**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**     |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| **For the fiscal year ended December 31, 2005**                                                                                                                                                 |
| **OR**                                                                                                                                                                                                    |
| **o**                                                                                                                                                                                                     | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| **For the transition period from                              to** |

 

**Commission filenumber:  0-23282**

**NMS COMMUNICATIONS CORPORATION**

(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:**None

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

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 statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

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                     Acceleratedfiler x                     Non-acceleratedfiler 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, 2005, the aggregate market value of the registrant’s common stockheld by non-affiliates of the registrant was $137.1 million based on theclosing sale price as reported on the National Association of Securities Dealers AutomatedQuotation System Global Market System.

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

| Class                                    | ** ** | **Outstanding at  March 13, 2006** |
|------------------------------------------|------------|-----------------------------------------|
| Common Stock,  $0.01 par value per share |       | 52,443,824 shares                       |

 

**DOCUMENTS INCORPORATED BY REFERENCE**

Portionsof the registrant’s Proxy Statement  onForm DEF 14-A relating to the 2005 Annual Meeting of Stockholders of theregistrant are incorporated 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,Mobile Place, MyCaller, Openera, Open Access, PacketMedia, Sonata*and *Video Access* are trademarks; StudioSound and Alliance Generation (AG) are registered trademarks of the registrant;and NMS is a trade name of the registrant. All other brand names or trademarksappearing in this Form 10-K are the property of their respectiveholders.

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 providerof technologies and solutions that enable new mobile and IP (Internet Protocol)voice, data and video applications and improve the performance and quality ofwireless networks. Our customers are network equipment manufacturers, systemintegrators and fixed-line and mobile telecommunications operators.Telecommunications operators use our products to improve customer acquisitionand retention, diversify revenue streams and reduce operating costs and capitalexpenditures. Network equipment and application providers use our products tohelp deploy leading technology solutions for their telecom operator andenterprise customers in a timely and cost-effective manner. We sell ourproducts worldwide through our direct sales force as well as through channeland system integrator partners. Our customers and partners include leadingtelecommunications operators and network equipment and application providerssuch as Vodafone, 3 Italy, MTN, Movilenet, NTT DoCoMo, Ericsson, LogicaCMG,Alcatel, Comverse, Avaya, Lucent Technologies, Huawei and Cisco.

**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 in mobileapplications and services and related infrastructure. Nonetheless, theseopportunities are not without challenges for market participants.

*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.* Changing industry regulations areminimizing previous barriers to customer migration between telecommunicationsoperators, while customer acquisition costs are still 

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relatively high.Operators, particularly in the wireless market, are under increasing pressureto reduce customer churn by providing high quality voice services as well as awide range of other services and functionality, such as access to Internetcontent and video communications.

·       *Diversifying revenue streams.* Intense competition hascompromised operators’ ability to compete on price, further highlighting theneed for high quality service and new and differentiated premium serviceofferings. Additionally, operators are seeking to expand margins and improveoperating performance by increasing the average revenue per customer throughpremium, value-added services that can be deployed rapidly andcost-effectively.

·       *Improving network quality and performance.* As wireless telecommunications operatorscontinue adding users and applications, overall network traffic is increasing.In this highly competitive industry, operators must respond to traffic growthwith investments in network quality, coverage and capacity to avoid degradationin service standards. Wireless operators are aggressively upgrading theirnetworks to next-generation infrastructures, including 2.5G, a standard whichadds data (such as Internet access and text messaging) to the current wirelessinfrastructure, and gradually migrating to 3G, a new standard forbandwidth-intensive data services. Similarly, wireline operators are seeking tocost-effectively upgrade their networks using IP technologies, in order toconnect traditional telephone networks with packet networks.

*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 andservices to telecommunications operators and enterprises. These offeringsinclude interactive voice response systems, automatic speech recognition, mediaservices, conferencing, unified communications, multimedia messaging, videocommunications, and content-based entertainment applications like ringtones andringback tones. These offerings enable telecommunications operators to rapidlydeploy premium services for their customers.

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.* Outsourcing certaindevelopment activities allows these providers to focus their time and resourceson their own core competencies, which include systems design, integration andapplication development.

·       *Accessing leading technologies.* In order to help theircustomers gain a competitive advantage, network equipment and applicationproviders need access to enabling technologies and platforms, which incorporatesystems building blocks and application programming interfaces (APIs) thatallow them to develop and/or operate their own applications and services.

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**Our Solutions**

Our offeringsaddress a wide range of our customers’ needs as they seek to develop and deployenhanced voice and data services and applications, and improve the quality andefficiency of communications networks. We believe that our offerings provide oneor more of the following benefits to our customers:

*Speedtime to market for network equipment and application providers.***Network equipment and applicationproviders leverage our offerings to provide lower cost, higher qualitytelecommunications systems more quickly to meet the demands of their serviceprovider and enterprise customers. Our offerings are designed for flexibilityin various development and network environments, utilizing open interfaces andindustry standards. We believe that with our offerings, our network equipmentand application provider customers are able to reduce product lifecycle costs,increase competitive value and remain focused on their core competencies andtechnologies.

*Enablecost-effective and timely deployment of communications applications andservices.* Our system building block offerings providea comprehensive set of enabling technologies for developing and deployingnext-generation applications.

*Enable cutting edge mobileservices such as ringback tones.***We deliver an end to end solution thatintegrates with existing operator networks and delivers music content and asubscriber profile and preference capability used by service providers forrevenue producing services such as ringback tones.

*Improvenetwork service quality.***Our voice quality offerings leverage our technicalexpertise in electrical echo cancellation, acoustic echo control, noisereduction, adaptive level control and noise level compensation for bothwireless and wireline deployments, thus allowing operators to provide improvedquality of service. These products are designed to provide better priceperformance and higher capacity relative to other alternatives and are designedto integrate with all major telecommunications switch vendors.

*Enablerapid growth in subscribers and reduce network infrastructure expenditures.***Our radio access network wirelessbackhaul optimizer allows mobile operators to save operating expenses byreducing voice and data traffic (backhaul) expenses between cell sites and theoperators’ switching sites while enabling accelerated deployment of futureservices and infrastructure, including enhanced data global system mobilecommunications (GSM) environment (EDGE) and universal mobile telecommunicationssystem (UMTS). Our wireless backhaul optimizer uses aggregation and bandwidthreduction techniques to provide up to 2:1 bandwidth savings in the radio accessnetwork of GSM networks.

*Provide flexible,interoperable, scalable and low cost of ownership solutions.***Our products are designed to providemaximum flexibility in designing and upgrading applications, by utilizing openinterfaces, industry standards and network flexibility for public switchedtelephone network (PSTN), signaling system 7 (SS7) and internet protocol(IP) networks. Our products are also highly scalable and can address needsranging from a handful of users to millions of subscribers. Additionally, oursystems and systems building blocks leverage mass-market components and customsilicon, with the objective of price/performance leadership. Our products havelower acquisition costs, are space-efficient and consume minimal power,resulting in low cost of ownership.

**Products and Services**

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, and improve thequality and efficiency of communications networks. Our products include systembuilding blocks, a service delivery system for personalized mobileentertainment applications and community-based mobile applications, voicequality systems and a wireless backhaul optimizer. We are organized into threebusiness 

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units, designed tooptimize our development resources and provide the greatest possible market andcustomer focus: Platform Solutions (PS), Mobile Applications (MA), previouslyreferred to as Network Solutions (NS) and Network Infrastructure (NI). During2005, we moved our voice quality products into our PS group because weincreasingly see our voice quality technologies being delivered to the marketas an embedded solution.

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 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. We believe this new set of applications complementsour existing application offerings in these growing market segments.

*Platform Solutions*

Our Platform Solutions team provides enablingtechnology and system-level products that allow our network equipment andapplication provider customers to develop and deploy next-generation voice,data, and video applications and services. The team also provides carrier-gradevoice quality and echo cancellation systems that allow both wireless andwireline telecommunications operators to bring superior voice quality to theirnetworks.

*OpenAccess.***Ourcomprehensive offering of systems building blocks, called *Open Access*, is composed of hardware andsoftware elements. The hardware elements consist principally of printed circuitboards that are used in computer systems or subsystems. The software elementsconsist primarily of media processing and switching functions, as well as APIsand a complete application development environment.

Our *Open Access*products are standards-based, IP-enabled, comply with the emerging IMSstandards and are used to develop and deploy next-generation voice, video anddata applications and services such as IP conferencing, speech activatedservices, music applications, and mobile video. Our *Open Access* products also offer a broad range of networkinterfaces, including analog and digital PSTN, IP and asynchronous transportmode (ATM), and associated protocol support, including channel associated(tone) signaling, integrated services digital network (ISDN), Signaling System7 (SS7), and Session Initiation Protocol (SIP) for Internet Protocol (IP)networks, providing interoperability with most legacy and next-generationnetworks and services around the world. These products are deployed in over 90countries in enhanced communications services, network infrastructure andenterprise 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 will include speech, mobile video, conferencing, SS7signaling, fixed-mobile convergence, and text and multimedia messaging. TheVision servers are designed to be ready to deploy in a wide range ofapplications, including network announcements, messaging, prepaid cardprocessing, conferencing, self-service, voice portals, call centers, IP andmobile Centrex, video chat, and more.

*VoiceQuality Systems.*Our Voice Quality Systems(“VQS”) products, which were built on pioneering innovations that originated atBell Labs, include our patented Studio Sound software, which creates animproved listening environment for all parties in a wireless telephoneconversation and is statistically proven to increase customer ratings onoverall voice quality. Our voice quality products are available as astand-alone system with multiple network interfaces or as embedded technologyon blades (high-

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availability carrier-gradecircuit boards), modules and chips. These products incorporate electrical echocancellation and acoustic echo control technology to reduce or eliminate theecho inherent in long distance, wireless and voice over IP (VoIP) networks.Utilizing our custom technology and patented voice quality software, we areable to provide a high density solution that dramatically improves the qualityof voice conversations through noise reduction, automatic gain control, noisecompression and dynamic speech restoration. Our voice quality systemsincorporate monitoring and measurement tools that give telecommunicationsoperators the ability to observe and analyze the performance of their networkvia direct interaction with our voice quality systems. Our voice qualityproducts have been deployed in the networks of over 100 leading wireless andwireline telecommunications operators worldwide.

Our Voice Quality Systems products include thefollowing:

·       *Studio Sound**®.* A comprehensive suite of voice qualitycapabilities for wireless communications incorporated into our *Mercury* and VM1000 products. Our patented *Studio Sound* software creates an improvedlistening environment for all parties in a wireless telephone conversation andis statistically proven to increase customer ratings on overall voice quality.

·       *Mercury and Mercury 14K.* An echo cancellation system thatremoves electrical and acoustic echo, incorporates our *Studio Sound* features, and supportsvarious protocol interfaces in a single package with transmixing capabilities. *Mercury 14K*, the latest version of theproduct, is highly scalable, accommodating up to 14,112 equivalent DS0/E0channels per shelf.

·       *VM 1000.* A compact mezzanine card (CMC) that packages 1024channels of echo cancellation, *Studio Sound*capabilities and network analysis functionality on an industry standard CMCoptimized for power and performance. The VM 1000 encompasses the broadest setof features and capabilities in the market.

·       *e256 Processor Chip.* A custom processor that provideshigh-density echo cancellation with automatic gain control. The processor isdesigned for suppliers of voice-based components or systems to implementon-board echo cancellation.

*Mobile Applications*

*MyCaller.*Launched in 2003 in collaboration with our content provider and systemsintegration partners, *MyCaller*allows mobile subscribers to select original recordings of popular or othercommercial music, sounds and voices for callers to hear in place of theconventional ringback (“ring, ring”) tone until the call is answered. *MyCaller* runs on an open, scalable,ready-to-deploy service delivery system that makes it possible for mobileoperators worldwide to deploy multiple market-specific content-based serviceson the same system.

*Mobile Place.*A single framework that combines multiple applications with a powerful,complete subscriber and content management system (CCRM). Building on the *MyCaller* offering, the *Mobile Place CCRM* enables rapid, targetedrollout and management of new services and content to provide an easy, cohesiveand satisfying user experience. Our CCRM works with operators’ existingapplications or applications from other vendors, and the CCRM can leverageservice delivery platforms from a variety of suppliers.

*Network Infrastructure*

*AccessGate.*First launched in 2003, *AccessGate*is a wireless backhaul optimization system that utilizes patent-pendingtechnology designed to improve the efficiency of wireless networks. Ourtechnology allows our mobile operator customers to carry up to twice as muchvoice and data traffic over backhaul connections in GSM networks, therebyreducing their backhaul expenses without compromising voice or data quality andfreeing up capacity for the delivery of new services.

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*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 division multipleaccess (TDMA), code division multiple access (CDMA) and/or enhanced data GSMenvironment (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.

·       Simplesoftware upgrades currently in development that will allow our customers toutilize AccessGate in both traditional TDM-based backhaul networks andnext-generation IP and ATM-based backhaul networks.

*NMS Services*

We offer a completerange of technical and operational support and training services to support ourcustomers throughout the product lifecycle including planning and design,evaluation, development, deployment and maintenance. Our service offerings spanbasic customer service and support to advanced architecture and system designbased on the needs of our customers. Our services include the following:

·       *Technical and Operational Support Services.* For our systemsbuilding block hardware and software products, we provide a complete range ofdeveloper support and maintenance service offerings. Our OEM and developercustomers may choose the type and level of services they require, from optionsspanning basic telephone support to premium deployment service agreements. Wealso provide a complete portfolio of services for our system-level andapplication products, from initial system configuration and site survey toinstallation and acceptance testing. We provide engineering and installation aswell as ongoing system support, program management, return materialauthorization for replacement of defective material and problem escalationservices.

·       *Training Services.* We provide professionally developedtechnical training curriculum for our *OpenAccess* and Voice Quality Systems products, based on self-containedmodules that are created in a standard format with learning objectives,exercises and tests.

**Growth Strategy**

We aim to be aleading provider of high value telecom solutions, with our primary focus onmobility and next generation services. Our strategies for achieving thisobjective 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.

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**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 22.6% of our 2005 revenues. Revenues from customersbased outside North America were 47% in both 2003 and 2004 and 65% in 2005. AtDecember 31, 2004 and 2005, we do not have a significant backlog ofunfilled orders. Further information relating to our revenues and long-livedassets by geographic area is set forth in Note 16 “Segment and GeographicInformation” to the consolidated financial statements included in this AnnualReport on Form 10-K. The tables below set forth a representative list ofour customers and channel partners:

| **Telecommunications Operators**                                                                                     | ** ** | **Network Equipment Providers**                                                                                                          |
|----------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|
| Celtel  Hutchison Telecom  Movilenet  NTT Communications  NTT DoCoMo  Nextel Partners  Rogers  SFR Cegetel  Vodafone |       | Alcatel  Avaya  Cisco Systems  Comverse  Ericsson  General Dynamics  Huawei                                                              |   | Lucent Technologies  Motorola  NEC  Raytheon  Siemens |
| **Channel Partners**                                                                                                 | ** ** | **Application Providers**                                                                                                                |
| Avnet  Beijing Linkhead  Channel Access Cyberpower  Hagemeyer HCOM  Integrys  Logica CMG  Nekotec                    |       | Eckoh Technologies  Edify  European Computer Telecommunications  Interactive Media  Inter-Tel  Microsoft  SER Solutions  SigValue  VAPPS |

 

**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 30 telecommunications operators and 20 networkequipment and application providers. As of December 31, 2005, our salesand marketing organization consisted of 103 employees in 19 offices worldwide,including 44 in North America, 19 in Europe and 23 in Asia. Historically, ourdirect sales force has been focused on selling systems building blocks offeredby our Platform Solutions business to network equipment and applicationproviders. Over the past two years, we have evolved to selling more complexsystem-level products to telecommunications operators and large networkequipment providers. At the same time, we have recruited additional channelpartners to expand the reach and improve coverage for our systems buildingblocks products and to enhance geographic coverage for our mobile applicationsofferings and wireless backhaul optimization products. In addition toperforming sales and some level of marketing support, these channel partnersprovide all or some of the following: pre- and post-sales support, systemsintegration, fulfillment and credit services. For 2005, 39% of worldwide totalcompany revenues were generated by direct sales, with 61% coming throughchannel partners.

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Our marketing strategyconsists of three primary methods to increase awareness and create demand forour offerings. Our public relations efforts are focused on communicationsindustry-related and general business media relationships, which increasegeneral awareness of our business and products, and on industry analysts whocan act as independent references and provide opinions on our technologies.With our direct marketing effort, we target specific audiences with a varietyof promotional materials consisting of mostly web-based communications. We alsoparticipate in selected industry trade shows around the world.

**Manufacturing**

We utilize third-party contract manufacturing partnersto assemble all of our systems building blocks and other product offerings.Through a supply agreement, we outsource the manufacturing and orderfulfillment of all printed circuit board products and subassemblies to PlexusCorp., a provider of advanced electronics design, testing and manufacturingservices. Teradyne Corporation, a leading provider of advanced interconnectionsystems, manufactures our wire frame equipment.

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 a singlesupplier, Agere Systems Inc. Although we believe we could develop othersources for each of these custom devices, the process could take severalmonths. The manufacturing processes for our products are designed to comply withFederal Communications Commission (FCC), Canadian Standards Association (CSA)and Underwriters Laboratories (UL) safety requirements and to IPC-610standards of assembly workmanship. Additionally, we maintain a formalproduct-specific structure for all required international regulatory andcompliance testing. Consistent with our commitment to provide the highestquality products and services to our customers, in 2002 and 2005 we receivedISO 9001:2000 certification. This certification includes all design and developmentactivities. In 2005, we also received ISO 14001 certification.

**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 and developmentactivities are primarily based on the business units described above. During2003, 2004 and 2005, we spent $30.3 million, $23.9 million, and $26.2 million,or 35%, 24% and 24%, respectively, of our revenue on research and development.Our increase in spending over the past two years is primarily due to anincrease in headcount. As of December 31, 2005, our current productdevelopment is conducted by 132 employees located at our headquarters inFramingham, Massachusetts, and at our offices in Red Bank, New Jersey,Schaumburg, Illinois, St.-Hubert, Quebec and Herzlyya, Israel.

**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. We hold 25 issued patents. In addition, we have filed four patentapplications relating to our AccessGate technology, which, we believe, will beof strategic importance to our business if issued. We distribute our softwareproducts under license agreements, which grant customers a non-exclusivelicense to use the software and contain certain terms and conditionsprohibiting its unauthorized reproduction or transfer. We enter into confidentialityagreements with our suppliers and customers when we disclose proprietaryinformation to them. In addition, we enter into confidentiality agreements andassignment of 

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invention agreements withour employees and consultants. Despite these precautions, unauthorized thirdparties may copy aspects of our products or obtain information that we regardas proprietary. We believe that our products and technology do not infringe onany 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 competitive differentiatorsin these markets include product quality and functionality, ease-of-use,integration capabilities, price performance, cost of ownership, speed ofdeployment and installation and technical support and service. Current thirdparty competitors for our product areas include:

*Platform Solutions:*

*Open Access and Vision Family*—AudioCodes Ltd.,Intel Corporation (through its Networking and Communications Division), ExcelSwitching, Corporation, Convedia and Hewlett Packard (Open Talk Software)

*VoiceQuality Systems*—Ditech Communications Corporation and Tellabs, Inc.

*Mobile Applications:*

*MyCaller and MobilePlace*—Comverseand Widerthan.

*Network Infrastructure:*

*AccessGate—*Celtro,Verso Technologies, Inc., Memotec, and Cisco

We believe that the keycompetitive differentiators in all these markets include product quality andfunctionality, ease-of-use, integration capabilities, price performance, costof ownership, speed of deployment and installation and technical support andservice.

**Employees**

As of December 31,2005, we had 344 full-time employees, consisting of 73 in sales, 30 inmarketing and business development, 132 in research and development, 25 inservices, 23 in operations and 61 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.

