcontrols over financial reporting as of December 31, 2006. Openera is awholly-owned subsidiary whose total assets and total revenues represent 2percent and less than 1 percent, respectively, of the related consolidatedfinancial statement amounts as of and for the year ended December 31, 2006. 

Our internal control over financial reporting includesthose policies and procedures that (i) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of our assets; (ii) provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that our receiptsand expenditures are being made only in accordance with authorizations of ourmanagement and directors, and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof our assets that could have a material effect on the financial statements. 

Because of inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements. Also, projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate. 

Our management assessed the effectiveness of ourinternal control over financial reporting as of December 31, 2006. In makingthis assessment, management used the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) in *Internal Control—Integrated Framework*. Based on ourassessment, management concluded that, as of December 31, 2006, our internalcontrol over financial reporting was effective based on those criteria. 

Our management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2006 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report which appears herein. 

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**C.**               AttestationReport of the Independent Registered Public Accounting Firm

See Report on Page 42.

**D.**              Changesin Internal Control Over Financial Reporting

There were no changes inour internal control over financial reporting, as such term is defined inExchange Act Rules 13a-15(f) and 15d-15(f), that occurredduring the fiscal quarter ended December 31, 2006 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

**ITEM 9B.**       OTHERINFORMATION

None.

**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT

Thefollowing table lists our directors as of December 31, 2006:

| **Name**                    | ** ** | ** ** | ** ** | **Age** | ** ** | **Position**                                                  | ** ** |
|-----------------------------|------------|------------|------------|---------|------------|---------------------------------------------------------------|------------|
| Robert P.  Schechter        |       |       | 58         |    |       | Chairman of the Board, President and Chief  Executive Officer |       |
| William E.  Foster(2)       |       |       | 62         |    |       | Director                                                      |       |
| Ofer Gneezy(1)              |       |       | 55         |    |       | Director                                                      |       |
| W. Frank King,  Ph.D.(1)(3) |       |       | 67         |    |       | Director                                                      |       |
| Pamela D. A.  Reeve(1)(3)   |       |       | 57         |    |       | Director                                                      |       |
| Ronald W.  White(2)         |       |       | 66         |    |       | Director                                                      |       |

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(1)          Member of the AuditCommittee.

(2)          Member of theCompensation Committee.

(3)          Member of the NominatingCommittee.

Each member of our board of directors is elected atthe annual meeting of stockholders and holds office for three years and untilhis or her successor is elected and qualified.

*Robert P. Schechter*hasserved as the Company’s President and Chief Executive Officer since 1995 and asChairman of the Board since 1996. From 1987 to 1994, Mr. Schechter heldvarious senior executive positions with Lotus Development Corporation, and from1980 to 1987 he was a partner of Coopers and Lybrand LLP. Mr. Schechter isalso a director of MapInfo Corporation, a developer of location-based softwareservices and solutions, Moldflow Corporation, a provider of software solutionsfor optimizing the design and manufacture of plastic products, UnicaCorporation, a developer of Enterprise Marketing Management Software solutionsand Avici Systems, Inc., a provider of carrier-class routing solutions forthe Internet.

*William E. Foster***hasserved as a director of our Company since 2000. Mr. Foster has been, since1997, a private investor. In 1980, Mr. Foster co-founded Stratus Computer, Inc.,a manufacturer of fault-tolerant computer systems and served as its Chairmanand Chief Executive Officer until 1997. Prior to 1980, Mr. Foster spent14 years in the computer industry, serving as Vice President of Softwarefor Data General Corporation and in management and technical positions withHewlett Packard Company. Mr. Foster is a director of several privatelyheld companies.

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*Ofer Gneezy***hasserved as a director of our Company since 2000. Mr. Gneezy was aco-founder, and has been, since 1996, President, Chief Executive Officer and adirector of iBasis, Inc., a provider of Internet-based communicationsservices for international carriers. From 1994 to 1996, Mr. Gneezy servedas President of Acuity Imaging, Inc., a multinational company focused onthe industrial automation industry. From 1980 to 1994, he was an executive ofAutomatix Inc. (a predecessor to Acuity Imaging), an industrial automationcompany, most recently serving as its President and Chief Executive Officer.