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**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, Annual Reportson Form 10-K, Quarterly Reports on Form 10-Q and CurrentReports on Form 8-K, and amendments to these reports, as soon asreasonably practicable after we electronically file such material with, orfurnish such material to, the United States Securities and Exchange Commission(SEC). Our SEC filings are also available over the Internet at the SEC’swebsite at www.sec.gov. You may also read and copy any document we file byvisiting 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 and Section 21Eof the Securities Exchange Act of 1934. You can identify these forward-lookingstatements by our use of the words “believes,” “anticipates,” “plans,” “expects,”“may,” “will,” “would,” “intends,” “estimates,” “predicts,” “potential,” “continue”and similar expressions, whether in the negative or affirmative. We cannotguarantee that we actually will achieve these plans, intentions andexpectations disclosed in the forward-looking statements we make. Factors thatcould cause or contribute to such differences include, but are not limited to,those discussed in Item 1A. “Risk Factors” below, as well as other risksand uncertainties referenced in this Form 10-K. We do not assume anyobligations to update any of the forward-looking statements after the date ofthis Form 10-K to conform these statements 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.

**Wehave experienced modest profitability in 2005 and 2004 after experiencingoperating losses in several prior years. We are not assured of continuedprofitability.**

We have experienced modestprofitability in 2005 and 2004. We experienced operating losses in three of thefour preceding fiscal years. The past operating losses have adversely affectedour working capital, total assets and stockholders’ equity. Our operating planhas established a cost structure that, based on expected revenue, will continueto contribute to our profitability. If revenues do not increase in accordancewith our current expectations, or if expenses are greater than we anticipate,we may experience losses again. Losses could force us to curtail ouroperations.

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**Ouroperating results fluctuate and are difficult to predict, which could cause ourstock 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.

**Thetelecommunications industry is experiencing a modest turnaround from theslowdown of the preceding three years, but a reversal of this trend couldimpact our ability to achieve anticipated revenue levels.**

In 2005, thetelecommunications industry experienced a modest turnaround. In the severalyears prior to 2005, the telecommunications industry experienced a severeslowdown characterized by economic uncertainty and substantial curtailment ofinfrastructure development and related capital spending. These broad-basedindustry conditions contributed to our operating losses and reduced our abilityto forecast future operating results. Despite the modest turnaround, there iscontinued uncertainty as to the future spending patterns of telecommunicationsoperators and the other enterprises that are the end-users of our products. Ifthe adverse economic conditions in our industry were to continue or worsen, wemay experience additional adverse effects on our revenues, net income and cashflow.

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

We currently operate inthree areas of the communications market: (1) mobile and IP-based enhancedservices; (2) voice quality systems for the global wireless markets; and (3) wirelessbackhaul optimization. Although we expect growth in these areas, each of thesemarket areas is characterized by emerging product categories and rapidtechnological change, and we may fail to generate demand for our products atthe levels we anticipate, which could limit our future revenues and harm ourbusiness.

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**Wehave launched significant initiatives involving new markets, products and salesand marketing strategies. We may not be successful with these initiatives,which could result in reduced revenues and/or increased expenses.**

Historically, our directsales force has been focused on selling systems building blocks offered by ourPlatform Solutions business to network equipment and application providers.Over the past two years, we have evolved to selling more complex system-levelproducts to telecommunications operators and large network equipment providers.At the same time, we have recruited additional channel partners to expand thereach and improve coverage for our systems building blocks products and toenhance geographic coverage for our mobile applications offerings and wirelessbackhaul optimization products. In addition to performing sales and some levelof marketing support, these channel partners provide all or some of thefollowing: pre- and post-sales support, systems integration, fulfillment andcredit services. These system level 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.

**Weare dependent on channel partners to sell a substantial portion of our revenuesand on other third parties to perform other functions important to ourbusiness.**

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 to generateand fulfill demand for our products. In 2005, 61% of our revenues wereattributable 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 haveoutsourced maintenance and technical support of our systems building blocksproducts to external suppliers. Therefore, we are increasingly reliant on theseoutsource partners to maintain the quality of our systems building blocksproducts and to provide timely and effective technical support to a segment ofour customer base. Moreover, we do not control the amount of resources thatthese outsource partners commit to marketing our products or productsincorporating our technologies or performing these other functions. If they donot commit sufficient resources to these activities, our revenues could suffer.

**Ourrevenue growth depends significantly on the timely development and launch ofnew products and product enhancements, and we cannot be sure that our newproducts will gain wide market acceptance.**

The communications industry is characterized by rapidtechnological change, which requires continual development and introduction ofnew products 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.

**Themarkets we serve are highly competitive, and we may be unable to competeeffectively, which could adversely affect demand for our 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,including those on which we have focused significant sales and marketingefforts. These competitive factors could render one or more of our productsobsolete, which would adversely affect our revenues.

**Internaldevelopment efforts by our customers may adversely affect demand for ourproducts.**

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 developsimilar technology and products internally or obtaining them throughacquisition. If our customers choose to produce internally rather than purchasefrom us, it will decrease the size of the market for our products.

**Offeringto sell system-level products that compete with the products manufactured byour customers could negatively affect our business.**

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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**Ourproducts typically have long sales cycles, causing us to expend significantresources before achieving agreements, “design wins” or “successful trials” andultimately recognizing revenue.**

The length of our salescycle typically ranges from six to 18 months and varies substantially fromcustomer to customer. Prospective customers generally must commit significantresources to test and evaluate our products and integrate them into their operatingenvironment or product offering. This evaluation period is often prolonged dueto delays associated with approval processes that typically accompany thedesign and testing of new communications equipment by our customers. Inaddition, the rapidly emerging and evolving nature of the markets in which ourcustomers and we compete may cause prospective customers to delay theirpurchase decisions as they evaluate new technologies and develop and implementnew systems. During the period in which our customers are evaluating whether toplace an order with us, we often incur substantial sales and marketingexpenses, without any assurance of future orders or their timing. Even after weachieve an agreement, “design win” or “successful trial” and our product isexpected to be utilized in a product or service offering being developed by ourcustomer, the timing of the development, introduction and implementation of theproduct is controlled by, and can vary significantly with the needs of ourcustomers and may exceed several months. This complicates our planningprocesses and reduces the predictability of our revenues. If sales forecastedfrom a specific customer for a particular quarter are not realized in thatquarter, we may fail to achieve our revenue goals.

**Oursupply agreement with Lucent ends on March 31, 2006 and we may not be ableto compensate for revenue from that source.**

As part of our acquisitionof Lucent’s voice quality business in December 2001, we entered into athree year supply agreement with Lucent in which Lucent agreed to purchase fromus, on an exclusive basis for Lucent’s resale purposes, any of our productsthat Lucent requires which incorporate the acquired voice quality products. Weextended the agreement to, and it will expire on, March 31, 2006, howeverthe exclusivity provisions are no longer in effect. Lucent continues toincorporate our products into products it markets to others. We are engaged indiscussions with Lucent regarding further extension of the supply agreement ora replacement agreement. We are relying on sales to Lucent to continue togenerate a significant portion of our near-term revenue for such products andhave incorporated this expectation in our operating plan. Revenues from Lucentfor the year ended December 31, 2005 were approximately 22.6% of our totalrevenues, with revenues from one end customer of Lucent accounting for inexcess of 10% of our 2005 revenue. We expect a significant decrease in businessfrom Lucent and the end customer in 2006. Accordingly, any delays, reductionsor other disruptions in Lucent’s purchasing volume, any significant disputes wemight become involved in regarding our commercial relationship with Lucent orfailure to extend the agreement or execute a replacement would have a significantand material adverse effect on our revenues.

**Werecently acquired a business and may acquire other businesses or technologiesin the future; we may be unable to integrate our new business, or businesses weacquire in the future, with our business.**

We recently acquiredOpenera Technologies, Inc. (“Openera”). The process of integrating Openera’sbusiness into ours may absorb significant management attention, produceunforeseen operating difficulties and expenditures and may not produce the favorablebusiness and market opportunities the acquisition was intended to provide.Additionally, the approximately 4.34 million shares of common stock we issuedin connection with the acquisition will have a dilutive impact on the number ofour shares outstanding. If we are presented with appropriateopportunities, we may acquire other businesses or technologies. We may not beable to identify, negotiate, or finance any future acquisition successfully. Ifwe engage in an acquisition transaction, the process of integration may produceunforeseen operating difficulties and expenditures and may absorb significantattention of our management that would otherwise be available for the ongoingdevelopment of our business. If we make future acquisitions, we may issueshares of stock 

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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.

**Werely on third parties to assemble, and in certain cases, to ship, distributeand install our products. Failures or delays by such parties in executing theirresponsibilities could subject us to product shortages or quality assuranceproblems, which, in turn, could lead to an increase in the cost of manufacturingor 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 2006 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 occur and persist in connection with the manufacture, delivery,quality or cost of the assembly of our products could affect our ability toship product and recognize revenue and harm our relationship with ourcustomers.

**Wedepend on sole source suppliers for certain components used in our products;any interruption in our supplies could affect our ability to deliver productsto 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 our sole source supplier for integrated circuit components used in many ofour products and customarily requires order lead times of 13 weeks or more.Neither Texas Instruments nor Agere is under a contractual obligation to supplyus 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, that process could take several months, and anyinterruption in our supplies could affect our ability to deliver products toour customers and record associated revenue. Additionally, our agreement withPlexus specifies that if Plexus’ inventory related to manufacture of ourproducts is not turned eight times per year, we are required to purchase enoughinventory to bring Plexus up to eight turns. This is assessed on a quarterlybasis.

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**We donot obtain binding purchase commitments from our customers and rely onprojections prepared by our customers and channel partners in assessing futuredemand for our 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 a customer,we rely heavily on the customer’s projections as to future needs for ourproduct, without having any binding commitment from the customer as to futureorders. Because our expenses are based on forecasting of future orders, asubstantial reduction or delay in orders for our products from our customerscould negatively impact our operating results.

**Wemay be unable to attract and retain management or key personnel we need tosucceed.**

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.

**Wemay not be able to adequately protect our intellectual property, which mayfacilitate the development 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.

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

There is a risk that 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 licensefrom the parties claiming the infringement. If we are unable to obtain alicense, we may be unable to market our affected products. Limitations on our abilityto market our products and delays and costs associated with monetary damagesand redesigns in compliance with an adverse judgment or settlement could harmour business.

**Defectsin our products or problems arising from the use of our products together withother vendors’ products may result in lost revenues or customer relationshipsand could 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 

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couldresult in lost revenues or customer relationships and could be detrimental toour business and reputation generally. Additionally, reduced market acceptanceof our services due to errors or defects in our technology would harm ourbusiness by reducing our revenues and damaging our reputation. In some of ourcontracts, we have agreed to indemnify our customers against certainliabilities arising from defects in our products. In addition, our customersgenerally use our products together with their own products and products fromother vendors. As a result, when a problem occurs in the network, it may bedifficult to identify the source of the problem. These problems may cause us toincur significant warranty and repair costs, divert the attention of ourengineering 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.

**Becausewe derive a significant portion of our revenues from international sales, ourbusiness could be adversely affected by downturns in economic conditions incountries outside the United States and other risks associated withinternational operations.**

Sales to customers outsideNorth America accounted for approximately 65% of our revenues in 2005, 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.

**Futureregulation or legislation could restrict our business or increase our costs.**

We are unable to predictthe impact, if any, that future legislation, legal decisions or regulations relatingto our target markets may have on our business, financial condition and resultsof operations. Regulation may focus on, among other things, assessing access orsettlement charges, or imposing tariffs or regulations based on thecharacteristics and quality of products and services, either of which couldrestrict 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.

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We lease facilities in Bangalore, India (primarilyused in connection with our Mobile Applications segment), Red Bank, New Jersey(primarily used in connection with our Platform Solutions segment), St. Hubert,Quebec (primarily used in connection with our Platform Solutions segment), andSchaumburg, Illinois, in which we conduct design and engineering operations. Wealso lease a facility in Reading, United Kingdom that serves as our Europeansales and service headquarters. In addition, we have short-term leases for 12sales offices 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 2005.

**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

**Price Range of Common Stock**

Ourcommon stock is quoted on the NASDAQ Global Market under the symbol “NMSS.” Thetable below shows the high and low sale prices per share of our common stock,as reported on the NASDAQ Global Market, for the periods indicated.

| **Year Ended December 31, 2004** | ** ** | ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------|------------|------------|------------|----------|------------|---------|------------|
| First Quarter                                        |       | $          | 8.52       |     | $          | 5.75    |       |
| Second Quarter                                       |       | 9.35       |       | 5.10     |       |
| Third Quarter                                        |       | 7.43       |       | 4.02     |       |
| Fourth Quarter                                       |       | 6.96       |       | 3.71     |       |
|                                                      |            |            |            |          |            |         |            |  |  |

 

| **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     |       |
|                                                      |            |            |            |          |            |         |            |  |  |

 

As of March 13, 2006,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.

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**Issuance ofUnregistered Securities**

We acquired Inno MediaLogic Company (IML) of St.-Hubert, Quebec in July 2000 for a combinationof cash and stock. We and our wholly owned Canadian subsidiaries issued to thestockholders of IML 982,296 shares of our common stock and shares exchangeableinto an additional 1,653,004 shares of our common stock. As ofDecember 31, 2005, an aggregate of 1,377,500 additional shares of ourcommon stock had been issued in exchange for exchangeable shares. The shares ofour common stock and the exchangeable shares were issued, as to acquirers inthe United States, in reliance on the exemption set forth inSection 4(2) of the Securities Act of 1933 (the Act) and, as toacquirers outside the United States, pursuant to Regulation S under theAct. We registered on Form S-3 under the Act, effectiveAugust 25, 2000, for public sale in the United States, all the shares ofour common stock which were or are to be issued to the former shareholders ofIML.

**IssuerPurchases of Equity Securities**

None.

**ITEM 6.**                SELECTEDFINANCIAL DATA

Componentsof selected financial information consist of the following:

| ** **                                                                       | ** ** | **Year Ended December 31,**                                | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2001**                                                                  | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                       | ** ** | **($ In thousands, except per share data)** | ** ** |
| Revenues                                                                         |       | $                                                                         | 80,984     |   | $ | 102,693 |   | $ | 87,147 |   | $ | 101,512 |   | $ | 109,474 |   |
| Gross profit                                                                     |       | 39,630                                                                    |       | 44,907 |   | 38,796 |   | 63,460 |   | 70,054 |   |
| Impairment  charges                                                              |       | 55,597                                                                    |       | 66,482 |   | 18,319 |   | — |   | — |   |
| Restructuring and  other related charges                                         |       | 11,029                                                                    |       | 5,010 |   | 6,948 |   | — |   | — |   |
| Operating income  (loss)                                                         |       | (150,527                                                                  | )          | (120,106 | ) | (54,332 | ) | 5,800 |   | 3,985 |   |
| Income (loss)  before income taxes                                               |       | (141,271                                                                  | )          | (99,975 | ) | (55,891 | ) | 4,168 |   | 5,340 |   |
| Income tax  expense (benefit)                                                    |       | 1,387                                                                     |       | (1,436 | ) | 115 |   | 66 |   | 368 |   |
| Net income (loss)                                                                |       | (142,658                                                                  | )          | (98,539 | ) | (56,006 | ) | 4,102 |   | 4,972 |   |
| Net earnings (loss) per share:                                                   |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Basic and diluted                                                                |       | $                                                                         | (3.90      | ) | $ | (2.73 | ) | $ | (1.54 | ) | $ | 0.09 |   | $ | 0.10 |   |
| Weighted average common  shares used in computing net earnings (loss) per share: |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Basic                                                                            |       | 36,551                                                                    |       | 36,069 |   | 36,430 |   | 44,709 |   | 47,884 |   |
| Diluted                                                                          |       | 36,551                                                                    |       | 36,069 |   | 36,430 |   | 46,894 |   | 48,285 |   |

 

| ** **     | ** ** | **December 31,**   | ** ** |
|----------------|------------|-------------------------|------------|
| ** **     | ** ** | **2001**                | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **     | ** ** | **(In thousands)** | ** ** |
| Total assets   |       | $                       | 319,105    |   | $ | 155,083 |   | $ | 86,328 |   | $ | 108,427 |   | $ | 93,303 |   |
| Long-term debt |       | 128,432                 |       | 69,067 |   | 57,742 |   | — |   | — |   |
|                |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

**Overview**

The Company operates in the telecommunicationsindustry which is a large, rapidly evolving market. Our products includesystems building blocks, service delivery systems and personalized mobileentertainment applications, voice quality systems and a wireless backhauloptimizer. We sell our products through channel partners, distributors, andsystem integrators and directly to end users. We have 

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established businesses inNorth America, Europe and Asia. Our products are manufactured by a third partymanufacturer, Plexus. We frequently monitor our inventory to ensure optimumefficiency at Plexus. We have a supporting team of engineers developing andresearching new products and technologies. Our research and developmentactivities focus primarily on opportunities relating to emerging wirelessapplications, network infrastructure efficiencies and emerging IP-basedservices, including VoIP. We also employ marketing and administrative personnelto support our business. Management monitors the revenues and costs of thebusiness to ensure alignment with the current business and financialobjectives. Management continually monitors the activities of our competitorsand analyzes the future of our industry to appropriately align our businessfocus. Management also reviews the risks presented by the volatiletelecommunications industry to ensure our actions are within the scope of ourobjectives.

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.  Our Platform Solutions (PS) business unitfocuses on systems building blocks or enabling technology solutions that aretargeted toward communications solution providers such as network equipmentproviders, application developers and systems integrators.  The PS business unit also manages our voicequality systems (VQS) product lines, as we increasingly see these technologiesbeing delivered to customers as systems building blocks or enablingtechnologies.  Previously VQS productswere included in the Network Infrastructure (NI) business unit and as aseparate unit before 2005.  The MobileApplications (MA) business unit, previously referred to as Network Solutions(NS), is aimed at delivering mobile solutions and related services to mobileoperators and the NI business unit is focused on solutions targeted at theradio access network (RAN) portion of mobile operators’ infrastructure.  Our product and service offerings aredescribed in detail in the business section of this report. All periodspresented have been retroactively restated to reflect current segments.

During 2005, as described more fully below, our revenuesgrew 7.8% based on a combination of stronger VQS product revenues, growth inMyCaller revenues, offset by a decline in sales of our Natural Access products.Net income for the year ended December 31, 2005 was $5.0 million, a modest improvementover 2004, led by higher sales and gross margins offset somewhat by increasedoperating expenses.  

We plan to continuethe execution of our strategy during 2006. To contribute to our growth strategyin the area of mobile applications, on February 24, 2006, we purchased OpeneraTechnologies, Inc. (“Openera”). Openera, whose operations are based primarilyin Bangalore, India, is a provider of mobile application handset solutions forconverged mobile networks. In connection with the acquisition, we issued approximately3,971,000 shares, approximately 51% of which will vest over the 30 month periodfollowing the closing contingent on the continued employment of certain keyemployees of Openera over the same period. In addition, we agreed to issue optionsto purchase approximately 369,000 additional shares pursuant to our assumptionof Operera’s 2005 Equity Plan.

In the year ended December 31, 2005, we generated cashfrom operations and we utilized $20.9 million to retire outstanding debtobligations and pay related interest costs.  We plan to generate positive cashflow from operations in 2006. We have used, and may continue to use, our cashfor general corporate purposes, which may include working capital, capitalexpenditures and potential acquisitions. As of December 31, 2005, we had $62.2million in cash and short-term marketable securities. We believe the Companyhas sufficient cash available to execute on its business objectives in 2006.

We plan to grow our MA andNI business unit revenues in 2006 and we anticipate modestly lower revenues fromour PS business unit driven by a significant reduction in the VQS product lineas revenues from one significant customer in 2005 will decline in 2006. Weanticipate increased revenues from our Natural Access product lines in the yearahead.  As such, we expect to achieverevenue growth in 2006 and to increase profitability as compared to 2005.

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**Critical Accounting Policies**

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 revenue recognition, allowances for salesreturns, allowances for doubtful accounts, write-downs for excess and obsoleteinventories, long-lived assets and goodwill, income taxes, restructuring andother related charges, and accounting for acquisitions. We base our estimateson historical experience and on various other assumptions that we believe to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. We have noted that our estimates usedin the past have been consistent with actual results. Actual results may differfrom these estimates under different assumptions or conditions.

We believe the following critical accounting policies involveour more significant judgments and estimates used in the preparation of ourconsolidated financial statements:

*RevenueRecognition.**  *Wederive our 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 consulting arrangements which may consist ofhardware and/or software customization projects provided to customers throughsuch contracts. We sell our products and services through direct sales andthrough channel partners, which includes resellers and distributors. Ourmanagement must make and use judgments and estimates in connection with therevenue recognized in any reporting period. Our products are generally shippedtogether as a bundled hardware and software solution. We have determined thatthe software sold in the bundled product is essential to the functionality ofthe hardware and as such, 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. We offer quarterly return rights to a limited numberof channel partners that allow the channel partner to rotate a percentage ofits inventory based on 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 ourestimations. Our actual results have been in line with our expectations. We donot offer rights of return on sales made through our direct sales force. An increasein our allowance for sales returns would reduce our revenue in the period forwhich the increase is recorded.

We evaluate our revenue recognition policies based onthe specific facts and circumstances related to each of our channel partners.When selling to resellers and distributors, we generally do not recognizerevenue upon shipment, since many of our distributors are thinly capitalizedand their ability to pay is, in substance, contingent upon their resale of ourproduct. In these cases, we defer revenue until collectibility is reasonablyassured. When revenue is deferred, if reliable reporting from the reseller ordistributor exists, we will recognize that revenue when the reseller ordistributor sells the product to an end-user (“sell through”). Where reliablereporting does not exist, revenue will be recognized upon our receipt ofpayment, or in limited circumstances, receipt of a letter of credit. We furthermonitor the payment history of our resellers and distributors and overall dayssales outstanding. We believe this revenue recognition policy minimizes therisk that product is shipped in excess of end-user demand and allows us toreasonably and reliably estimate product returns.

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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 products, maintenance and/or professional services, we allocate the entiresale price to each respective element based on vendor specific objectiveevidence (“VSOE”). When arrangements contain multiple elements and VSOE of fairvalue exists for all undelivered elements, we recognize revenue for thedelivered elements using the residual method. We base our determination of VSOEof fair value of each of the undelivered elements in multi-element arrangementson either the price we charge when the same element is sold separately or theprice established by the members of our management, who have the relevantauthority to set prices, for an element not yet sold separately. Forarrangements 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 8.6%, 8.8% and 7.4% ofrevenue for the years ended December 31, 2003, 2004 and 2005,respectively. Service revenue is primarily comprised of engineering servicesand maintenance and support services. Engineering Professional services consistof hardware and/or software customization projects provided to customersthrough contracts. We recognize revenue allocated to professional serviceelements as the services are performed for time and materials contracts. Whenthe customization is essential to the functionality of the licensed software,then both the software license and professional services revenue are recognizedunder the percentage of completion method, which requires revenue to berecognized as services are performed. We recognize revenue and gross profitusing labor hours as an input measure of progress to completion on thesearrangements. Maintenance and support services, which are 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 Sales Returns.**  *Weevaluate and track returns on a continual basis. We record allowances forestimated sales returns and allowances on product revenue in the same period asthe related revenue is recorded. In evaluating the returns, we consider thetype of product return, the time of return compared to the original date ofsale and the value of product return. Over the past two years the return ratehas been approximately 1% of product revenue. The results of monitoring thereturn rate and its effect on inventory levels have not identified significantincreases or excess inventory levels in the distribution channels as a resultof returns. Our policies and practices allow the Company to make a 

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reasonable estimate of itsreturns and allow for timely identification of necessary changes in estimates.We must make judgments and estimates in connection with establishing theallowances for estimated sales returns in any reporting period. The amount andtiming of our revenue for any reporting period may materially differ if actualsales returns and allowances differ from our estimates of $0.3 millionrecorded as of December 31, 2005.

*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 31,2005, 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 $6.1million recorded as of December 31, 2005.

*Long-livedAssets and Goodwill.**  *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 are required toevaluate the carrying value of our long-lived assets and certain intangibleassets. SFAS No. 144 first requires an assessment of whether circumstancescurrently exist which suggest the carrying value of long-lived assets may notbe recoverable. At December 31, 2005, we did not believe any suchconditions existed. Had these conditions existed, we would assess therecoverability of the carrying value of our long-lived assets based onestimated undiscounted cash flows to be generated from such assets. Inassessing the recoverability of these assets, we would have projected estimatedenterprise-level cash flows based on various operating assumptions such asaverage revenue per unit, disconnect rates, and sales and workforceproductivity ratios. If the projection of undiscounted cash flows did notexceed the carrying value of the long-lived assets, we would be required torecord an impairment charge to the extent the carrying value exceeded the fairvalue of such assets.

*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 recorded avaluation allowance of $147.3 million as of December 31, 2005 due touncertainties related to our ability to utilize some of our deferred taxassets, primarily consisting of net operating losses carried forward. We basethe valuation allowance on our estimates of taxable income by jurisdiction inwhich we operate and the period over which our deferred tax assets will berecoverable. If actual results differ from these estimates or we adjust theseestimates in future periods, we may need to adjust our valuation allowance,which could materially impact our consolidated financial position and resultsof operations.

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*Restructuringand Other Related Charges.**  *During 2002 and 2003, we initiated consolidation ofcertain operations in order to enhance operational efficiency and reduceexpenses, and recorded significant restructuring charges in connection withthese actions. We continue to monitor and assess our facility obligations, realestate markets and our operating expenses. These restructuring charges and ourcontinued analysis of our facilities require us to make estimates based uponreal estate market conditions, rental rates, future corporate requirements,general economic conditions and future estimated cash flows. We review exitcosts in each of these circumstances on a case-by-case basis to determinewhether a restructuring charge is required to be recorded in accordance withSFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities*. The provisions of SFAS No. 146require us 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. We base estimates related to anticipated subleasemarket rates for excess facilities on assumptions regarding the time periodrequired to locate and contract with suitable subtenants and base theseassumptions on market trend information analysis. Subsequent to recording areserve, changes in market or other conditions may result in changes toassumptions upon which the original reserve was recorded that could result inan adjustment to the reserve and, depending on the circumstances, suchadjustment could be material.

**Results of Operations**

Thefollowing table sets forth, for the periods indicated, certain items from ourconsolidated statements of operations as a percentage of revenues.

| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues                                |       | 100.0                                      | %          | 100.0 | % | 100.0 | % |
| Cost of revenues                        |       | 55.5                                       |       | 37.5 |   | 36.0 |   |
| Gross profit                            |       | 44.5                                       |       | 62.5 |   | 64.0 |   |
| Operating expenses:                     |       |                                       |       |   |   |   |   |
| Selling, general and administrative     |       | 43.1                                       |       | 33.3 |   | 36.5 |   |
| Research and development                |       | 34.8                                       |       | 23.5 |   | 23.9 |   |
| Impairment charges                      |       | 21.0                                       |       | — |   | — |   |
| Restructuring and other related charges |       | 8.0                                        |       | — |   | — |   |
| Total operating expenses                |       | 106.9                                      |       | 56.8 |   | 60.4 |   |
| Operating income  (loss)                |       | (62.4                                      | )          | 5.7 |   | 3.6 |   |
| Other income  (expense), net            |       | (1.7                                       | )          | (1.6 | ) | 1.2 |   |
| Income (loss)  before income taxes      |       | (64.1                                      | )          | 4.1 |   | 4.8 |   |
| Income tax  expense                     |       | 0.1                                        |       | 0.1 |   | 0.3 |   |
| Net income (loss)                       |       | (64.2                                      | )%         | 4.0 | % | 4.5 | % |

 

*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 systems building block products and services and videoproducts 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 products and related services. The NI businessunit revenues consist of our wireless backhaul optimizer product and services.

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*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 2003, the Company also had amortization of acquired completed technology andimpairment charges in “Cost of revenues”. No similar charges were recorded ineither 2004 or 2005.

*Selling,general and administrative expenses.**  *Selling, general and administrativeexpenses consist primarily of salaries, commissions and related personnelexpenses for those engaged in our sales, marketing, promotional, publicrelations, executive, accounting and administrative activities. In 2003 and2004, the amortization of intangible assets and non-cash compensation wereincluded in selling, general and administrative costs. There were no suchcharges in 2005.

*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.

*Impairmentcharges.**  *Impairmentcharges consist of the reduction to fair value of the goodwill, tangible andintangible assets related to previous acquisitions.

*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.

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

**Revenues**

| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **Amount**                                 | ** ** | **% of total** | ** ** | **Amount** | ** ** | **% of total** | ** ** | **Change** | ** ** |
| ** **     | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| PS             |       |                                       | $          | 100.9 |   |   |   | 99.4 | % |   |   | $ | 101.8 |   |   |   | 93.0 | % |   | 0.9 | % |
| MA             |       |                                       | 0.3        |   |   |   | 0.3 |   |   |   | 6.8 |   |   |   | 6.2 |   |   | 1857.0 | % |
| NI             |       |                                       | 0.3        |   |   |   | 0.3 |   |   |   | 0.9 |   |   |   | 0.8 |   |   | 192.4 | % |
| Total revenues |       |                                       | $          | 101.5 |   |   |   | 100.0 | % |   |   | $ | 109.5 |   |   |   | 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 theyexperienced from their operator, service provider and enterprise customers. Webelieve the enterprise sector had the largest impact on demand during thisperiod. In 2005, demand from our customers increased during the third quarterof 2005 and was stable through the remainder of the year. Sales of our voicequality products and services were up significantly in 2005, based primarily ondeployments of our products in the 3G network of a major Japanese operator. Thisdeployment started in the second quarter and is expected to continue throughthe first quarter of 2006, with the fourth quarter of 2005 representing thevolume peak. Sales to this customer are made through a reseller agreement withLucent Technologies Inc. (“Lucent”) which will expire on March 31, 2006,but which we are currently in the process of renegotiating. Over time, weexpect voice quality 

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infrastructure to beincorporated in other carrier infrastructure equipment and as a result most ofour new business development activities for the VQS products are targeted atequipment OEMs. Our view is that over time echo cancellation and voicequality functionality will be incorporated in other carrier infrastructure equipment.During 2004, we received royalty fees from Lucent in connection with our VQStechnology of $2.4 million. Our royalty agreement 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 expect orders and revenues from MyCaller to continue togrow during 2006 as we deploy products and services to additional operators

We experienced modest growth in the NI business unitduring the year ended December 31, 2005 as compared to the year ended December 31,2004. Revenues associated with AccessGate were lower than expected. In 2005, were-focused our sales efforts on emerging markets and have signed agreementswith channel partners to assist with the execution of our strategy. Currently,AccessGate is deployed in several field trials and we expect additional ordersin 2006.

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,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2004**                                   | ** ** | **2005** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **Amount **                           | ** ** | **% of total** | ** ** | **Amount** | ** ** | **% of total** | ** ** | **Change** | ** ** |
| ** **     | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North America  |       |                                       | $          | 53.4 |   |   |   | 52.6 | % |   |   | $ | 37.9 |   |   |   | 34.6 | % |   |   | (29.1 | )% |   |
| International  |       |                                       | 48.1       |   |   |   | 47.4 |   |   |   | 71.6 |   |   |   | 65.4 |   |   |   | 48.9 | % |   |
| Total revenues |       |                                       | $          | 101.5 |   |   |   | 100.0 | % |   |   | $ | 109.5 |   |   |   | 100.0 | % |   |   | 7.8 | % |   |

 

We have experienced growthin our international markets due primarily to growth in the Asian market. TheAsian market experienced the strongest growth during the latter half of 2005,due in large part to the deployment of our VQS products by a major Japanesemobile operator, as described above. The increase in Asia was partially offsetby lower sales of PS products in Europe and the Americas. The North Americanmarket declined when compared to the previous year due primarily to lower salesof our PS products as described in the preceding section.

**Costof Revenues and Gross Margin**

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

 

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Productcosts vary with revenues and to a lesser extent due to fluctuations in productmix and are discussed in the following paragraph. Service costs which representprimarily pre and post sales technical support activities did not changesignificantly during 2005. Substantially all manufacturing activities areoutsourced to a contract manufacturer.

| ** **                   | ** ** | **Year Ended**

**December 31,** | ** ** | ** ** | ** ** |
|------------------------------|------------|--------------------------------------------|------------|------------|------------|
| ** **                   | ** ** | **2004**                                   | ** ** | **2005**   | ** ** | **Change** | ** ** |
| ** **                   | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** |
| Revenues                     |       | $                                          | 101.5      |       | $          | 109.5 |   |   | 7.8 | % |   |
| Cost of revenues             |       | 38.0                                       |       | 39.4       |       |   | 3.6 | % |   |
| Gross profit                 |       | $                                          | 63.5       |       | $          | 70.1 |   |   | 10.4 | % |   |
| As a percentage of  revenues |       | 62.5                                       | %          | 64.0       | %          |   |   |   |   |

 

We experienced animprovement in gross profit margin for the year ended December 31, 2005 ascompared to the year ended December 31, 2004, due to higher productmargins and product volume increases in our VQS products which were partiallyattributable to the sale of approximately $0.7 million of previously written-downinventory. We expect gross profit as a percent of revenue to decline in 2006due to an increase in  MyCaller andAccessGate revenues offset by a decrease in VQS revenues.

**Selling,General and Administrative**

| ** **                           | ** ** | **Year Ended  December 31,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(In millions)**                 | ** ** |
| Selling, general  and administrative |       | $                                      | 33.8       |   | $ | 39.9 |   |
| As a percentage of  revenues         |       | 33.3                                   | %          | 36.5 | % |
|                                      |            |                                        |            |  |  |  |  |

 

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. The independent investigation was completedafter the discovery of an accounting error that resulted in the restatement ofthe financial results for the three and six months ended June 30, 2005. Weexpect selling, general and administrative spending to remain flat in 2006.

**Research andDevelopment**

| ** **                   | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------------|------------|----------------------------------------|------------|
| ** **                   | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **                   | ** ** | **(In millions)**                 | ** ** |
| Research and  development    |       | $                                      | 23.9       |   | $ | 26.2 |   |
| As a percentage of  revenues |       | 23.5                                   | %          | 23.9 | % |
|                              |            |                                        |            |  |  |  |  |

 

Our research anddevelopment spending and headcount increased 9.4% during the year ended December 31,2005 in comparison to the year ended December 31, 2004. Our research anddevelopment activities are primarily focused on opportunities relating toemerging wireless applications, radio access networks and emerging IP-basedservices, including VoIP. We are currently investing research and developmentexpenditures including product extensions to our CG and TX board families, nextgeneration 

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boardand related software offerings incorporating for example, video capabilities,our recently announced Vision series of application ready media servers, andour more recent product families, MyCaller and AccessGate, with the expectationthat these products will contribute to future revenues and growth. During 2005we invested approximately $10.7 million in the MyCaller and AccessGate products.In 2006, we expect research and development spending to increase due toincreases in payroll related costs and continued investments in exisiting andnew products.

**Restructuringand Other Related Charges**

Therewere no restructuring and other related charges in either 2004 or 2005. Thefollowing table sets forth restructuring and other related charges accrualactivity during the twelve months of 2005, related to restructuring actionstaken in fiscal years 2002 and 2003:

| ** **                                               | ** ** | **Employee  Related**   | ** ** | **Facility  Related** | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|-----------|------------|-----------|------------|
| ** **                                               | ** ** | **(In thousands)** | ** ** |
| 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 |   |

 

The remaining accrualbalances for facility related charges are expected to be settled in cash overthe next four years.

**Other Income(Expense), Net**

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

 

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 2004 and 2005. 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,** | ** ** |
|---------------------|------------|----------------------------------------|------------|
| ** **          | ** ** | **2004**                               | ** ** | **2005** | ** ** |
| ** **          | ** ** | **(In millions)**                 | ** ** |
| Income tax  expense |       | $                                      | 0.1        |   | $ | 0.4 |   |
|                     |            |                                        |            |  |  |  |  |

 

Income tax expense for theyears ended December 31, 2004 and 2005 was $66,000 and $368,000,respectively. Income tax expense is primarily due to foreign taxes incurred byforeign subsidiaries.

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For U.S. federal incometax purposes, we had net operating loss carryforwards available to reducetaxable income of approximately $149.4 million at December 31, 2005. Underthe provision of the Internal Revenue Code Section 382, certain changes inthe Company’s ownership structure may result in a limitation on the amount ofnet operating loss carryforwards and research and development creditcarryforwards which may be used in future years. These carryforwards will beginto expire in 2006. We also had foreign net operating loss carryforwards ofapproximately $36.9 million. As of December 31, 2005, we had approximately$6.9 million of tax credits in the U.S. that are composed of federal researchand development credits, foreign tax credits and state and local credits. Thesecredits begin to expire in 2006. In addition, we had Canadian investment taxcredits of approximately $3.5 million. These credits begin to expire in 2014.

We have established avaluation allowance against net deferred tax assets, in certain jurisdictionsincluding the United States, because we believe that it is more likely than notthat the tax assets in those jurisdictions will not be realized prior to theirexpiration. During fiscal year 2005, the deferred tax asset valuation allowancedecreased by approximately $6.2 million, primarily as the result of netoperating losses and credits that expired during 2005. We will continue toassess the valuation allowance and to the extent it is determined that suchallowance is no longer required, the tax benefit of the remaining net deferredtax assets will be recognized in the future. Approximately $7.5 million of thevaluation allowance for deferred tax assets relates to the tax benefit fromstock option deductions, which, if realized, will be allocated directly toadditional paid-in capital.

United States income taxes were not provided oncumulative undistributed earnings for certain non-U.S. subsidiaries ofapproximately $1.9 million. We intend to reinvest these earnings indefinitelyoutside the United States in our operations.

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued FASB Staff PositionNo. SFAS 109-2 (“SFAS 109-2”), “Accounting and Disclosure Guidance for theForeign Earnings Repatriation Provision within the American Jobs Creation Actof 2004.”  The American Jobs Creation Act of 2004 (“the Act”) was passedin October 2004.  The Act contains certain tax incentives including adeduction for income from qualified production activities and an 85% dividendsreceived deduction for certain dividends from controlled foreigncorporations.  These incentives are subject to a number oflimitations.  At this time, none of these incentives are expected to havea significant impact on our income tax liability.

**YearEnded December 31, 2004 Compared to Year Ended December 31, 2003**

**Revenues**

| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2003**                                   | ** ** | ** ** | ** ** | **2004** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **Amount**                                 | ** ** | **% of total** | ** ** | **Amount** | ** ** | **% of total** | ** ** | **Change** | ** ** |
| ** **     | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| PS             |       |                                       | $          | 87.0 |   |   |   | 99.9 | % |   |   | $ | 100.9 |   |   |   | 99.4 | % |   |   | 15.9 | % |   |
| MA             |       |                                       | —     |   |   |   | — |   |   |   | 0.3 |   |   |   | 0.3 |   |   |   | — |   |   |
| NI             |       |                                       | 0.1        |   |   |   | 0.1 |   |   |   | 0.3 |   |   |   | 0.3 |   |   |   | 236.6 | % |   |
| Total revenues |       |                                       | $          | 87.1 |   |   |   | 100.0 | % |   |   | $ | 101.5 |   |   |   | 100.0 | % |   |   | 16.5 | % |   |

 

Our revenue growth was attributable to an increase inrevenues from the PS business unit and recognition of initial revenues from theMA and NI business units. The change in PS revenue resulted from a 26.9%increase in the platform solutions products offset by a 20.0% decrease in ourVQS sales. The PS business unit revenue growth, reflected through volumeincreases in both channel partner and direct sales, resulted from improvementin capital spending by enterprise and telecommunications companies in ourmarkets. The improved capital spending trend in the telecommunicationsequipment market was 

30

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driven by wirelessoperators, and that was an area of particular focus for our sales efforts. Thedecrease in VQS business unit revenues was primarily due to a continued declinein the market. Our VQS business has had a decline in each of the years ended December 31,2003 and 2004. VQS business unit revenues from royalty fees were$2.4 million for the year ended December 31, 2004, a$0.7 million decrease from $3.1 million for the year ended December 31,2003.