*W. Frank King, Ph.D.***hasserved as a director of our Company since 1997. Dr. King has been, since1998, a private investor. From 1992 to 1998, he was Chief Executive Officer anda director of PSW Technologies, Inc., a provider of software services.From 1988 to 1992, Dr. King was a Senior Vice President of Development ofLotus Development Corporation and for the previous 19 years served in variouspositions with IBM Corporation, including his last position as Vice PresidentDevelopment for the entry system division. He is a director of eOnCommunications Corporation., a provider of telecommunications applications,Concero Inc., formerly known as PSW Technologies, Inc., and iBasis, Inc.,a provider of Internet-based communications services

*Pamela D. A. Reeve***hasserved as a director of our Company since 1997. Ms. Reeve has served asthe CEO of The Boston Wireless Initiative, building a wholesale wirelessnetwork in the city of Boston since 2006. From 1993 to 2004 she served as ChiefExecutive Officer and a director and, from 1989 to 1993, as President, ChiefOperating Officer and a director of Lightbridge, Inc., a provider ofproducts and services which enable wireless telecommunications carriers toimprove customer acquisition and retention processes, and the leading internetpayment gateway. From 1978 to 1989, she was with The Boston Consulting Group, amanagement consulting firm. Ms. Reeve is a director of American TowerCorporation, a provider of infrastructure facilities and services to thewireless, Internet and broadcasting industries.

*Ronald W. White***hasserved as a director of our Company since 1988. Mr. White, has been, since2002, a consultant and private investor. From 1997 until 2002, he was a partnerof Argo Global Capital, a venture capital firm. From 1983 until 2002, he was apartner of Advanced Technology Development Fund, also a venture capital firm. Mr. Whiteis a director of AirNet Communications, a provider of infrastructure solutionsfor commercial GSM customers and government agencies.

Thefollowing table lists our executive officers as of December 31, 2006:

| **Name**             | ** ** | ** ** | ** ** | **Age** | ** ** | **Position**                                                                             | ** ** |
|----------------------|------------|------------|------------|---------|------------|------------------------------------------------------------------------------------------|------------|
| Robert P.  Schechter |       |       | 58         |    |       | Chairman of the Board, President and Chief Executive  Officer                            |       |
| Herbert Shumway      |       |       | 59         |    |       | Treasurer, Senior Vice President of Finance and  Operations and  Chief Financial Officer |       |
| Joel Hughes          |       |       | 42         |    |       | Vice President and General Manager                                                       |       |
| Daniel Daly          |       |       | 50         |    |       | Vice President and General Manager                                                       |       |

 

*Robert P. Schechter*hasserved as the Company’s President and Chief Executive Officer since 1995 and asChairman of the Board since 1996. From 1987 to 1994, Mr. Schechter heldvarious senior executive positions with Lotus Development Corporation, and from1980 to 1987 he was a partner of Coopers and Lybrand LLP. Mr. Schechter isalso a director of MapInfo Corporation, a developer of location-based softwareservices and solutions, Moldflow Corporation, a provider of software solutionsfor optimizing the design and manufacture of plastic products, Unica Corporation,a developer of Enterprise Marketing Management Software solutions and AviciSystems, Inc., a provider of carrier-class routing solutions for theInternet.

*Herbert Shumway* has served as theCompany’s Treasurer, Senior Vice President of Finance and Operations and ChiefFinancial Officer since 2005. Prior to that, Mr. Shumway served as theCompany’s 

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Vice President,Operations, which included Corporate Quality, Technical Services, andInformation Technology from 2000 to 2005. Mr. Shumway has over 20 yearsexperience in the high-tech industry, including executive positions inoperations and business development with Compaq Computer and Digital EquipmentCorporation.

*Joel Hughes* joined our Company in2006 as a Vice President and General Manager, as part of the acquisition of IMShandset applications provider Openera Technologies Inc., where he was Presidentand Chief Executive Officer since 2004. Mr. Hughes founded SnowShore Networks,a pioneering IP media server company, and served as its President and ChiefExecutive Officer from 2000 to 2004 when it was acquired by Brooktrout.

*Daniel Daly* has served as theCompany’s Vice President and General Manager responsible for NMS’s AccessGateproduct offerings since 2005. Prior to that, Mr. Daly served as the Company’sVice President of Business Development, Network Infrastructure from 2004 to2005 and as the Company’s Vice President of Engineering from 1995 to 2004.Prior to joining NMS, Mr. Daly held various engineering and managementpositions for Pitney Bowes and Wang Laboratories, Inc.

The information appearingunder the captions “Board of Directors and Committee Meetings” and “Section 16Reporting” of our Proxy Statement for our Annual Meeting of Stockholders to beheld May 2, 2007 is incorporated herein by reference.