Revenues from Lucent, our primary VQS reseller tonetwork operators and an emerging PS customer, represented 11.7% and 15.6% oftotal revenues for the year ended December 31, 2004 and 2003,respectively. At December 31, 2004, two customers, Avaya and a channelpartner in the United States, represented 22.4% and 12.2%, respectively, of theCompany’s outstanding net accounts receivable balance. At December 31,2003, no customer accounted for 10% or more of the Company’s accountsreceivable balance.

We recognized initial revenues of approximately $0.3 millionfrom MyCaller in the fourth quarter of 2004.

The NIbusiness unit had modest revenues in 2004 and 2003. We recognized initialrevenues of approximately $0.3 million from AccessGate sales in the fourthquarter of 2004.

| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2003**                                   | ** ** | **2004** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **     | ** ** | **Amount**                                 | ** ** | **% of total** | ** ** | **Amount** | ** ** | **% of total** | ** ** | **Change** | ** ** |
| ** **     | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North America  |       |                                       | $          | 46.6 |   |   |   | 53.5 | % |   |   | $ | 53.4 |   |   |   | 52.6 | % |   |   | 14.6 | % |   |
| International  |       |                                       | 40.5       |   |   |   | 46.5 |   |   |   | 48.1 |   |   |   | 47.4 |   |   |   | 18.6 | % |   |
| Total revenues |       |                                       | $          | 87.1 |   |   |   | 100.0 | % |   |   | $ | 101.5 |   |   |   | 100.0 | % |   |   | 16.5 | % |   |

 

We have experienced growthin both our North American and International markets with Europe having thehighest sales growth in 2004. Our revenue growth, reflected through volumeincreases in both channel partner and direct sales, resulted from improvementin capital spending by enterprise and telecommunications companies in ourmarkets. We recognized our first revenues from MyCaller and AccessGate in ourEuropean market in the fourth quarter of 2004. In the fourth quarter of 2003,we made some changes in our European sales management staff and we experiencedthe benefit of these changes in 2004.

**Cost of Revenues**

| ** **             | ** ** | **Year Ended December 31,** | ** ** |
|------------------------|------------|--------------------------------------------|------------|
| ** **             | ** ** | **2003**                                   | ** ** | ** ** | ** ** | **2004** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Amount**                                 | ** ** | **% of revenues** | ** ** | **Amount** | ** ** | **% of revenues** | ** ** | **Change** | ** ** |
| ** **             | ** ** | **(In millions)**                     | ** ** | ** ** | ** ** | **(In millions)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product                |       |                                       | $          | 25.8 |   |   |   | 29.6 | % |   |   | $ | 26.0 |   |   |   | 25.6 | % |   | 1.0 | % |
| Service                |       |                                       | 7.3        |   |   |   | 8.4 |   |   |   | 7.1 |   |   |   | 7.0 |   |   | (3.5 | )% |
| Overhead               |       |                                       | 6.9        |   |   |   | 7.9 |   |   |   | 4.9 |   |   |   | 4.9 |   |   | (28.3 | )% |
| Other                  |       |                                       | 8.3        |   |   |   | 9.6 |   |   |   | — |   |   |   | — |   |   | (100.0 | )% |
| Total cost of revenues |       |                                       | $          | 48.3 |   |   |   | 55.5 | % |   |   | $ | 38.0 |   |   |   | 37.5 | % |   | (21.3 | )% |

 

Our cost of revenuesdecreased approximately 21% since 2003 primarily due to reductions in forcethat occurred during 2003 and a one-time impairment charge related to theamortization and impairment of completed technology related to pastacquisitions of $8.3 million. Product costs increased slightly as a resultof increased volume in our PS business offset by efficiencies achieved with ourcontract manufacturer. Service costs and overhead costs decreased due toreductions in force.

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**Gross Profit**

| ** **                   | ** ** | **Year Ended  December 31,** | ** ** | ** ** | ** ** |
|------------------------------|------------|----------------------------------------|------------|------------|------------|
| ** **                   | ** ** | **2003**                               | ** ** | **2004**   | ** ** | **Change** | ** ** |
| ** **                   | ** ** | **(In millions)**                 | ** ** | ** ** | ** ** |
| Revenues                     |       | $                                      | 87.1       |       | $          | 101.5 |   |   | 16.5 | % |   |
| Cost of revenues             |       | 48.3                                   |       | 38.0       |       |   | (21.3 | )% |   |
| Gross profit                 |       | $                                      | 38.8       |       | $          | 63.5 |   |   | 63.6 | % |   |
| As a percentage of  revenues |       | 44.5                                   | %          | 62.5       | %          |   |   |   |   |

 

The improvements in grossmargin, from 2003 to 2004, were primarily driven by increased volume in our PSbusiness, product mix, cost reduction actions and efficiencies achieved withour contract manufacturer.

**Selling,General and Administrative**

| ** **                           | ** ** | **Year Ended  December 31,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **2003**                               | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **(In millions)**                 | ** ** |
| Selling, general  and administrative |       |                                   | $          | 37.6 |   |   | $ | 33.8 |   |
| As a percentage of  revenues         |       |                                   | 43.1       | % |   | 33.3 | % |
|                                      |            |                                        |            |  |  |  |  |  |  |

 

Selling, general andadministrative expenses decreased 10.1% during the year ended December 31,2004 compared to the same period of 2003. The primary reason for the decreasein selling, general and administrative expense is the realization of costsavings from the reductions-in-force during 2003. Additionally, included inselling, general and administrative expense for the year ended December 31,2003 are $1.1 million of amortization of intangible assets and$1.0 million of non-cash compensation expense, both related to prioracquisitions. These expenses did not reoccur in the year ended December 31,2004. The decrease was offset by expenses incurred during 2004 associated withapproximately $2.2 million of commissions of escalated sales andapproximately $0.7 million of professional fees related to our compliancewith Sarbanes Oxley.

**Research andDevelopment**

| ** **                   | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------------|------------|----------------------------------------|------------|
| ** **                   | ** ** | **2003**                               | ** ** | **2004** | ** ** |
| ** **                   | ** ** | **(In millions)**                 | ** ** |
| Research and  development    |       | $                                      | 30.3       |   | $ | 23.9 |   |
| As a percentage of  revenues |       | 34.8                                   | %          | 23.5 | % |
|                              |            |                                        |            |  |  |  |  |

 

Research and developmentexpense decreased 21.2% during the year ended December 31, 2004 comparedto the same period of 2003. The decrease is attributable to cost savings fromreductions-in-force in 2003. Research and development spending and headcount werestable throughout 2004. In 2004, we incurred approximately $6.0 million ofresearch and development expense each quarter. Our research and developmentactivities are primarily focused on opportunities relating to emerging wirelessapplications, network infrastructure efficiencies and emerging IP-based services,including VoIP.

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**Impairment Charges**

| ** **                                                   | ** ** | **Year Ended  December 31,** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                   | ** ** | **2003**                               | ** ** | **2004** | ** ** |
| ** **                                                   | ** ** | **(In millions)**                 | ** ** |
| *In cost  of revenues:*                                      |       |                                   |       |   |   |   |   |
| Acquired  completed technology from past acquisitions        |       | $                                      | 7.4        |   |   | $ | — |   |   |
| *In operating expenses:*                                     |       |                                   |       |   |   |   |   |
| Goodwill and  intangible assets related to past acquisitions |       | 10.3                                   |       |   | — |   |   |
| Fixed assets  associated with the VQS and PS business units  |       | 4.0                                    |       |   | — |   |   |
| Goodwill and  intangible assets related to VQS               |       | 4.0                                    |       |   | — |   |   |
|                                                         |       | 18.3                                   |       |   | — |   |   |
| Total impairment charges                                     |       | $                                      | 25.7       |   |   | $ | — |   |   |

 

During the year ended December 31,2003, the Company recorded impairment charges totaling approximately$25.7 million related to the goodwill, indefinite-lived intangible assetsand amortizable intangible assets associated with past acquisitions. Due tolower actual and forecasted revenues, as compared to the previous budget forthe business units that included these intangible assets, the estimated valueof goodwill, indefinite-lived intangible assets and amortizable intangibleassets acquired in past acquisitions had decreased. Based on the results of theimpairment analyses performed on the goodwill, indefinite-lived intangibleassets and amortizable intangible assets, these assets were written down totheir estimated fair value.

**Restructuringand Other Related Charges**

| ** **                                     | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **2003**                               | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(In millions)**                 | ** ** |
| Involuntary  severance related costs           |       | $                                      | 4.8        |   |   | $ | — |   |   |
| Lease termination  costs                       |       | 0.4                                    |       |   | — |   |   |
| Write-down of  fixed assets                    |       | 1.6                                    |       |   | — |   |   |
| Other                                          |       | 0.1                                    |       |   | — |   |   |
| Total restructuring and  other related charges |       | $                                      | 6.9        |   |   | $ | — |   |   |

 

The Company’s restructuring efforts during the yearended 2003 resulted in the recording of total restructuring and other relatedcharges of $6.9 million. These charges consist of $4.8 million ofinvoluntary severance related costs, $0.4 million of lease terminationcosts, $1.6 million write down of fixed assets, and a $0.1 millioncharge for a write down of an IML facility to fair market value (as the assetwas being held for sale and was sold in the quarter ended June 30, 2004).

In the year ended December 31,2003, involuntary severance related costs of $4.8 million resulted fromthe elimination of approximately 140 positions at the Company’s facilities inthe United States, Canada, Europe and Asia based on terminations that wereannounced in January, April, July and October of 2003 and involvedall areas of the Company.

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**OtherIncome (Expense), Net**

| ** **                             | ** ** | **Year Ended  December 31,** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | **2003**                               | ** ** | **2004** | ** ** |
| ** **                             | ** ** | **(In millions)**                 | ** ** |
| Interest income                        |       |                                   | $          | 0.7 |   |   | $ | 1.2 |   |
| Interest expense                       |       |                                   | (3.7       | ) |   | (2.2 | ) |
| Gain (loss) on  extinguishment of debt |       |                                   | 2.1        |   |   | (0.3 | ) |
| Other                                  |       |                                   | (0.7       | ) |   | (0.3 | ) |
| Total other income  (expense), net     |       |                                   | $          | (1.6 | ) |   | $ | (1.6 | ) |

 

The decrease in interestexpense in 2004 compared to 2003 is attributed to the repurchase and retirementof outstanding convertible debt throughout 2003 and 2004. The increase ininterest income earned for the year ended December 31, 2004 compared to2003 is primarily due to an increase in our cash, cash equivalents andmarketable securities. The Company completed an underwritten public stockoffering that raised $49.5 million in March of 2004. In 2003, werecognized a gain of $2.1 million associated with our repurchase of$11.3 million of our convertible notes at a market value less than the parvalue. However, in 2004, due to the close proximity of the market and par valueof our notes, we recognized a loss of $0.3 million upon the repurchase of$37.8 million of our notes.

**Income Tax Expense**

| ** **          | ** ** | **Year Ended  December 31,** | ** ** |
|---------------------|------------|----------------------------------------|------------|
| ** **          | ** ** | **2003**                               | ** ** | **2004** | ** ** |
| ** **          | ** ** | **(In millions)**                 | ** ** |
| Income tax  expense |       | $                                      | 0.1        |   | $ | 0.1 |   |
|                     |            |                                        |            |  |  |  |  |

 

Income tax expense for the year endedDecember 31, 2004 and 2003 was $66,000 and $115,000, respectively. Incometax expense is primarily due to state and foreign taxes.

For U.S. federal income tax purposes, we had netoperating loss carryforwards available to reduce taxable income ofapproximately $147.2 million at December 31, 2004, a portion of whichmay be limited under Internal Revenue Code Section 382. Thesecarryforwards will begin to expire in 2019. We also had a foreign net operatingloss carryforward of approximately $55.5 million. We had $6.1 millionof tax credits that were composed of federal research and development credits,foreign tax credits and state and local credits. These credits began to expirein 2004. During 2004 we did not utilize any of our net operating losscarryforwards.

Based upon availableevidence, management believes that the realization of certain deferred taxassets is more unlikely than not and, accordingly has established a fullvaluation allowance against those assets. During fiscal 2004, the deferred taxasset valuation allowance increased by $11.6 million, primarily as theresult of additional net operating loss carryforwards and the amortization ofintangible assets. We will continue to assess the valuation allowance and tothe extent it is determined that such allowance is no longer required, the taxbenefit of the remaining net deferred tax assets will be recognized in thefuture. Approximately $6.5 million of the valuation allowance for deferredtax assets relates to benefits for stock option deductions, which, whenrealized, will be allocated directly to additional paid-in capital. We did notrelease any of our valuation allowances in 2004.

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**Liquidity and Capital Resources**

| ** **                                        | ** ** | **December 31,**  | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **2004**               | ** ** | **2005** | ** ** |
| ** **                                        | ** ** | **(In millions)** | ** ** |
| Cash, cash  equivalents and marketable securities |       | $                      | 80.6       |   | $ | 62.2 |   |
| Working capital                                   |       | 60.9                   |       | 67.0 |   |
|                                                   |            |                        |            |  |  |  |  |

 

As of December 31, 2005, our liquid assetsincluded cash, cash equivalents and marketable securities of $62.2 million. InMarch, 2004, we completed the sale of 9.2 million shares of common stock in anunderwritten public offering which resulted in net proceeds of $49.5 million.We intend to use our cash for general corporate purposes, which may includeworking capital, capital expenditures and potential acquisitions. The remainingconvertible subordinated notes of $19.9 million were repaid in October,2005. The majority of our liquid assets are invested in short-term andlong-term marketable securities. We had no significant capital spending orpurchase commitments other than facility leases and open purchase orders in theordinary course of business.

We believe that our available liquid assets andworking capital are sufficient to meet our operating expenses, capitalrequirements and contractual obligations for at least the next 12 months and wedo not anticipate the need for additional financing. Material risks to cashflow from operations include delayed cash receipts accompanying sales ofproduct. There can be no assurance that changes in our plans or other eventsaffecting our operations will not result in materially accelerated orunexpected expenditures. Long-term cash requirements other than normaloperating expenses, are anticipated for the continued development of newproducts, financing anticipated growth and the possible acquisition ofbusinesses or technologies complemetary 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.

We may require or desire additional funds to supportour operating expenses and capital requirements or for other purposes, such asacquisitions, or for competitive reasons, and may seek to raise such additionalfunds through public or private equity financing or from other sources. We cannotprovide assurance that additional funding will be available at all or that, ifavailable, such financing will be obtainable on terms favorable to us and wouldnot have an adverse impact on our earnings. Our future liquidity and cashrequirements will depend on numerous factors, including, but not limited to,the level of revenue we will be able to achieve in the future, the successfulintroduction of new products and potential acquisitions of related businessesand/or technologies.

Sources and uses of cashfor the year to date periods are summarized in the table below. Sources anduses of our liquid assets are shown in detail in the statement of cash flows ofour financial statements.

**Cash Flow:**

| ** **                                           | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(In millions)**                     | ** ** |
| Net cash provided  by (used in) operating activities |       | $                                          | (16.8      | ) | $ | 7.1 |   | $ | 3.6 |   |
| Net cash provided  by (used in) investing activities |       | $                                          | 26.8       |   | $ | (49.6 | ) | $ | 32.8 |   |
| Net cash provided by  (used in) financing activities |       | $                                          | (8.0       | ) | $ | 16.1 |   | $ | (18.0 | ) |

 

The principal driver of cash flow is net income,which, as described more fully above, increased from $4.1 million to $5.0million in the year ended December 31, 2005. Depreciation and amortizationwere lower in 2005, in comparison to the prior years presented, as a result ofreduced capital spending during the past few years. Accounts receivable changesrepresented a use of cash in all periods. Our revenue has continued to growannually since 2003. We expect continued growth with increasing accountsreceivable 

35

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and deferred revenue in2006. As of December 31, 2003, 2004 and 2005 days sales outstanding (DSO)were 36 days, 49 days and 48 days, respectively. DSO is significantly affectedby the timing of customer invoicing which for most of our products takes placeat the time of shipment. However, for some of our products, we partiallyinvoice our customers at the time of order receipt, with the remainder of theorder being invoiced at certain milestones. Finally, deferred revenuesrepresent products shipped to customers or services billed where revenue is notyet recognized. As MyCaller and AccessGate revenues become a larger proportionof overall revenues, this balance will grow and affect cash flows accordingly.Deferred revenues positively affect our cash flows provided from operations ifpayments are received prior to the recognition of related revenues.

During the years ended December 31,2003, 2004 and 2005 we used $9.3 million, $38.5 million and $20.4 million,respectively, to repurchase our debt obligation and related interest, which asdescribed elsewhere in this report, was fully retired in October, 2005.

**Off-BalanceSheet Arrangements and Contractual Obligations**

We do not have anyoff-balance sheet financing arrangements, other than property operating leasesthat are disclosed in the contractual obligations table below and in ourconsolidated 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 payments due under contractual obligations.

**ContractualObligations**

| ** **                     | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                  | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| ** **                     | ** ** | **(In thousands)**                   | ** ** |
| Property and  equipment leases |       | $                                         | 4,090      |   | $ | 3,514 |   | $ | 3,215 |   | $ | 2,930 |   | $ | 2,835 |   |   | $ | 3,950 |   |   | $ | 20,534 |   |
| Open purchase  orders          |       | 2,919                                     |       | — |   | — |   | — |   | — |   |   | — |   |   | 2,919 |   |
| Total contractual  obligations |       | $                                         | 7,009      |   | $ | 3,514 |   | $ | 3,215 |   | $ | 2,930 |   | $ | 2,835 |   |   | $ | 3,950 |   |   | $ | 23,453 |   |

 

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

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. At December 31,2005, the Company had satisfied the eight turn goal in all preceding quarters.As such, we have not included any amounts in the table of contractualobligations related to a commitment with Plexus at December 31, 2005. TheCompany can only ascribe value to such commitment when the Company has not metthe condition as determined at a specific point in time, based on future factsand circumstances. Plexus is the Company’s only third-party contractmanufacturer with this type of arrangement. As such, the Company is not partyto any other such arrangements with its other third-party contractmanufacturers .

**Recent Accounting Pronouncements**

In November 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 151, “Inventory Costs—anAmendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends ARB 43,Chapter 4, to clarify that abnormal amounts of idle facility expense,freight, handling costs, and wasted materials 

36

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(spoilage) should berecognized as current-period charges. In addition, this Statement requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. The provisions of this Statementare effective for inventory costs incurred during fiscal years beginning after June 15,2005. The adoption of the provisions of SFAS No. 151 is not expected tohave a material impact on the Company’s financial position or results ofoperations.

In December 2004, the FASB issued SFAS No. 123(R),“Share-Based Payment”, which is a revision of SFAS No. 123 and supersedesAPB Opinion No. 25. SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to be valuedat fair value on the date of grant, and to be expensed over the applicablevesting period. Pro forma disclosure of the income statement effects ofshare-based payments is no longer an alternative. SFAS No. 123(R) iseffective for all stock-based awards granted on or after January 1, 2006.In addition, companies must also recognize compensation expense related to anyawards that are not fully vested as of the effective date. Compensation expensefor the unvested awards will be measured based on the fair value of the awardspreviously calculated in developing the pro forma disclosures in accordancewith the provisions of SFAS No. 123. The Company expects the adoption ofSFAS No. 123(R) will have a material impact on our consolidatedresults of operations. We currently measure compensation costs related toshare-based payment transactions as set forth in Note B to the ConsolidatedFinancial Statements for pro forma information required under Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation.”

In May 2005, the FASBissued SFAS No. 154, Accounting Changes and Error Corrections—AReplacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154requires retrospective application to prior periods’ financial statements forchanges in accounting principle, unless it is impracticable to determine eitherthe period-specific effects or the cumulative effect of the change. SFAS No. 154also requires that retrospective application of a change in accountingprinciple be limited to the direct effects of the change. Indirect effects of achange in accounting principle, such as a change in non-discretionaryprofit-sharing payments resulting from an accounting change, should berecognized in the period of the accounting change. SFAS No. 154 alsorequires that a change in depreciation, amortization, or depletion method forlong-lived non-financial assets be accounted for as a change in accountingestimate affected by a change in accounting principle. SFAS No. 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. Early adoption is permitted foraccounting changes and corrections of errors made in fiscal years beginningafter the date this Statement is issued. The Company is required to adopt theprovision of SFAS No. 154, as applicable, beginning in fiscal 2006.