**ITEM 11.**         EXECUTIVECOMPENSATION

The information appearingunder the captions  “Board of Directorsand Committee Meetings,” “Compensation Committee Report,” “ExecutiveCompensation,” and “Compensation Committee Interlocks and Insider Participation”of our Proxy Statement for our Annual Meeting of Stockholders to be held May 2,2007 is incorporated herein by reference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The information appearingunder the caption “Stock Ownership of Directors, Executive Officers andPrincipal Stockholders” of our Proxy Statement for our Annual Meeting ofStockholders to be held May 2, 2007 is incorporated herein by reference.

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**EQUITY COMPENSATIONPLANS**

The following tablesets forth information about the shares of the Company’s Common Stock that maybe issued upon the exercise of options and other rights under all of itsexisting equity compensation plans as of December 31, 2006.

| **Plan Category**                         | ** ** | ** ** | ** ** | **Number of Shares  to be issued upon  Exercise of  Outstanding  Options** | ** ** | **Weighted Average  Per Share  Exercise Price  of Outstanding  Options** | ** ** | **Number of Shares  Remaining Available for  Future Issuance  under Equity  Compensation Plans  (excluding shares  reflected in  first column)** | ** ** |
|------------------------------------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Plans approved by stockholders                 |       |       |       |                                                                                                     |       |                                                                                         |       |                                                                                                                                                                                               |       |   |   |   |   |
| 1993  Stock Option Plan                        |       |       | 384,000    |                                                                                                     |       |                                                                                         | $          | 6.24                                                                                                                                                                                               |       |   |   | — |   |   |
| 1993  Non-Employee Directors Stock Option Plan |       |       | 105,000    |                                                                                                     |       |                                                                                         | $          | 14.96                                                                                                                                                                                              |       |   |   | — |   |   |
| 2000  Equity Incentive Plan                    |       |       | 5,375,423  |                                                                                                     | ** ** | ** **                                                                                   | $          | 3.52                                                                                                                                                                                               |       |   |   | 1,813,888 |   |   |
| 2005 Openera Incentive Plan                    |       |       | 397,510    |                                                                                                     |       |                                                                                         | $          | 1.69                                                                                                                                                                                               |       |   |   | 4,985 |   |   |
| 2006 India Incentive Plan                      |       |       | 73,900     |                                                                                                     |       |                                                                                         | $          | 1.94                                                                                                                                                                                               |       |   |   | 525,550 |   |   |
| 2003 Employee Stock Purchase Plan              |       |       | 6,335,833  |                                                                                                     |       |                                                                                         | $          | 3.74                                                                                                                                                                                               |       |   |   | 233,458 |   |   |
| Plans not  approved by stockholders            |       |       |       |                                                                                                     |       |                                                                                         |       |                                                                                                                                                                                               |       |   |   |   |   |
| 1995 Non-Statutory Stock Option Plan (1)       |       |       | 1,725,734  |                                                                                                     |       |                                                                                         | $          | 5.14                                                                                                                                                                                               |       |   |   | — |   |   |
|                                           |       |       | 1,725,734  |                                                                                                     |       |                                                                                         | $          | 5.14                                                                                                                                                                                               |       |   |   |   |   |   |
| ** **                                     |       |       | 8,061,567  |                                                                                                     |       |                                                                                         | $          | 4.04                                                                                                                                                                                               |       |   |   | 2,577,881 |   |   |

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(1)          The1995 Non-Statutory Stock Option Plan expired in October 2005.  There are no shares remaining for futureissuances.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

**Theinformation appearing under the captions “Board of Directors and CommitteeMeetings” and “Related Person Transactions” of our Proxy Statement of ourAnnual Meeting of Stockholders to be held May 2, 2007 is incorporatedherein by reference.**

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

The information appearingunder the caption “Information Regarding Independent Registered PublicAccounting Firm” is incorporated herein by reference to our Proxy Statement forour Annual Meeting of Stockholders to be held May 2, 2007.

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**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

**(a)**          (1) FINANCIALSTATEMENTS

*Thefollowing are included in Part II of this report:*

Report of Independent Registered Public AccountingFirm

Consolidated Balance Sheets as of December 31, 2006and 2005

Consolidated Statements of Operations for the YearsEnded December 31, 2006, 2005 and 2004.

Consolidated Statements of Stockholders’ Equity forthe Years Ended December 31, 2004, 2005 and 2006

Consolidated Statements of Cash Flows for the YearsEnded December 31, 2006, 2005 and 2004.

Notesto the Consolidated Financial Statements.