37

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**QuarterlyInformation (Unaudited)**

| ** **                                              | ** ** | **Quarter Ended**                                                     | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Mar. 31,  2004**                                               | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** | **Dec. 31,  2004** | ** ** | **Mar. 31,  2005** | ** ** | **June 30,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **Dec. 31,  2005** | ** ** |
| ** **                                              | ** ** | **(Unaudited)**                                                       | ** ** |
| ** **                                              | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenues                                                |       | $                                                                     | 24,379     |   | $ | 25,262 |   | $ | 25,693 |   | $ | 26,178 |   | $ | 22,600 |   | $ | 24,919 |   | $ | 30,271 |   | $ | 31,684 |   |
| Cost of revenues                                        |       | 8,822                                                                 |       | 9,722 |   | 9,477 |   | 10,031 |   | 9,518 |   | 9,394 |   | 10,083 |   | 10,425 |   |
| Gross profit                                            |       | 15,557                                                                |       | 15,540 |   | 16,216 |   | 16,147 |   | 13,082 |   | 15,525 |   | 20,188 |   | 21,259 |   |
| Operating  expenses:                                    |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative                     |       | 8,090                                                                 |       | 7,981 |   | 8,727 |   | 8,978 |   | 8,942 |   | 9,344 |   | 10,078 |   | 11,565 |   |
| Research and development                                |       | 5,961                                                                 |       | 6,187 |   | 5,906 |   | 5,831 |   | 6,192 |   | 6,323 |   | 6,837 |   | 6,788 |   |
| Total operating expenses                                |       | 14,051                                                                |       | 14,168 |   | 14,633 |   | 14,809 |   | 15,134 |   | 15,667 |   | 16,915 |   | 18,353 |   |
| Operating income (loss)                                 |       | 1,506                                                                 |       | 1,372 |   | 1,583 |   | 1,338 |   | (2,052 | ) | (142 | ) | 3,273 |   | 2,906 |   |
| Other income (expense), net                             |       | (838                                                                  | )          | (320 | ) | (453 | ) | (21 | ) | 150 |   | 485 |   | 117 |   | 603 |   |
| Income (loss) before income taxes                       |       | 668                                                                   |       | 1,052 |   | 1,130 |   | 1,317 |   | (1,902 | ) | 343 |   | 3,390 |   | 3,509 |   |
| Income tax expense (benefit)                            |       | 25                                                                    |       | 16 |   | 24 |   | — |   | 200 |   | 285 |   | 63 |   | (180 | ) |
| Net income (loss)                                       |       | $                                                                     | 643        |   | $ | 1,036 |   | $ | 1,106 |   | $ | 1,317 |   | (2,102 | ) | $ | 58 |   | 3,327 |   | 3,689 |   |
| Basic and diluted  net earnings (loss) per common share |       | $                                                                     | 0.02       |   | $ | 0.02 |   | $ | 0.02 |   | $ | 0.03 |   | $ | (0.04 | ) | $ | 0.00 |   | $ | 0.07 |   | $ | 0.08 |   |

 

| ** **                                         | ** ** | **Quarter Ended** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| **(As a percent of revenues)** | ** ** | ** **             | ** ** | **Mar. 31,  2004** | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** | **Dec. 31,  2004** | ** ** | **Mar. 31,  2005** | ** ** | **June 30,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **Dec. 31,  2005** | ** ** |
| ** **                                         | ** ** | **(Unaudited)**        | ** ** |
| Revenues                                           |       |                   | 100.0      | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |
| Cost of revenues                                   |       |                   | 36.2       |   |   |   | 38.5 |   |   |   | 36.9 |   |   |   | 38.3 |   |   |   | 42.1 |   |   |   | 37.7 |   |   |   | 33.3 |   |   |   | 32.9 |   |   |
| Gross profit                                       |       |                   | 63.8       |   |   |   | 61.5 |   |   |   | 63.1 |   |   |   | 61.7 |   |   |   | 57.9 |   |   |   | 62.3 |   |   |   | 66.7 |   |   |   | 67.1 |   |   |
| Operating expenses:                                |       |                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative                |       |                   | 33.2       |   |   |   | 31.6 |   |   |   | 34.0 |   |   |   | 34.3 |   |   |   | 39.6 |   |   |   | 37.5 |   |   |   | 33.3 |   |   |   | 36.5 |   |   |
| Research and development                           |       |                   | 24.5       |   |   |   | 24.5 |   |   |   | 23.0 |   |   |   | 22.3 |   |   |   | 27.4 |   |   |   | 25.4 |   |   |   | 22.6 |   |   |   | 21.4 |   |   |
| Total operating expenses                           |       |                   | 57.7       |   |   |   | 56.1 |   |   |   | 57.0 |   |   |   | 56.6 |   |   |   | 67.0 |   |   |   | 62.9 |   |   |   | 55.9 |   |   |   | 57.9 |   |   |
| Operating income (loss)                            |       |                   | 6.1        |   |   |   | 5.4 |   |   |   | 6.1 |   |   |   | 5.1 |   |   |   | (9.1 | ) |   |   | (0.6 | ) |   |   | 10.8 |   |   |   | 9.2 |   |   |
| Other income (expense), net                        |       |                   | (3.4       | ) |   |   | (1.2 | ) |   |   | (1.7 | ) |   |   | (0.1 | ) |   |   | 0.1 |   |   |   | 1.9 |   |   |   | 0.4 |   |   |   | 1.9 |   |   |
| Income (loss) before income taxes                  |       |                   | 2.7        |   |   |   | 4.2 |   |   |   | 4.4 |   |   |   | 5.0 |   |   |   | (9.0 | ) |   |   | 1.3 |   |   |   | 11.2 |   |   |   | 11.1 |   |   |
| Income taxes expense (benefit)                     |       |                   | 0.1        |   |   |   | 0.1 |   |   |   | 0.1 |   |   |   | — |   |   |   | 0.1 |   |   |   | 1.1 |   |   |   | 0.2 |   |   |   | (0.5 | ) |   |
| Net income (loss)                                  |       |                   | 2.6        | % |   |   | 4.1 | % |   |   | 4.3 | % |   |   | 5.0 | % |   |   | (9.1 | )% |   |   | 0.2 | % |   |   | 11.0 | % |   |   | 11.6 | % |   |
|                                                    |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the first half of 2005, we experienced adecrease in quarterly revenue in comparison to prior quarters of 2004. Weattribute this decrease to a decline in our PS business unit as discussedabove. During the latter half of 2005, we experienced growth in revenue andimprovement in gross margin attributable to an increase in sales related toMyCaller and revenue associated with sales to Lucent, our  most significant customer of voice qualityproducts and services, as well as an increase in our PS business unit sales.

Selling, general and administrative expenses havegenerally increased during 2004 and 2005 primarily due to increases in commissionexpenses, headcount increases and expenses related to compliance with theSarbanes-Oxley Act of 2002.

Research and development expenses were stable during2004 and through the first quarter of 2005. For the remainder of 2005 increasesin research and development expense were attributable to an increase inheadcount. As noted earlier, we are currently investing research anddevelopment expenditures including product extensions to certain boardfamilies, next generation board and related software offerings incorporating,for example, video capabilities, and our more recent product families, MyCallerand AccessGate, with the expectation that those products will moresignificantly contribute to revenues in 2006.

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

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

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

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary market risk exposures are in the areas ofinterest rate risk and foreign currency exchange rate risk. Our investmentportfolio of cash equivalents, marketable securities and non-marketablesecurities are subject to interest rate fluctuations, but we believe this riskis immaterial due to the short-term nature of these investments. Our exposureto currency exchange rate fluctuations has been moderate due to the fact thatthe revenues are billed primarily in U.S. dollars.

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

**Report of Independent Registered Public AccountingFirm**

To the Board of Directors and Stockholders of NMSCommunications Corporation:

We have completedintegrated audits of NMS Communications Corporation’s 2005 and 2004consolidated financial statements and of its internal control over financialreporting as of December 31, 2005, and an audit of its 2003 consolidatedfinancial statements in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

*Consolidated financial statements and financial statementschedules*

In our opinion, the consolidated financial statements listed inthe index appearing under Item 15(a)(1)presents fairly, in all material respects, the financial position of NMSCommunications Corporation and its subsidiaries at December 31, 2005 andDecember 31, 2004, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2005 in conformitywith accounting principles generally accepted in the United States of America.  Inaddition, in our opinion, the financial statement schedules listed in the indexunder Item 15(a)(2)presentsfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements. Thesefinancial statements and financial statement schedule are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thesefinancial statements and financial statement schedule based on our audits. Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An audit offinancial statements includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

*Internal controlover financial reporting*

Also, in our opinion, management’s assessment,included in Management's Report on Internal Control Over Financial Reportingappearing under Item 9A, that the Company maintained effective internal controlover financial reporting as of December 31, 2005 based on criteria establishedin *Internal Contro—Integrated Framework* issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO),is fairly stated, in all material respects, based on those criteria.Furthermore, in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31, 2005,based on criteria 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 overfinancial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. An audit of internal control over financial reportingincludes obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing suchother 

40

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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, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate. 

/s/ PricewaterhouseCoopers LLPBoston, MassachusettsMarch 16, 2006

41

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**NMSCommunications Corporation**

**ConsolidatedBalance Sheets**

| ** **                                                                                                                                                                | ** ** | **December 31,**                                                              | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                                | ** ** | **2004**                                                                           | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                                | ** ** | **(In thousands, except  share and per share data)** | ** ** |
| **Assets**                                                                                                                                                                |       |                                                                               |       |   |   |
| Current assets:                                                                                                                                                           |       |                                                                               |       |   |   |
| Cash and cash equivalents                                                                                                                                                 |       | $                                                                                  | 33,804     |   | $ | 51,212 |   |
| Marketable securities                                                                                                                                                     |       | 46,815                                                                             |       | 11,002 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $1,004 and $794, respectively                                                                             |       | 14,315                                                                             |       | 16,895 |   |
| Inventories                                                                                                                                                               |       | 3,446                                                                              |       | 2,844 |   |
| Prepaid expenses and other assets                                                                                                                                         |       | 2,539                                                                              |       | 4,092 |   |
| Total current assets                                                                                                                                                      |       | 100,919                                                                            |       | 86,045 |   |
| Property and  equipment, net                                                                                                                                              |       | 6,147                                                                              |       | 6,535 |   |
| Other assets                                                                                                                                                              |       | 1,361                                                                              |       | 723 |   |
| Total assets                                                                                                                                                              |       | $                                                                                  | 108,427    |   | $ | 93,303 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                             |       |                                                                               |       |   |   |
| Current liabilities:                                                                                                                                                      |       |                                                                               |       |   |   |
| Accounts payable                                                                                                                                                          |       | $                                                                                  | 4,728      |   | $ | 4,855 |   |
| Accrued expenses and other liabilities                                                                                                                                    |       | 10,706                                                                             |       | 10,394 |   |
| Deferred revenue                                                                                                                                                          |       | 4,620                                                                              |       | 3,959 |   |
| Short-term debt obligations                                                                                                                                               |       | 19,942                                                                             |       | — |   |
| Total current liabilities                                                                                                                                                 |       | 39,996                                                                             |       | 19,208 |   |
| Commitments and  contingencies (note 15)                                                                                                                                  |       |                                                                               |       |   |   |
| Stockholders’  equity:                                                                                                                                               |       |                                                                               |       |   |   |
| Preferred stock, $0.01 par value, 3,000,000 shares authorized  at December 31, 2004 and 2005, respectively, no shares issued and  outstanding                        |       | —                                                                             |       | — |   |
| Common stock, $0.01 par value, 125,000,000 shares  authorized; 47,369,352 and 48,412,589 shares issued and outstanding at  December 31, 2004 and 2005, respectively. |       | 474                                                                                |       | 484 |   |
| Additional paid-in capital                                                                                                                                                |       | 412,989                                                                            |       | 414,939 |   |
| Accumulated deficit                                                                                                                                                       |       | (342,732                                                                           | )          | (337,760 | ) |
| Accumulated other comprehensive loss                                                                                                                                      |       | (2,300                                                                             | )          | (3,568 | ) |
| Total stockholders’ equity                                                                                                                                           |       | 68,431                                                                             |       | 74,095 |   |
| Total liabilities  and stockholders’ equity                                                                                                                          |       | $                                                                                  | 108,427    |   | $ | 93,303 |   |

 

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

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**NMSCommunications Corporation**

**ConsolidatedStatements of Operations**

| ** **                                   | ** ** | **Year Ended December 31,**                                 | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2003**                                                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(In thousands except for per share data)** | ** ** |
| Revenues                                     |       | $                                                                          | 87,147     |   | $ | 101,512 |   | $ | 109,474 |   |
| Cost of revenues                             |       | 48,351                                                                     |       | 38,052 |   | 39,420 |   |
| Gross profit                                 |       | 38,796                                                                     |       | 63,460 |   | 70,054 |   |
| Operating expenses:                          |       |                                                                       |       |   |   |   |   |
| Selling, general and administrative          |       | 37,569                                                                     |       | 33,776 |   | 39,929 |   |
| Research and development                     |       | 30,292                                                                     |       | 23,884 |   | 26,140 |   |
| Impairment charges                           |       | 18,319                                                                     |       | — |   | — |   |
| Restructuring and other related charges      |       | 6,948                                                                      |       | — |   | — |   |
| Total operating expenses                     |       | 93,128                                                                     |       | 57,660 |   | 66,069 |   |
| Operating income  (loss)                     |       | (54,332                                                                    | )          | 5,800 |   | 3,985 |   |
| Other income (expense):                      |       |                                                                       |       |   |   |   |   |
| Interest income                              |       | 685                                                                        |       | 1,223 |   | 1,643 |   |
| Interest expense                             |       | (3,685                                                                     | )          | (2,186 | ) | (878 | ) |
| Gain (loss) on extinguishment of debt        |       | 2,120                                                                      |       | (369 | ) | — |   |
| Other                                        |       | (679                                                                       | )          | (300 | ) | 590 |   |
| Other income (expense), net                  |       | (1,559                                                                     | )          | (1,632 | ) | 1,355 |   |
| Income (loss)  before income taxes           |       | (55,891                                                                    | )          | 4,168 |   | 5,340 |   |
| Income tax expense                           |       | 115                                                                        |       | 66 |   | 368 |   |
| Net income (loss)                            |       | $                                                                          | (56,006    | ) | $ | 4,102 |   | $ | 4,972 |   |
| Basic earnings (loss) per common share       |       | $                                                                          | (1.54      | ) | $ | 0.09 |   | $ | 0.10 |   |
| Weighted average basic shares outstanding    |       | 36,430                                                                     |       | 44,709 |   | 47,884 |   |
| Diluted earnings (loss) per common share     |       | $                                                                          | (1.54      | ) | $ | 0.09 |   | $ | 0.10 |   |
| Weighted average  diluted shares outstanding |       | 36,430                                                                     |       | 46,894 |   | 48,285 |   |

 

The accompanying notes are an integral part of theconsolidated financial statements.

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**NMSCommunications Corporation**

**ConsolidatedStatements of Stockholders’ Equity**

| ** **                                                | ** ** | **Common Stock** | ** ** | **Additional  paid-in** | ** ** | **Accumulated** | ** ** | **Accumulated  other  comprehensive** | ** ** | **Deferred** | ** ** | **Treasury  stock**    | ** ** | **Total  stockholders’** | ** ** | **Comprehensive**  | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------|------------|---------------------------------------|------------|--------------|------------|------------------------|------------|-------------------------------|------------|--------------------|------------|
| **(In thousands)**                                   | ** ** | ** **            | ** ** | **Shares**              | ** ** | **Amount**      | ** ** | **capital**                           | ** ** | **deficit**  | ** ** | **income (loss)** | ** ** | **compensation**              | ** ** | **(at cost)** | ** ** | **equity** | ** ** | **Income (loss)** | ** ** |
| Balance, December 31, 2002                           |       | 36,603                |       | $                       | 366        |            |       | $                                     | 362,776    |         |       |                   | $          | (290,828                      | )          |               |       | $ | (2,704 | ) |   |   | $ | (2,531 | ) |   |   | $ | (2,896 | ) |   |   | $ | 64,183 |   |   |   | $ | (100,860 | ) |   |
| Issuance of common stock under employee purchase plan     |       |                  |       |                    |       |            | $          | (855                                  | )          |         |       |                   |       |                          |       |               |       |   |   |   |   |   |   | $ | 995 |   |   |   | 140 |   |   |   |   |   |   |
| Amortization of deferred compensation                     |       |                  |       |                    |       |            | —     |                                  |       |         |       |                   |       |                          |       |               |       |   | 643 |   |   |   |   |   |   |   | 643 |   |   |   |   |   |   |
| Termination of options issued at below FMV                |       |                  |       |                    |       |            | (1,786     | )                                     |       |         |       |                   |       |                          |       |               |       |   | 1,786 |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Exercise of common stock options and warrants             |       |                  |       |                    |       |            | (716       | )                                     |       |         |       |                   |       |                          |       |               |       |   |   |   |   |   | 1,616 |   |   |   | 900 |   |   |   |   |   |   |
| Adjustment of forfeited stock under IML merger  agreement |       | 135                   |       | 1                       |       |            | (1         | )                                     |       |         |       |                   |       |                          |       |               |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Foreign currency translation adjustment                   |       |                  |       |                    |       |            |       |                                  |       |         |       |                   |       |                          | 378        |               |       |   |   |   |   |   |   |   |   |   | 378 |   |   |   | 378 |   |   |
| Net loss                                                  |       |                  |       |                    |       |            |       |                                  |       |         | (56,006    | )                      |       |                          |       |               |       |   |   |   |   |   |   |   |   |   | (56,006 | ) |   |   | (56,006 | ) |   |
| Balance, December 31, 2003                           |       | 36,738                |       | $                       | 367        |            |       | $                                     | 359,418    |         |       |                   | $          | (346,834                      | )          |               |       | $ | (2,326 | ) |   |   | $ | (102 | ) |   |   | $ | (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      |                                  |       |         |       |                   |       |                          |       |               |       |   |   |   |   |   | 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 |   |   |
|                                                           |            |                       |            |                         |            |                 |            |                                       |            |              |            |                        |            |                               |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanyingnotes are an integral part of the consolidated financial statements

44

 

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**NMSCommunications Corporation**

**ConsolidatedStatements of Cash Flows**

| ** **                                                                                      | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2003**                                    | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                      | ** ** | **(In thousands)**                     | ** ** |
| Cash flow from operating  activities:                                                           |       |                                        |       |   |   |   |   |
| Net income (loss)                                                                               |       | $                                           | (56,006    | ) | $ | 4,102 |   | $ | 4,972 |   |
| Adjustments to reconcile  net income (loss) to cash provided by (used in) operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and amortization of property and  equipment                                        |       | 7,524                                       |       | 3,898 |   | 2,564 |   |
| Amortization of other intangibles                                                               |       | 1,989                                       |       | — |   | — |   |
| Foreign exchange translation gain on intercompany  debt                                         |       | (1,507                                      | )          | (180 | ) | (378 | ) |
| Loss on impairment and disposal of property and  equipment                                      |       | 5,943                                       |       | 137 |   | 164 |   |
| Loss on impairment of goodwill and other intangibles                                            |       | 21,702                                      |       | — |   | — |   |
| Loss (gain) on extinguishment of long-term debt                                                 |       | (2,120                                      | )          | 369 |   | — |   |
| Write-off and amortization of debt issuance costs                                               |       | 602                                         |       | 320 |   | 131 |   |
| Deferred stock compensation expense amortized                                                   |       | 643                                         |       | 102 |   | — |   |
| Changes in  operating assets and liabilities, net of effects of acquisitions:                   |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                             |       | (249                                        | )          | (5,046 | ) | (2,580 | ) |
| Inventories                                                                                     |       | 6,979                                       |       | (254 | ) | 602 |   |
| Prepaid expenses and other assets                                                               |       | 1,708                                       |       | 2,454 |   | (1,160 | ) |
| Accounts payable                                                                                |       | (1,853                                      | )          | (371 | ) | 514 |   |
| Deferred revenue                                                                                |       | (1,360                                      | )          | 2,982 |   | (661 | ) |
| Accrued expenses and other liabilities                                                          |       | (761                                        | )          | (1,461 | ) | (522 | ) |
| Cash (used in) provided by operating activities                                                 |       | (16,766                                     | )          | 7,052 |   | 3,646 |   |
| Cash flow from  investing activities:                                                           |       |                                        |       |   |   |   |   |
| Purchases of property and equipment                                                             |       | (2,436                                      | )          | (2,368 | ) | (3,337 | ) |
| Purchases of marketable securities                                                              |       | (23,844                                     | )          | (61,492 | ) | (42,321 | ) |
| Proceeds from the maturity of marketable securities                                             |       | 53,070                                      |       | 14,250 |   | 78,440 |   |
| Cash provided by (used in) investing activities                                                 |       | 26,790                                      |       | (49,610 | ) | 32,782 |   |
| Cash flow from  financing activities:                                                           |       |                                        |       |   |   |   |   |
| Repurchase or retirement of long-term debt                                                      |       | (9,044                                      | )          | (37,849 | ) | (19,942 | ) |
| Proceeds from issuance of common stock                                                          |       | 1,040                                       |       | 53,963 |   | 1,960 |   |
| Cash (used in) provided by financing activities                                                 |       | (8,004                                      | )          | 16,114 |   | (17,982 | ) |
| Effect of  exchange rate changes on cash                                                        |       | 1,129                                       |       | 331 |   | (1,038 | ) |
| Net increase  (decrease) in cash and cash equivalents                                           |       | 3,149                                       |       | (26,113 | ) | 17,408 |   |
| Cash and cash  equivalents, beginning of year                                                   |       | 56,768                                      |       | 59,917 |   | 33,804 |   |
| Cash and cash  equivalents, end of year                                                         |       | $                                           | 59,917     |   | $ | 33,804 |   | $ | 51,212 |   |
| Supplemental cash  flow information:                                                            |       |                                        |       |   |   |   |   |
| Interest paid                                                                                   |       | $                                           | 3,350      |   | $ | 2,304 |   | $ | 997 |   |
| Taxes paid                                                                                      |       | 351                                         |       | 332 |   | 251 |   |

 

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

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**Notes to Consolidated Financial Statements**

**1—Summary of Significant Accounting Policies**

**Business Description**

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, addressa wide range of customers’ needs as they seek to develop and deploy enhancedvoice and data services and applications, and improve the quality andefficiency of communications networks. Telecommunications operators use theCompany’s products to improve customer acquisition and retention, diversifyrevenue streams and reduce operating costs and capital expenditures. Networkequipment and application providers use the Company’s products to help deployleading technology solutions for their telecommunications and enterprisecustomers in a timely and cost-effective manner. The Company sells its productsworldwide through its direct sales force as well as through channel partnersand system integrator partners. The Company’s customers include leadingtelecommunications operators and network equipment and application providerssuch as Vodafone, 3 Italy, MTN, Movilnet, NTT DoCoMo, Ericsson, LogicaCMG,Alcatel, Comverse, Avaya, Lucent Technologies, Huawei, Cisco , InteractiveMedia,  European ComputerTelecommunications, and Microsoft.

**Principles of Consolidation**

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

**Reclassifications**

Certain prior year amountshave been reclassified to conform to the current year’s presentation.

**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 its estimates, including those relatedto revenue recognition, allowances for sales returns, allowance for doubtfulaccounts, allowance for warranty obligations, write-down of excess and obsoleteinventories, long-lived assets and goodwill, income taxes, restructuring andother related charges, and accounting for acquisitions. Management bases theseestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions.

**Foreign Currency Translation**

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 

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componentof accumulated other comprehensive income (loss) within stockholders’ equity,since the Company expects those loans to be permanently reinvested.

**Revenue Recognition**

The Company derives its revenue primarily from twosources: sales of products, including hardware and software licenses, andservices, including maintenance, support and professional services. Maintenanceand support services consist of on-site support, telephone support, systemhosting and training. Professional services consist of consulting arrangementswhich may consist of hardware and/or software customization projects providedto customers through such contracts. The Company sells its products andservices through direct sales and through channel partners, which includesresellers and distributors and system integrators. Management must make and usejudgments and estimates in connection with the revenue recognized in anyreporting period. The Company’s products are generally shipped together as abundled hardware and software solution. The software sold in the bundledproduct is essential to the functionality of the hardware and as such, theCompany recognizes revenue in accordance with the provisions of the AmericanInstitute of Certified Public Accountants Statement of Position (SOP) 97-2,*Software Revenue Recognition*, andrelated interpretations. The Company recognizes revenue from the sale ofproducts when persuasive evidence of an arrangement exists, delivery hasoccurred, the fee is fixed or determinable, and collection is consideredprobable.

When selling to resellers and distributors, theCompany defers revenue until collectibility is reasonably assured. When revenueis deferred, if reliable reporting from the reseller or distributor exists, theCompany will recognize that revenue when the reseller or distributor sells theproduct to an end-user (“sell through”). Where reliable reporting does notexist, revenue will be recognized upon our receipt of payment, or in limitedcircumstances, 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 when Right of ReturnExists,” the Company recognizes revenue upon shipment of product to itsstocking distributors, net of estimated returns. The Company offers quarterlyreturn rights to a limited number of channel partners that allow the channelpartner to rotate a percentage of its inventory based on its prior quarterpurchases. The Company provides for these return rights each quarter in anamount equal to estimated returns. The Company does not offer rights of returnon sales made through its direct sales force.

When an arrangement involves multiple elements, suchas products, maintenance and/or professional services, the Company allocatesthe entire sale price to each respective element based on vendor specificobjective evidence (“VSOE”). When arrangements contain multiple elements andVSOE of fair value exists for all undelivered elements, the Company recognizesrevenue for the delivered elements using the residual method. The Company basesits determination of VSOE of fair value of each of the undelivered elements inmulti-element arrangements on either the price the Company charges when thesame element is sold separately or the price established by the members of ourmanagement, who have the relevant authority to set prices, for an element notyet sold separately. For arrangements containing multiple elements where VSOEof fair value does not exist for all undelivered elements, the Company defersrevenue for the delivered and undelivered elements until VSOE of fair valueexists or all 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 

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determines VSOE onmaintenance and support services by establishing a substantive renewal price asa percentage of the sale price in its 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, thenboth the software license and professional services revenue are recognizedunder the percentage of completion method, which requires revenue to berecognized as a percentage of the project completed. The Company recognizesrevenue and gross profit using labor hours as an input measure of progress tocompletion on these arrangements.

Maintenance and support services and professionalservice revenue represents 8.6%, 8.8% and 7.4% of revenue for the years ended December 31,2003, 2004 and 2005, respectively

When there are shippingand handling fees, The Company invoices customers for such fees. The Company recognizesthe invoiced amounts as revenue. The related costs are recognized in cost ofrevenue.

**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; suchreceivables represented approximately $2.5 million and $2.8 million of theaccounts receivable balance as of December 31, 2004 and 2005,respectively.

The Company establishes reserves against its accountsreceivable for potential credit losses when it determines receivables are atrisk for collection based upon the length of time the receivables areoutstanding, as well as various other criteria. Receivables are written offagainst these reserves 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 identification methodfor determining the cost of securities. The Company periodically evaluates thecarrying value of its investments for other than temporary impairment.

**Advertising**

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

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**Inventories**

Inventories are valued 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.

**Property and Equipment**

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                                    |
| Building                               |   | 20 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.

**Long-lived Assets and Goodwill**

The Company reviews goodwill on an annual basis forimpairment. The Company reviews long-lived intangible and tangible assets forimpairment whenever events or changes in business circumstances indicate thatthe carrying value of the assets may not be fully recoverable in accordancewith SFAS 142, “Financial Accounting and Reporting for Acquired Goodwilland Other Intangible Assets”, and SFAS 144, “Accounting for the Impairmentor Disposal of Long-Lived Assets

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

In performing this assessment, the Company assignslong-lived assets and goodwill to reporting units and then performs a two-stepanalysis to test for impairment. The first step is used to identify a potentialimpairment loss by comparing the estimated undiscounted cash flows to begenerated from the assets of each reporting unit to the unit’s carrying value.In assessing the recoverability of these assets, the Company must project cashflows that are based on various operating assumptions such as revenue budgetsand forecasts, projected expenditures and terminal value of each reportingunit. The Company develops these cash flow projections on a periodic basis andcontinuously reviews the projections based on actual operating trends andeconomic developments around the globe and within the telecommunicationsindustry in particular.

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

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Different assumptionsregarding a reporting unit’s cash flow projections and fair value, both ofwhich are highly dependent upon future revenue projections, could result in achange in the timing and amount of impairment losses, if any.

**Research and Development**

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.

**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.

**Financial Instruments**

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 31,2004 and 2005. Fair value of short-term debt at December 31, 2004 was$19.7 million. The debt obligation was repaid in 2005. Debt is recorded atits face value.

**Income Taxes**

Deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their tax bases. Deferred tax assets and liabilities aremeasured using enacted statutory tax rates in effect in the year in which thedifferences are expected to reverse. A deferred tax asset is established forthe expected future benefit of net operating loss and credit carry-forwards. Avaluation reserve against net deferred tax assets is required, if, based uponavailable evidence, it is more likely than not that some or all of the deferredtax assets will not be realized.

**StockOption and Stock Purchase Plans**

As more fully described in Note 14 to theconsolidated financial statements, the Company has stock option and stockpurchase plans authorizing various types of stock-based awards that may begranted to officers and employees. In the consolidated financial statements,the Company applied Accounting Principles Board Opinion No. 25 “Accountingfor Stock Issued to Employees,” and related interpretations in accounting forits stock option and employee stock purchase plans. All options granted underthe various plans administered by the Company have a vesting life not to exceedfour years, and these options have an expiration date of up to ten years fromthe date of grant.

In the fourth quarter of 2005, the Company acceleratedthe vesting of certain unvested stock options awarded to employees, officersand other eligible participants under the Company’s various stock option plans.As such, the Company fully vested options to purchase 589,499 shares of theCompany’s common stock with exercise prices greater than or equal to $4.03 pershare. The acceleration of the vesting of these options did not result in acharge based on generally accepted accounting principles. For pro forma 

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disclosure requirementsunder SFAS 123, the Company recognized $2.9 million of stock-based compensationfor all options whose vesting was accelerated. These modifications were made inanticipation of adopting SFAS No. 123(R)  issued on December 16,2004. SFAS 123(R) supersedes APB Opinion No. 25 and its relatedimplementation guidance and requires the fair value of share based paymentssuch as stock options be recognized in the financial statements as compensationexpense. SFAS 123(R) becomes effective for the Company on January 1,2006. These actions were undertaken to produce a more favorable impact on theCompany’s results of operations upon adoption of SFAS 123(R).

Inaccordance with SFAS No. 123, “Accounting for Stock- Based Compensation,”the fair value of each stock-based award has been estimated on the date ofgrant using the Black-Scholes option-pricing model. The weighted average fairvalue at date of grant for stock options granted during the years ended December 31,2003, 2004 and 2005 was $1.31, $6.30 and $3.49, respectively. The weightedaverage fair value of employee stock purchases during the years ended December 31,2003, 2004 and 2005 was $0.41, $3.60 and $1.74, respectively. The followingtable summarizes the weighted average assumptions used in the Black-Scholesoption-pricing model:

| ** **              | ** ** | **2003** | ** ** | **2004** | ** ** | **2005**   | ** ** |
|-------------------------|------------|----------|------------|----------|------------|------------|------------|
| Risk Free Interest Rate |       | 3.0%     |       | 3.4%     |       | 4.0%       |       |
| Expected Life           |       | 5  years |       | 5  years |       | 3.5  years |       |
| Expected  Volatility    |       | 115%     |       | 115%     |       | 82%        |       |
| Expected Dividend Yield |       | 0%       |       | 0%       |       | 0%         |       |

 

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

| ** **                                                                                                  | ** ** | **Year Ended December 31,**                         | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2003**                                                           | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                  | ** ** | **(In thousands, except per share data)** | ** ** |
| Net income  (loss), as reported                                                                             |       | $                                                                  | (56,006    | ) | $ | 4,102 |   | $ | 4,972 |   |
| Add: Stock-based  employee compensation expense included in net income (loss)                               |       | 643                                                                |       | 102 |   | — |   |
| Less: Total  stock-based employee compensation expense determined under Black-Scholes option  pricing model |       | (6,326                                                             | )          | (5,625 | ) | (8,449 | ) |
| Pro forma net  loss                                                                                         |       | $                                                                  | (61,689    | ) | $ | (1,421 | ) | $ | (3,477 | ) |
| Weighted average  basic shares outstanding                                                                  |       | 36,430                                                             |       | 44,709 |   | 47,884 |   |
| Weighted average  diluted shares outstanding                                                                |       | 36,430                                                             |       | 44,709 |   | 47,884 |   |
| Earnings (loss)  per share:                                                                                 |       |                                                               |       |   |   |   |   |
| Basic and diluted net earnings (loss) per common  share, as reported                                        |       | $                                                                  | (1.54      | ) | $ | 0.09 |   | $ | 0.10 |   |
| Basic and diluted  net loss per common share, pro forma                                                     |       | $                                                                  | (1.69      | ) | $ | (0.03 | ) | $ | (0.07 | ) |

 

**Basicand Diluted Net Earnings (Loss) Per Common Share**

Basic net earnings (loss)per common share are computed by dividing net income (loss) by theweighted-average number of common shares outstanding during the period. Dilutednet earnings (loss) per common share is computed by dividing the net income(loss) by the sum of the weighted-average number of common shares outstandingplus all additional common shares that would have been outstanding ifpotentially dilutive common stock equivalents had been issued.

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Thefollowing table sets forth the computation of basic and diluted earnings (loss)per share for the years ended December 31, 2003, 2004 and 2005:

| ** **                                   | ** ** | **2003**                                                           | ** ** | **2004** | ** ** | **2005** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                   | ** ** | **(In thousands, except per share data)** | ** ** |
| Numerator:                                   |       |                                                               |       |     |       |     |       |
| Net income (loss)                            |       | $                                                                  | (56,006    | )        | $          | 4,102    |       | $ | 4,972 |   |
| Denominator:                                 |       |                                                               |       |     |       |     |       |
| Basic weighted  average shares outstanding   |       | 36,430                                                             |       | 44,709   |       | 47,884   |       |
| Dilutive stock options                       |       | —                                                             |       | 2,185    |       | 401      |       |
| Diluted weighted  average shares outstanding |       | 36,430                                                             |       | 46,894   |       | 48,285   |       |
| Net earnings  (loss) per share:              |       |                                                               |       |     |       |     |       |
| Basic and diluted                            |       | $                                                                  | (1.54      | )        | $          | 0.09     |       | $ | 0.10 |   |

 

The number of options thatwere excluded from the calculation of diluted earnings (loss) per common share,as their inclusion would have been anti-dilutive at December 31, 2003,2004 and 2005 were 8,901,814, 4,321,213 and 3,131,954, respectively. Additionalcommon stock equivalents related to the Company’s Convertible Notes of 914,726and 315,289 at December 31, 2003 and 2004, respectively, have beenexcluded from the calculation of diluted earnings per common share as theirinclusion would have been anti-dilutive.

**Recent Accounting Pronouncements**

In November 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 151, “Inventory Costs—anAmendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends ARB 43,Chapter 4, to clarify that abnormal amounts of idle facility expense,freight, handling costs, and wasted materials (spoilage) should berecognized as current-period charges. In addition, this Statement requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. The provisions of thisStatement are effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005. The adoption of the provisions of SFAS No. 151is not expected to have a material impact on the Company’s financial positionor results of operations.

In December 2004, the FASB issued SFAS No. 123(R),“Share-Based Payment”, which is a revision of SFAS No. 123 and supersedes APBOpinion No. 25. SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to be valuedat fair value on the date of grant, and to be expensed over the applicablevesting period. Pro forma disclosure of the income statement effects ofshare-based payments is no longer an alternative. SFAS No. 123(R) iseffective for all stock-based awards granted on or after January 1, 2006.In addition, companies must also recognize compensation expense related to anyawards that are not fully vested as of the effective date. Compensation expensefor the unvested awards will be measured based on the fair value of the awardspreviously calculated in developing the pro forma disclosures in accordancewith the provisions of SFAS No. 123. The Company expects the adoption ofSFAS No. 123(R) will have a material impact on our consolidatedresults of operations. We currently measure compensation costs related toshare-based payment transactions as set forth in Note 1 to the ConsolidatedFinancial Statements for pro forma information required under Statement ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation.”

In May 2005, the FASBissued SFAS No. 154, Accounting Changes and Error Corrections—A Replacementof APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154requires retrospective application to prior periods’ financial statements forchanges in accounting principle, unless it is impracticable to determine eitherthe period-specific effects or the cumulative effect of the change. SFAS No. 154also requires that retrospective application of a change in accountingprinciple be limited to the 

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directeffects of the change. Indirect effects of a change in accounting principle,such as a change in non-discretionary profit-sharing payments resulting from anaccounting change, should be recognized in the period of the accounting change.SFAS No. 154 also requires that a change in depreciation, amortization, ordepletion method for long-lived non-financial assets be accounted for as achange in accounting estimate affected by a change in accounting principle.SFAS No. 154 is effective for accounting changes and corrections of errorsmade in fiscal years beginning after December 15, 2005. Early adoption ispermitted for accounting changes and corrections of errors made in fiscal yearsbeginning after the date this Statement is issued. The Company is required toadopt the provision of SFAS No. 154, as applicable, beginning in fiscal2006.

**2—Risks and Uncertainties**

The Company’s futureresults of operations involve a number of risks and uncertainties. Factors thatcould affect the Company’s future operating results and cause actual results tovary materially from expectations include, but are not limited to, dependenceon suppliers, rapid industry changes, competition, competitive pricingpressures, changes in foreign laws and regulations, risks associated withindirect channels of distribution, uneven quarterly sales patterns, ability tosustain and manage growth, inability to attract and retain key personnel,undetected problems in the Company’s products, risks associated withacquisitions, investments and alliances, enforcement of the Company’sintellectual property rights, litigation, changes in regulations, demand in thetelecommunications market and stock price volatility.

**3—Goodwill and Other Intangibles**

As of December 31,2004 and 2005, there is no goodwill or long-lived intangible assets on theCompany’s balance sheet. Amortization expense related to intangible assets was$2.0 million for the year ended December 31, 2003. There was noamortization expense recorded in either 2004 or 2005.

**Impairment Charges**

| ** **                                                      | ** ** | **Year Ended  December 31,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                      | ** ** | **2003**                               | ** ** |
| *In cost  of revenues:*                                         |       |                                   |       |   |   |
| Acquired  completed technology from IML, Mobilee, MMI and VQS   |       |                                   | $          | 7.4 |   |   |
| *In operating expenses:*                                        |       |                                   |       |   |   |
| Goodwill and  intangible assets related to IML, MMI and Mobilee |       |                                   | 10.3       |   |   |
| Fixed assets  associated with the VQS and PS business unit      |       |                                   | 4.0        |   |   |
| Goodwill and  intangible assets related to VQS                  |       |                                   | 4.0        |   |   |
|                                                            |       |                                   | 18.3       |   |   |
| Total impairment charges                                        |       |                                   | $          | 25.7 |   |   |

 

During 2003, the Company recorded impairment chargesrelated to its intangible assets associated with its Inno Media Logic (“IML”),Mobilee Inc. “Mobilee”, Message Machines Inc. (“MMI”) and Voice Quality Systems(“VQS”) acquisitions. Due to lower actual and forecasted revenues, as comparedto the previous budget for the reporting units that included these assets, thefair value of goodwill, intangible assets and fixed assets associated with eachreporting unit had decreased. Based on the results of the impairment analysesperformed, these assets were written down to their estimated fair value.