**(a)**          (2) FINANCIALSTATEMENT SCHEDULES

*Thefollowing are included on the indicated pages of this report:*
|                                                     | ** ** | Page No. | ** ** |
|-----------------------------------------------------|------------|---------------|------------|
| Schedule  II—Valuation and Qualifying Accounts |       |          | 77         |   |   |
|                                                     |            |               |            |  |  |

 

Schedulesnot listed above are omitted because they are not required or because therequired information is given in the Consolidated Financial Statements or Notesthereto.

**(a)**          (3) EXHIBITS

The Exhibit Index,appearing after the signature page, is incorporated herein by reference.

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, as amended, the Registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.
|        | NMS COMMUNICATIONS CORPORATION |
|--------|--------------------------------|
|   | By:                            | /s/ ROBERT P. SCHECHTER |
|   |                           | Robert P.  Schechter |
|   |                           | President, Chief  Executive Officer and  Chairman of the Board |
|   | By:                            | /s/ HERBERT SHUMWAY |
|   |                           | Herbert Shumway |
|   |                           | Senior Vice  President of Finance, Chief Financial  Officer and Treasurer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant in thecapacities and on the dates indicated.
|                                      | **Name** | ** **                                                        | ** ** | ** **          | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** | ** ** |
|--------------------------------------|----------|-------------------------------------------------------------------|------------|---------------------|-----------|------------|------------|------------|----------|------------|------------|
| /s/  ROBERT  P. SCHECHTER  |     | President, Chief  Executive Officer and                           |       | March 16, 2007 |      |
| Robert  P. Schechter                 |     | Chairman of the Board of  Directors (Principal Executive Officer) |       |                |      |
| /s/  HERBERT  SHUMWAY      |     | Senior Vice  President of Finance, Chief                          |       | March 16, 2007 |      |
| Herbert  Shumway                     |     | Financial Officer and  Treasurer (Principal Financial Officer)    |       |                |      |
| /s/  WILLIAM  E. FOSTER    |     | Director                                                          |       | March 16, 2007 |      |
| William  E. Foster                   |     |                                                              |       |                |      |
| /s/  OFER  GNEEZY          |     | Director                                                          |       | March 16, 2007 |      |
| Ofer  Gneezy                         |     |                                                              |       |                |      |
| /s/  W.  FRANK KING, PH.D. |     | Director                                                          |       | March 16, 2007 |      |
| W.  Frank King, Ph.D.                |     |                                                              |       |                |      |
| /s/  PAMELA  D. A. REEVE   |     | Director                                                          |       | March 16, 2007 |      |
| Pamela  D. A. Reeve                  |     |                                                              |       |                |      |
| /s/  RONALD  W. WHITE      |     | Director                                                          |       | March 16, 2007 |      |
| Ronald W. White                      |     |                                                              |       |                |      |

 

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***Exhibit Index***

The Company will furnishto 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 TheCompany may require payment of a reasonable fee not to exceed our cost offurnishing such exhibit.
|             | **No.** | ** **                                                                                                                                                                                                                                                             | ** ** | **Title** | ** ** | ** ** |
|-------------|---------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|------------|
|   2.6* |    | Merger Agreement dated  as of May 18, 2000 by and among the Registrant, NMS 3758982 Canada Inc.,  Michel Laurence, Michel Brule, Stephane Tremblay, and Investissements Novacap  Inc. (filed with the Registrant’s Form 8-K dated July 20,  2000). |
|   2.7* |    | Asset Purchase  Agreement dated October 15, 2001 by and between the Registrant and  Lucent Technologies Inc. (filed with the Registrant’s Form 10-Q  for the quarter ended September 30, 2001).                                                    |
|   2.8* |    | Agreement and  Plan of Merger dated as of February 13, 2006 by and among the  Registrant, Openera Technologies, Inc. and the other parties thereto  (filed with the Registrant’s Form 8-K dated February 17,  2006).                          |
|   3.1* |    | Fourth Restated  Certificate of Incorporation of the Registrant (filed with the Registrant’s  Form 10-K for the year ended December 31, 1995).                                                                                                          |
|   3.2* |    | By-laws of  Registrant, as amended (filed with the Registrant’s registration statement on  Form S-1 (#33-72596)).                                                                                                                                            |
|   3.4* |    | Certificate of  Amendment to Fourth Restated Certificate of Incorporation of the Registrant  (filed with the Registrant’s Form 8-K dated May 4, 2001).                                                                                                  |
|   4.1* |    | Specimen  Certificate for the Common Stock (filed with the Registrant’s registration  statement on Form S-1 (#33-72596)).                                                                                                                                    |
| 10.1#*      |    | Employment  agreement dated as of June 28, 2005 by and between the Registrant and  Herbert Shumway (filed with the Registrant’s Form 8-K dated  July 5, 2005).                                                                                     |
| 10.2#*      |    | Employment  agreement dated as of June 28, 2005 by and between the Registrant and  Paul J. Deeley, Jr. (filed with the Registrant’s Form 8-K  dated July 5, 2005).                                                                            |
| 10.3#*      |    | Severance  Protection Agreement dated as of May 17, 2005 by and between the  Registrant and Herbert Shumway (filed with the Registrant’s Form 8-K  dated May 25, 2005).                                                                            |
| 10.12#*     |    | 1993 Stock Option  Plan, as amended and restated (filed with the Registrant’s registration  statement on Form S-8 (333-40940)).                                                                                                                              |
| 10.13#*     |    | 2003 Employee  Stock Purchase Plan, as amended and restated (filed with the Registrant’s  registration statement on Form S-8 (333-40940) on  June 19, 2003).                                                                                            |
| 10.14#*     |    | 1993 Non-Employee  Directors Stock Option Plan, as amended and restated (filed with the  Registrant’s registration statement on Form S-8 (333-  40940)).                                                                                                     |
| 10.15#      |    | Openera  Technologies, Inc., 2005 Equity Incentive Plan.                                                                                                                                                                                                          |
| 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 the 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, as amended and restated (filed with the Registrant’s registration  statement on Form S-8 (333-40940), as amended).                                                                                                              |

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| 10.24#* |   | Form of  Non-Statutory Stock Option Agreement (filed with the Registrant’s  Form 10-Q for the quarter ended March 31, 2005).                                                                                                                                                                      |
|---------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.27*  |   | Form of  Incentive Stock Option Agreement (filed with the Registrant’s Form 10-Q  for the quarter ended March 31, 2005).                                                                                                                                                                          |
| 10.27*  |   | Lease Agreement  between the Registrant and National Development of New England, LLC dated  April 1, 2000 (filed with the Registrant’s Form 10-Q for the  quarter ended March 31, 2001).                                                                                                          |
| 10.29*  |   | Supply Agreement,  dated November 30, 2001, between the Registrant and Lucent  Technologies, Inc. (filed with the Registrant’s Form 8-K  dated December 14, 2001).                                                                                                                           |
| 10.30*  |   | Intellectual  Property Agreement, dated November 30, 2001, by and among the Registrant  and Lucent Technologies, Inc. and Lucent Technologies GRL Corporation  relating to the sale of Lucent’s Voice Quality Business (filed with the  Registrant’s Form 8-K dated December 14, 2001). |
| 10.31*  |   | Form of NMS  Communications Corporation Non-Qualified Stock Option Agreement for Openera  Technologies, Inc. 2005 Equity Incentive Plan (filed with the  Registrant’s Form 10-Q for the quarter ended June 30, 2006).                                                                        |
| 10.32#* |   | Offer Letter from  NMS Communications Corporation to Todd Donahue, entered into as of  January 12, 2007 (filed with the Registrant’s Form 8-K dated  January 12, 2007).                                                                                                                           |
| 10.33   |   | Sublease dated  December 28, 2006 between NMS Communications Corporation and Genzyme  Corporation                                                                                                                                                                                                                |
| 10.34   |   | 2006 Management  Bonus Program.                                                                                                                                                                                                                                                                                       |
| 21.1    |   | Subsidiaries of  the Company.                                                                                                                                                                                                                                                                                         |
| 23.1    |   | Consent of Independent  Registered Public Accounting Firm.                                                                                                                                                                                                                                                            |
| 31.1    |   | Chief Executive  Officer certification required by Rule 13a-14(a) (17 CFR  240.13a-14(a)) or Rule 15d-14(a) (17 CFR 240.15d-14(a)).                                                                                                                                                               |
| 31.2    |   | Chief Financial  Officer certification required by Rule 13a-14(a) (17 CFR  240.13a-14(a)) or Rule 15d-14(a) (17 CFR 240.15d-14(a)).                                                                                                                                                               |
| 32.1    |   | Chief Executive  Officer certification pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                           |
| 32.2    |   | Chief Financial Officer  certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                           |

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*                    Previouslyfiled with the registration statement or report indicated.

#                 Managementcontract or compensatory plan or arrangement.

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