The total impairmentcharge included $10.3 million to reduce the carrying value of the goodwilland indefinite-lived intangible assets related to the MMI and Mobileeacquisitions to estimated fair value. The balance of the 2003 impairment chargeof $8.0 million resulted from a reduction in the carrying values of 

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theamortizable intangible assets and fixed assets related to the VQS, MMI andMobilee acquisitions. Of these costs, $3.9 million is related to thereduction in carrying value of a VQS supply agreement and $0.1 million isrelated to the reduction in carrying value of VQS trademarks and patents. Fixedassets associated with the VQS and PS business units were also written down totheir estimated fair value resulting in charges of $1.2 million and$2.8 million, respectively. Additionally, $0.6 million,$1.5 million and $5.3 million are related to the write-down ofacquired completed technology from the Mobilee, MMI and VQS acquisitions,respectively, and are included in cost of revenues within the statement ofoperations for 2003.

**4—Restructuringand Other Related Charges Accruals**

Thefollowing table sets forth restructuring and other related charges accrualactivity during the years ended December 31, 2003, 2004 and 2005,respectively, related to restructuring actions taken in fiscal years 2002 and2003:

| ** **                                                    | ** ** | **Employee  Related**   | ** ** | **Facility  Related** | ** ** | **Impaired  Assets** | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|----------------------|------------|-----------|------------|-----------|------------|
| ** **                                                    | ** ** | **(In thousands)** | ** ** |
| Restructuring  accrual balance at December 31, 2002 |       |                    | $          | 800                   |       |                 | $          | 3,134     |       |      | $          | — |   |   | $ | 399 |   | $ | 4,333 |   |
| Restructuring and  other related charges                      |       |                    | 4,786      |                  |       | 494                  |       |      | 1,590      |      |       | 78 |   | 6,948 |   |
| Non-cash  utilization                                         |       |                    | —     |                  |       | —               |       |      | (1,590     | )         |       | — |   | (1,590 | ) |
| Cash payments                                                 |       |                    | (4,071     | )                     |       | (1,936               | )          |      | —     |      |       | (356 | ) | (6,363 | ) |
| 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 |   |

 

Theremaining accrual balances for facility related charges are expected to besettled in cash over the next three and a half years.

| ** **                                     | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | **2003**                               | ** ** |
| ** **                                     | ** ** | **(In millions)**                 | ** ** |
| Involuntary  severance related costs           |       |                                   | $          | 4.8 |   |   |
| Lease termination                              |       |                                   | 0.4        |   |   |
| Write-down of  fixed assets                    |       |                                   | 1.6        |   |   |
| Other                                          |       |                                   | 0.1        |   |   |
| Total restructuring and  other related charges |       |                                   | $          | 6.9 |   |   |

 

Involuntary severance related costs of$4.8 million resulted from the elimination of approximately 140 positionsat the Company’s facilities in the United States, Canada, Europe and Asia basedon terminations that were announced in January, April, July and October of2003. These terminations involved all areas of the Company. At December 31,2003, the remaining accrued balance for this charge was approximately$1.5 million and is included in the consolidated balance sheetclassification, “Accrued expenses and other liabilities.”

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At December 31, 2002, the Company had beenleasing a facility in Schaumburg, Illinois that was no longer being occupied.At December 31, 2002, the Company had accrued a total of $1.4 millionrelated to the termination of this lease. On January 31, 2003, the Companyentered into a lease termination agreement with the landlord of the facilityand paid $1.5 million to the landlord to completely terminate any futurerights or obligations under the lease. The $0.1 million excess paymentamount over the established accrual was recorded as restructuring and otherrelated charges in 2003.

A sublease in the Tustin, CA facility was unexpectedlyterminated in 2003. As a result the Company recorded a charge for$0.3 million in 2003 representing the value of remaining sublease paymentsthe Company had expected to receive.

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

During 2003, the Company decided to place certainoffice buildings in St. Hubert, Canada for sale, as those buildings were nolonger used by the Company. The Company classified the buildings asheld-for-sale and wrote down the value of these buildings to estimated fairmarket value, less cost to sell, and recorded a $1.0 million restructuringloss that is included as a component of “Restructuring and other relatedcharges” in the statement of operations. In 2004, the Company sold the buildingand recognized a loss of $0.1 million on such sale. The charge for theloss is included as a component of “other expense” in the statement ofoperations.

There was no restructuringexpense recorded in either 2004 or 2005.

**5—Businessand Credit Concentration**

At December 31, 2005, Lucent Technologies Inc. (“Lucent”)and Ericsson represented 26.2 % and 17.0%, respectively, of the Company’soutstanding net accounts receivable balance. At December 31, 2004, twocustomers, Avaya and a channel partner in the United States, represented 22.4%and 12.2%, respectively, of the Company’s outstanding net accounts receivablebalance.

During 2005 and 2004, onecustomer, Lucent represented 22.6% and 11.7%, respectively, of the Company’stotal revenues. During 2003, two customers, Lucent and a channel partner in theUnited States, represented 15.6% and 12.6%, respectively, of the Company’stotal revenues.

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**6—Investments**

Investmentsin marketable securities categorized as “available for sale” are carried atfair value and consist of the following:

| ** **                             | ** ** | **December 31, 2004** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **Amortized Cost**         | ** ** | **Unrealized Gains** | ** ** | **Unrealized Losses** | ** ** | **Fair  Value** | ** ** |
| ** **                             | ** ** | **(In thousands)**         | ** ** |
| Money market fund                      |       |                            | $          | 10,349 |   |   |   | $— |   |   |   | $— |   |   | $ | 10,349 |   |
| U.S. government  and agency bonds      |       |                            | 46,923     |   |   |   | — |   |   |   | (108 | ) |   | 46,815 |   |
|                                   |       |                            | $          | 57,272 |   |   |   | $— |   |   |   | $ | (108 | ) |   | $ | 57,164 |   |
| Included in cash  and cash equivalents |       |                            | 10,349     |   |   |   | — |   |   |   | — |   |   | 10,349 |   |
| Marketable  securities                 |       |                            | $          | 46,923 |   |   |   | $— |   |   |   | $ | (108 | ) |   | $ | 46,815 |   |

 

| ** **                             | ** ** | **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, 2004 and 2005, all marketablesecurities were due to mature within one year. Proceeds from maturity ofsecurities for the years ended December 31, 2003, 2004 and 2005 were$53.1 million, $14.3 million and $78.4 million, respectively. Therewere no gross realized gains or losses from sale of securities for the yearsended December 31, 2003, 2004 and 2005.

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, 2003and 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.

**7—Inventories**

| ** **                     | ** ** | **December 31,**   | ** ** |
|--------------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **2004**                | ** ** | **2005** | ** ** |
| ** **                     | ** ** | **(In thousands)** | ** ** |
| Raw materials                  |       | $                       | 161        |   | $ | 490 |   |
| Work in process                |       | 323                     |       | 228 |   |
| Finished goods                 |       | 1,207                   |       | 658 |   |
| Inventories at  customer sites |       | 1,755                   |       | 1,468 |   |
| Inventory                      |       | $                       | 3,446      |   | $ | 2,844 |   |

 

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**8—Property and Equipment**

Propertyand equipment consist of the following:

| ** **                    | ** ** | **December 31,**   | ** ** |
|-------------------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **2004**                | ** ** | **2005** | ** ** |
| ** **                    | ** ** | **(In thousands)** | ** ** |
| Computer  equipment           |       | $                       | 16,834     |   | $ | 19,123 |   |
| Computer software             |       | 9,452                   |       | 10,405 |   |
| Furniture and  fixtures       |       | 2,898                   |       | 2,652 |   |
| Machinery and  equipment      |       | 3,651                   |       | 2,211 |   |
| Leasehold  improvements       |       | 5,394                   |       | 5,547 |   |
| Software in  Process          |       | —                  |       | 509 |   |
|                          |       | 38,229                  |       | 40,447 |   |
| Less accumulated depreciation |       | (32,082                 | )          | (33,912 | ) |
|                          |       | $                       | 6,147      |   | 6,535 |   |
|                               |            |                         |            |  |  |  |  |

 

Depreciation andamortization expense related to property and equipment was $7.5 million,$3.9 million and $2.6 million for the years ended December 31, 2003,2004 and 2005, respectively.

**9—Income Taxes**

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

| ** **                                                   | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                   | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**                    | ** ** |
| Current income tax  expense (benefit):                       |       |                                       |       |   |   |   |   |
| Federal                                                      |       | $                                          | —     |   | $ | — |   | $ | — |   |
| State                                                        |       | —                                     |       | — |   | 20 |   |
| Foreign                                                      |       | 115                                        |       | 66 |   | 348 |   |
|                                                         |       | 115                                        |       | 66 |   | 368 |   |
| Deferred income  tax expense (benefit):                      |       |                                       |       |   |   |   |   |
| Federal                                                      |       | —                                     |       | — |   | — |   |
| State                                                        |       | —                                     |       | — |   | — |   |
| Foreign                                                      |       | —                                     |       | — |   | — |   |
|                                                         |       | —                                     |       | — |   | — |   |
|                                                         |       | $                                          | 115        |   | $ | 66 |   | $ | 368 |   |
| Deferred tax  assets (liabilities) consist of the following: |       |                                       |       |   |   |   |   |
| Net operating loss carryforwards                             |       | $                                          | 70,234     |   | $ | 75,103 |   | $ | 71,411 |   |
| Tax credit carryforwards                                     |       | 5,023                                      |       | 5,340 |   | 9,330 |   |
| Capital loss carryforwards                                   |       | 2,614                                      |       | 2,657 |   | 2,885 |   |
| Inventories                                                  |       | 459                                        |       | 514 |   | 505 |   |
| Accrued expenses                                             |       | 706                                        |       | 362 |   | 400 |   |
| Intangible assets                                            |       | 66,867                                     |       | 67,136 |   | 60,522 |   |
| Other                                                        |       | 3,502                                      |       | 3,004 |   | 2,825 |   |
|                                                         |       | $                                          | 149,405    |   | $ | 154,116 |   | $ | 147,878 |   |
| Fixed assets                                                 |       | (963                                       | )          | (635 | ) | (592 | ) |
| Valuation allowance:                                         |       | (148,442                                   | )          | (153,481 | ) | (147,286 | ) |
| Net deferred taxes                                           |       | $                                          | —     |   | $ | — |   | $ | — |   |

 

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For U.S. federal income tax purposes, the Company hadnet operating loss carryforwards available to reduce taxable income ofapproximately $149.4 million at December 31, 2005. Under the provisions 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 will begin to expire in 2006. TheCompany also had foreign net operating loss carryforwards of approximately$36.9 million. As of December 31, 2005, the Company has approximately $6.9million of tax credits in the U.S. that are composed of federal research anddevelopment credits, foreign tax credits and state and local credits. Thesecredits begin to expire in 2006. In addition, the Company has Canadianinvestment tax credits of approximately $3.5 million. These credits begin toexpire in 2014.

The Company has established a valuation allowanceagainst 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. Duringfiscal year 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. The Company will continue to assess thevaluation allowance and to the extent it is determined that such allowance isno longer required, the tax benefit of the remaining net deferred tax assetswill be recognized in the future. Approximately $7.5 million of thevaluation allowance for deferred tax assets relates to the tax benefit fromstock option deductions, which, if realized, will be allocated directly toadditional paid-in capital.

United States income taxes were not provided oncumulative undistributed earnings for certain non-U.S. subsidiaries ofapproximately $1.9 million. The Company intends to reinvest these earningsindefinitely outside the United Stated in its operations.

In December 2004,the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. SFAS109-2 (“SFAS 109-2”), “Accounting and Disclosure Guidance for theForeign Earnings Repatriation Provision within the American Jobs Creation Actof 2004.”  The American Jobs Creation Act of 2004 (“the Act”) was passedin October 2004. The Act contains certain tax incentives including adeduction for income from qualified production activities and an 85% dividendsreceived deduction for certain dividends from controlled foreign corporations. Theseincentives are subject to a number of limitations. At this time, none of theseincentives are expected to have a significant impact on the Company’s incometax liability.

| ** **                                                     | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                     | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| 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) |       | 5.6                                        |       | (30.2 | ) | (19.1 | ) |
| Tax rate and tax  law differential of foreign operations       |       | 4.4                                        |       | (38.1 | ) | (22.6 | ) |
| U.S. federal  research and development credits                 |       | 0.9                                        |       | (12.0 | ) | 5.6 |   |
| Foreign tax  deductions                                        |       | 0.1                                        |       | (5.7 | ) | (7.0 | ) |
| Other tax credits                                              |       | 0.5                                        |       | (7.6 | ) | (11.2 | ) |
| Change in  valuation allowance                                 |       | (40.5                                      | )          | 51.2 |   | 26.8 |   |
| Nondeductible  intangibles                                     |       | (5.7                                       | )          | — |   | — |   |
| Nondeductible  expenses                                        |       | (0.1                                       | )          | 4.4 |   | (0.3 | ) |
| Other                                                          |       | 0.6                                        |       | 5.6 |   | 0.7 |   |
| Effective tax rate                                             |       | (0.2                                       | )%         | 1.6 | % | 6.9 | % |

 

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

| ** ** | ** ** | **Year Ended December 31,** | ** ** |
|------------|------------|--------------------------------------------|------------|
| ** ** | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** ** | ** ** | **(In thousands)**                    | ** ** |
| Domestic   |       | $                                          | (52,074    | ) | $5,741 |   | $ | 8,106 |   |
| Foreign    |       | (3,817                                     | )          | (1,573 | ) | (2,766 | ) |
|       |       | $                                          | (55,891)   |   | $ | 4,168 |   | $ | 5,340 |   |
|            |            |                                            |            |  |  |  |  |  |  |  |

 

**10—AccruedExpenses and Other Liabilities**

Componentsof accrued expenses and other liabilities consist of the following:

| ** **                                       | ** ** | **December 31,**   | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **2004**                | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **(In thousands)** | ** ** |
| Accrued  compensation and related expenses       |       | $                       | 4,692      |   | $ | 5,153 |   |
| Accrued interest  expense                        |       | 212                     |       | — |   |
| Income taxes  payable                            |       | 178                     |       | 556 |   |
| Deferred rent                                    |       | 1,814                   |       | 1,927 |   |
| Accrued  restructuring and other related charges |       | 1,308                   |       | 916 |   |
| Other liabilities                                |       | 2,502                   |       | 1,842 |   |
|                                             |       | $                       | 10,706     |   | $ | 10,394 |   |

 

**11—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. Unamortized issuance costs of $0.1 million at December 31,2004 are included in the 2004 consolidated balance sheet caption “Other assets.”These issuance costs were fully amortized at December 31, 2005.

For the years ended December 31,2003, 2004 and 2005, the Company paid $9.3 million, $38.5 million and $20.9million, respectively, to extinguish $11.3 million, $37.8 million and$19.9 million,  respectively, of facevalue of the Notes. As a result, in the years ended December 31, 2003,2004 and 2005, the Company wrote off $0.2 million, $0.9 million and0.1 million respectively, of unamortized debt issuance costs and recorded arelated gain (loss) of $2.1 million and $(0.3) million, respectively inother income and expense on the income statement. In 2005, the Company did notincur any related losses or gains associated with the repayment of its debt.

**12—Profit Sharing Plans**

The Company hasestablished a 401(k) cash or deferred profit sharing plan covering alleligible full-time employees of the Company. Contributions to the 401(k) planare made by the participants to their 

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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’s compensation,not to exceed the federal limit of $14,000 per calendar year. The employercontribution for the years ended December 31, 2003, 2004 and 2005 was$0.8 million, $0.5 million and $0.6 million, respectively.

**13—Equity**

**Common Stock Offering**

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 theoffering were $49.5 million. In April 2004, the Company invested thenet proceeds of this offering in interest-bearing, investment-grade securities.

**Stock Repurchase Program**

During 2001, the Board ofDirectors approved a stock repurchase program authorizing the Company torepurchase up to 2,500,000 shares of its outstanding common stock for an aggregatepurchase price not to exceed $5.0 million. The Company made no repurchasesduring 2003, 2004 or 2005 but as of December 31, 2003, the Company hadrepurchased 915,000 shares for an aggregate purchase price of$4.7 million. There were 52,444 treasury shares outstanding as of December 31,2003. During 2004, the remaining 52,444 treasury shares were issued inconjunction with the exercise of stock options in 2004. There were no treasuryshares outstanding as of December 31, 2004 or 2005.

**Preferred Stock**

Under its restatedcertificate of incorporation the Company has authorized 3,000,000 shares ofpreferred stock, par value $0.01 per share. As of December 31, 2004 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 Rights Plan**

The Company’s Board ofDirectors adopted a Stockholders Rights Plan (“the Rights Plan”) on December23, 1998, under which a dividend of one Common Stock Purchase Right (each a“Right”) was declared for and attached to each outstanding share of theCompany’s Common Stock, $0.01 par value per share (“Common Stock”) held bystockholders of record as of January 4, 1999. The Rights Plan was amended onApril 22, 1999. Shares of Common Stock issued after December 23, 1998 alsocontain such Rights. The Rights become exercisable following the tenth dayafter a person 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 

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to twotimes the Purchase Price of the Right for the Purchase Price, once the Rightsbecome exercisable. Under some circumstances, the Board of Directors of theCompany may exchange the Rights at an exchange rate of one Share of CommonStock per Right. Rights are redeemable at the Company’s option for $0.01 perRight at any time after the acquisition of 15% or more of the Company’s CommonStock. As of December 31, 2005, none of the Rights are exercisable. TheRights expire on the earliest of (a) December 23, 2008, (b) exchangeor redemption of the Rights as described above, or (c) consummation of a mergeror consolidation or sale of assets resulting in termination of the Rights. 

**14—StockOption and Stock Purchase Plans**

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 Option Plan**

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, directors and consultants. Options granted under the 1993 Plangenerally vest over 4 years. The expiration dates of options granted underthe 1993 Plan do not exceed 10 years. In March 1998, the Board ofDirectors adopted and in April 1998, the Company’s stockholders approved (i) anincrease in the number of shares available under the 1993 Plan from 3,000,000to 3,800,000 and (ii) a requirement that the exercise price of optionsgranted under the 1993 Plan be at least equal to the fair market value of theCompany’s common stock on the date of grant. In March 2000, the Board ofDirectors superseded the 1993 Plan with the Company’s 2000 Equity IncentivePlan (the “2000 Plan”) and no further grants under the 1993 Plan will be madeafter the adoption of the 2000 Plan. Options granted previously under the 1993Plan will continue to be governed by the terms of the 1993 Plan. As of December 31,2005 there are 564,000 options outstanding under the 1993 Plan. The outstandingoptions under the 1993 Plan are fully vested as of December 31, 2005.

**1993Non-Employee Directors 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 pursuant to the grant of non-statutory stock optionsto directors who are not employees of the Company. Option granted under theDirectors Plan generally vest over 4 years. The expiration dates ofoptions granted under the Directors Plan do not exceed 10 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 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 Directors Planfrom 240,000 to 480,000 shares. The exercise price of the options may not beless 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 Plan and no further grants under the DirectorsPlan will be made after the adoption of the 2000 Plan. As of December 31,2004, 280,000 shares had been granted at prices ranging from $2.44 to $24.63per share. As of December 31, 2005, there are 113,410 options outstandingunder the Directors Plan. The outstanding options under the Directors Plan arefully vested as of December 31, 2005. Options granted previously under theDirectors Plan will continue to be governed by the terms of the Directors Plan.

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**1995Non-Statutory Stock Option Plan**

In October 1995, the Company’s Board of Directorsadopted the 1995 Non-Statutory Stock Option Plan (the “1995 Plan”). The 1995Plan expired in October, 2005.

The exercise price ofoptions outstanding under the 1995 Plan are not less than 100% of the fair market value of the company’s commonstock on the date of grant. Options outstanding under the 1995 Plan generallyvest over 2 years. The expiration dates of options granted under the 1995Plan do not exceed 10 years. As of December 31, 2005, there are2,699,852 options outstanding under the 1995 Plan.

**2000 Equity Incentive 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 providesfor the grant of incentive stock options and stock appreciation rights toemployees and non-statutory stock options, stock bonuses, rights to purchaserestricted stock and other awards based on the Company’s common stock(collectively, “Stock Awards”) to employees, non-employee directors andconsultants. On April 28, 2005 the Company’s shareholders 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, asamended,  is 7,050,000 plus any shares ofthe Company’s common stock represented by options granted under the 1993 Planand the Directors Plan (both of which are superseded by the 2000 Plan) whichare forfeited, expire or are canceled. The exercise price of options grantedpursuant to the 2000 Plan may not be less than the fair market value of thecompany’s common stock on the date of grant. Options granted under the 2000Plan generally vest over 2 years. Options granted to new hires generallyvest over 3 years. The expiration dates of options granted under the 2000Plan do not exceed 10 years. As of December 31, 2005, there are4,302,046 options outstanding under the 2000 Plan.

**2003 Employee Stock Purchase Plan**

In March 2003, the Board of Directors adopted andin April 2003 the Company’s stockholders approved the 2003 Employee StockPurchase Plan (the “Purchase Plan”). The Purchase Plan permits employees andofficers of the Company to participate in periodic plan offerings, in whichpayroll deductions may be used to purchase shares of common stock. The purchaseprice is 85% of the lower of the fair market value at the date the offering commencesor terminates. The Company has reserved 750,000 shares for the Purchase Plan.During 2005, 144,862 shares were issued under the Purchase Plan at a weightedaverage price of $2.71 per share.

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A summaryof the transactions under all stock option plans for the three years ended December 31,2005 is as follows:

| ** **                          | ** ** | **Year Ended  December 31, 2003** | ** ** | **Year Ended  December 31, 2004** | ** ** | **Year Ended  December 31, 2005** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **Options**                                      | ** ** | **Weighted  Average  Exercise  Price**           | ** ** | **Options**                                      | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding at  beginning of period |       | 8,674,691                                        |       |                                             | $          | 10.84                                            |       |   | 8,901,814 |   |   | $ | 8.54 |   |   | 8,626,392 |   |   | $ | 8.03 |   |   |
| Granted                             |       | 2,381,195                                        |       |                                             | 1.66       |                                             |       | 1,818,944 |   |   | 6.30 |   |   | 2,401,202 |   |   | 3.49 |   |   |
| Exercised                           |       | (297,015                                         | )          |                                             | 3.03       |                                             |       | (1,337,299 | ) |   | 2.91 |   |   | (908,086 | ) |   | 1.74 |   |   |
| Forfeited or  expired               |       | (1,857,057                                       | )          |                                             | 11.41      |                                             |       | (757,067 | ) |   | 19.10 |   |   | (2,440,200 | ) |   | 15.74 |   |   |
| Outstanding at  end of period       |       | 8,901,814                                        |       |                                             | 8.54       |                                             |       | 8,626,392 |   |   | 8.03 |   |   | 7,679,308 |   |   | 4.90 |   |   |
| Exercisable at end of  period       |       | 6,201,820                                        |       |                                             | 11.38      |                                             |       | 6,016,546 |   |   | 9.37 |   |   | 5,551,917 |   |   | 5.52 |   |   |

 

Thefollowing table summarizes outstanding stock options as of December 31,2005:

| **Range of Exercise Prices** | ** ** | ** ** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Average  Exercise Price** | ** ** |
|---------------------------------------------|------------|------------|------------|-------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------|------------|-------------------------|------------|----------------------------------|------------|
| $0.01—$5.00                            |       |       | 5,323,335  |                    |       |                                                | 3.2        |                                       |       |                    | $          | 3.05                             |       |   | 3,224,658 |   |   | $ | 2.93 |   |   |
| $5.01—$10.00                           |       |       | 1,985,635  |                    |       |                                                | 2.4        |                                       |       |                    | 7.14       |                             |       | 1,956,921 |   |   | 7.16 |   |   |
| $10.01—$20.00                          |       |       | 151,600    |                    |       |                                                | 1.4        |                                       |       |                    | 13.01      |                             |       | 151,600 |   |   | 13.01 |   |   |
| $20.01—$30.00                          |       |       | 91,508     |                    |       |                                                | 2.1        |                                       |       |                    | 17.38      |                             |       | 91,508 |   |   | 17.38 |   |   |
| $30.01—$40.00                          |       |       | 77,000     |                    |       |                                                | 3.2        |                                       |       |                    | 24.43      |                             |       | 77,000 |   |   | 24.43 |   |   |
| $40.01—$50.00                          |       |       | 43,730     |                    |       |                                                | 1.7        |                                       |       |                    | 33.11      |                             |       | 43,730 |   |   | 33.11 |   |   |
| $50.01—$60.00                          |       |       | 6,500      |                    |       |                                                | 1.5        |                                       |       |                    | 45.19      |                             |       | 6,500 |   |   | 45.19 |   |   |
|                                        |       |       | 7,679,308  |                    |       |                                                | 3.0        |                                       |       |                    | $          | 4.90                             |       |   | 5,551,917 |   |   | $ | 5.52 |   |   |

 

As of December 31,2005, a total of 11,340,761 shares of common stock have been reserved forissuance upon the exercise of stock options.

**Option Forfeiture**

On October 28, 2002,certain officers and members of upper management of the Company forfeited atotal of 808,000 outstanding common stock options. These options were grantedat various times from April 28, 2000 to October 13, 2000 at exerciseprices ranging from $30.94 to $56.69. Upon the date of forfeiture, the fairvalue of the options was immaterial. The forfeited option shares will be usedfor future grants to the Company’s employees in the ordinary course ofbusiness. Although some or all of the participants in this forfeiture may fromtime to time receive future grants in the ordinary course of business, therewere no agreements, arrangements or obligations between the Company and theseparticipants for subsequent option grants to these individuals.

**15—Commitmentsand Contingencies**

**Leases**

The Company leases itscurrent corporate headquarters office facilities under non-cancelable leasesextending to May 31, 2012. The Company occupies other facilities underleases, which expire within one to four years. Rental expenses under alloperating lease agreements in effect during the years ended 

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December 31,2003, 2004 and 2005 amount to approximately $4.0 million,$5.2 million and $4.5 million, respectively.

The Company has variousother facilities which serve as sales offices throughout North America, Europeand Asia that have short-term leases. The Company believes that the existingfacilities are adequate for its current needs and that suitable space will beavailable to meet future needs.

At December 31,2005, commitments under operating leases for minimum future payments consist ofthe following, of which $0.9 million of these future operating leasepayments have been accrued as part of the Company’s restructuring and otherrelated charges and will not impact the Company’s results of operations in futureperiods:

| **Year ending December 31,** | ** ** | **(In thousands)** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| 2006                                        |       |                    | $          | 4,090 |   |   |
| 2007                                        |       |                    | 3,514      |   |   |
| 2008                                        |       |                    | 3,215      |   |   |
| 2009                                        |       |                    | 2,930      |   |   |
| 2010                                        |       |                    | 2,835      |   |   |
| Thereafter                                  |       |                    | 3,950      |   |   |
|                                        |       |                    | $          | 20,534 |   |   |

 

**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. At December 31,2004 and 2005, the Company had met the eight turn goal in all precedingquarters. As such, the Company does not have any contractual obligationsrelated to a commitment with Plexus at December 31, 2004 and 2005. TheCompany can only ascribe value to such commitment when the Company has not metthe condition as determined at a specific point in time, based on future factsand circumstances. Plexus is the Company’s only third-party contractmanufacturer with this type of requirement. As such, NMS is not party to anyother such arrangements with its other third-party manufacturers.

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**Guarantees**

The Company’s hardware products are generally soldwith a 18-24 month warranty period. Parts and labor are coveredunder the terms of the warranty agreement. The warranty provision is based onhistorical experience by product, configuration and geographic region.

Changesin the warranty reserves were as follows:

| ** **               | ** ** | **December 31,**   | ** ** |
|--------------------------|------------|-------------------------|------------|
| ** **               | ** ** | **2004**                | ** ** | **2005** | ** ** |
| ** **               | ** ** | **(In thousands)** | ** ** |
| Beginning balance        |       | $                       | 332        |   | $ | 342 |   |
| Provisions for  warranty |       | 250                     |       | 196 |   |
| Expenditures             |       | (240                    | )          | (168 | ) |
| Ending balance           |       | $                       | 342        |   | $ | 370 |   |

 

As noted above, theCompany’s products are generally sold with an 18-24 month warranty.Accordingly, current warranty provisions are related to the past one and a halfto two years’ revenues and warranty consumption is associated with current andprior year’s revenues.

**Indemnification**

The Company enters into indemnification agreementswith certain of its customers in its ordinary course of business. Pursuant tothese agreements the Company agrees that, subject to certain limitations, inthe event its products infringe upon any proprietary right of a third party, itwill indemnify its customer against any loss, expense or liability from anydamages that may be awarded against the Customer. There have been no claimsbrought against the Company under 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.

**16—Segmentand Geographic Information**

In order to achieve focus and domain knowledge in themarket segments where the Company has chosen to compete, the Company hasorganized the Company’s product management and development activities aroundspecific target markets. The Company’s Platform Solutions (PS) business unitfocuses on systems building blocks or enabling technology solutions that aretargeted toward communications solution providers such as network equipmentproviders, application developers and systems integrators. The PS business unitalso manages the Company’s voice quality systems (VQS) product lines, as the Companyincreasingly sees these technologies being delivered to customers as systemsbuilding blocks or enabling technologies. Previously VQS products were includedin the Network Infrastructure (NI) business unit and as a separate unit before2005. The Mobile Applications (MA) business unit, previously referred to asNetwork Solutions (NS), is aimed at delivering mobile solutions and relatedservices to mobile operators and the NI business unit is focused on solutionstargeted at the radio access network (RAN) portion of mobile operators’infrastructure. The Company’s product and service offerings are described indetail in the business section of this report. In addition to the PS, MA and NIbusiness segments, the Company has a Corporate business segment. The Corporatebusiness segment contains all changes related to goodwill, intangible assets,impairment and restructuring. All periods presented have been retroactivelyrestated to reflect current segments.

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Thefollowing table presents the Company’s revenues and operating loss, by businessunit and by geography.

| **(In thousands)**                 | ** ** | ** ** | ** ** | **PS** | ** ** | **MA**  | ** ** | **NI**  | ** ** | **Corporate** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|------------|------------|--------|------------|---------|------------|---------|------------|---------------|------------|-----------|------------|
| Revenues:                               |       |       |       |   |       |    |       |    |       |          |       |
| 2003                                    |       | $          | 86,941     |   | $          | 113     |       | $       | 93         |          | $          | —    |       | $ | 87,147 |   |
| 2004                                    |       | 100,830    |       | 369    |       | 313     |       | —  |       | 101,512       |       |
| 2005                                    |       | 101,790    |       | 6,769  |       | 915     |       | —  |       | 109,474       |       |
| Income (loss)  from operations:         |       |       |       |   |       |    |       |    |       |          |       |
| 2003                                    |       | $          | 10,554     |   | $          | (12,043 | )          | $       | (5,267     | )             | $          | (47,576   | )          | $ | (54,332 | ) |
| 2004                                    |       | 32,267     |       | (9,438 | )          | (9,663  | )          | (7,366  | )          | 5,800         |       |
| 2005                                    |       | 37,232     |       | (8,303 | )          | (11,243 | )          | (13,701 | )          | 3,985         |       |
| Capital  expenditures:                  |       |       |       |   |       |    |       |    |       |          |       |
| 2003                                    |       | $          | 833        |   | $          | 803     |       | $       | 172        |          | $          | 628       |       | $ | 2,436 |   |
| 2004                                    |       | 819        |       | 16     |       | 571     |       | 962     |       | 2,368         |       |
| 2005                                    |       | 723        |       | 507    |       | 540     |       | 1,567   |       | 3,337         |       |
| Depreciation and  amortization expense: |       |       |       |   |       |    |       |    |       |          |       |
| 2003                                    |       | $          | 3,966      |   | $          | 768     |       | $       | 95         |          | $          | 4,684     |       | $ | 9,513 |   |
| 2004                                    |       | 2,252      |       | 21     |       | 80      |       | 1,545   |       | 3,898         |       |
| 2005                                    |       | 768        |       | 136    |       | 422     |       | 1,445   |       | 2,771         |       |
| Total assets:                           |       |       |       |   |       |    |       |    |       |          |       |
| 2004                                    |       | $          | 17,237     |   | $          | 548     |       | $       | 1,624      |          | $          | 89,018    |       | $ | 108,427 |   |
| 2005                                    |       | 16,454     |       | 4,394  |       | 1,005   |       | 71,450  |       | 93,303        |       |
| Long-lived  assets:                     |       |       |       |   |       |    |       |    |       |          |       |
| 2004                                    |       | $          | 1,223      |   | $          | 12      |       | $       | 657        |          | $          | 4,255     |       | $ | 6,147 |   |
| 2005                                    |       | 1,211      |       | 256    |       | 648     |       | 4,420   |       | 6,535         |       |

 

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

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As of December 31,2005 the Company had operations established in 12 countries outside the UnitedStates and its products are sold throughout the world. The Company is exposedto the risk of changes in social, political and economic conditions inherent inforeign operations and the Company’s results of operations and the value of itsforeign assets are affected by fluctuations in foreign currency exchange rates.The following table presents the Company’s revenues, operating income (loss),total assets, long-lived assets, capital expenditures, and depreciation andamortization expense by geographic region. Revenues by geographic region arepresented by attributing revenues from external customers on the basis of whereproducts are sold. “Rest of World” is Latin America and properly reflects howthe regions are analyzed by senior management. The previous years have been retroactivelyrestated to define the “Rest of World” Latin America. As the Company sellsthrough a series of regional distributors, tracking revenues by country isimpracticable. For the years ended December 31, 2003, 2004 and 2005, theloss from operations for “North America” includes all impairment losses andacquisition related amortization expenses.

| **(In thousands)**                 | ** ** | ** ** | ** ** | **North America** | ** ** | **Europe** | ** ** | **Asia** | ** ** | **Rest of World** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|------------|------------|------------------------|------------|------------|------------|----------|------------|-----------------------------|------------|-----------|------------|
| Revenues:                               |       |       |       |                   |       |       |       |     |       |                        |       |      |       |   |   |
| 2003                                    |       |       | $          | 46,597                 |       |       | $          | 15,252   |       | $                           | 24,086     |      |       | $ | 1,212 |   |   | $ | 87,147 |   |
| 2004                                    |       |       | 53,401     |                   |       | 20,446     |       | 26,602   |       |                        | 1,063      |      |       | 101,512 |   |
| 2005                                    |       |       | 37,843     |                   |       | 24,295     |       | 44,023   |       |                        | 3,313      |      |       | 109,474 |   |
| Income (loss) from  operations:         |       |       |       |                   |       |       |       |     |       |                        |       |      |       |   |   |
| 2003                                    |       |       | $          | (67,054                | )          |       | $          | (2,880   | )          | $                           | 14,405     |      |       | $ | 1,197 |   |   | $ | (54,332 | ) |
| 2004                                    |       |       | (21,395    | )                      |       | 9,055      |       | 17,222   |       |                        | 918        |      |       | 5,800 |   |
| 2005                                    |       |       | (23,516    | )                      |       | (510       | )          | 25,484   |       |                        | 2,527      |      |       | 3,985 |   |
| Capital expenditures:                   |       |       |       |                   |       |       |       |     |       |                        |       |      |       |   |   |
| 2003                                    |       |       | $          | 2,371                  |       |       | $          | 58       |       | $                           | 7          |      |       | $ | — |   |   | $ | 2,436 |   |
| 2004                                    |       |       | 2,264      |                   |       | 94         |       | 10       |       |                        | —     |      |       | 2,368 |   |
| 2005                                    |       |       | 3,135      |                   |       | 48         |       | 154      |       |                        | —     |      |       | 3,337 |   |
| Depreciation and  amortization expense: |       |       |       |                   |       |       |       |     |       |                        |       |      |       |   |   |
| 2003                                    |       |       | $          | 8,562                  |       |       | $          | 734      |       | $                           | 217        |      |       | $ | — |   |   | $ | 9,513 |   |
| 2004                                    |       |       | 3,786      |                   |       | 38         |       | 74       |       |                        | —     |      |       | 3,898 |   |
| 2005                                    |       |       | 2,682      |                   |       | 56         |       | 33       |       |                        | —     |      |       | 2,771 |   |
| Total assets:                           |       |       |       |                   |       |       |       |     |       |                        |       |      |       |   |   |
| 2004                                    |       |       | $          | 97,950                 |       |       | $          | 6,618    |       | $                           | 3,859      |      |       | $ | — |   |   | $ | 108,427 |   |
| 2005                                    |       |       | 82,329     |                   |       | 6,092      |       | 4,882    |       |                        | —     |      |       | 93,303 |   |
| Long-lived assets:                      |       |       |       |                   |       |       |       |     |       |                        |       |      |       |   |   |
| 2004                                    |       |       | $          | 6,018                  |       |       | $          | 110      |       | $                           | 19         |      |       | $ | — |   |   | $ | 6,147 |   |
| 2005                                    |       |       | 6,317      |                   |       | 79         |       | 139      |       |                        | —     |      |       | 6,535 |   |

 

**17—Subsequent Events**

On February 13, 2006,the Company entered into an Agreement and Plan of Merger (the “*Merger Agreement*”) by and among the Company, OrcaAcquisition Corporation, a wholly-owned subsidiary of NMS (“*Sub*”), Openera Technologies, Inc. (“*Openera*”), certain of the stockholders of Openera, certainother individuals and Joel A. Hughes, as Stockholder Representative, to acquireall of the issued and outstanding capital stock of Openera for considerationconsisting of approximately 4.34 million shares (the “*MergerShares*”) of the Company’s common stock. Approximately 51% of theMerger Shares will be contingent upon the continued employment of certain keyemployees of Openera over the 30-month period following the closing ofthe Merger. The closing of the Merger occurred on February 24, 2006.Pursuant to the Merger Agreement, Sub was merged with and into Openera withOpenera continuing as the surviving corporation and a wholly-owned subsidiaryof the Company (the “*Merger*”). Pursuantto the 

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Mergerthe Company assumed the Openera Technologies, Inc. 2005 Equity IncentivePlan. The Company will account for the acquisition as a purchase, andaccordingly, the Company will include the results of operations of Openera inits operating results from February 24, 2006. Openera, whose operationsare based primarily in Bangalore, India, is a provider of mobile applicationhandset solutions for converged mobile networks.

**18—QuarterlyInformation (Unaudited)**

| ** **                                              | ** ** | **Quarter Ended**                                                | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **Mar. 31,  2004**                                               | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** | **Dec. 31,  2004** | ** ** | **Mar. 31,  2005** | ** ** | **June 30,  2005** | ** ** | **Sept. 30,  2005** | ** ** | **Dec. 31,  2005** | ** ** |
| ** **                                              | ** ** | **(Unaudited)**                                                       | ** ** |
| ** **                                              | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenues                                                |       |                                                                  | $          | 24,379 |   |   |   | $ | 25,262 |   |   |   | $ | 25,693 |   |   |   | $ | 26,178 |   |   |   | $ | 22,600 |   |   |   | $ | 24,919 |   |   |   | $ | 30,271 |   |   |   | $ | 31,684 |   |   |
| Cost of revenues                                        |       |                                                                  | 8,822      |   |   |   | 9,722 |   |   |   | 9,477 |   |   |   | 10,031 |   |   |   | 9,518 |   |   |   | 9,394 |   |   |   | 10,083 |   |   |   | 10,425 |   |   |
| Gross profit                                            |       |                                                                  | 15,557     |   |   |   | 15,540 |   |   |   | 16,216 |   |   |   | 16,147 |   |   |   | 13,082 |   |   |   | 15,525 |   |   |   | 20,188 |   |   |   | 21,259 |   |   |
| Operating  expenses:                                    |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative                     |       |                                                                  | 8,090      |   |   |   | 7,981 |   |   |   | 8,727 |   |   |   | 8,978 |   |   |   | 8,942 |   |   |   | 9,344 |   |   |   | 10,078 |   |   |   | 11,565 |   |   |
| Research and development                                |       |                                                                  | 5,961      |   |   |   | 6,187 |   |   |   | 5,906 |   |   |   | 5,831 |   |   |   | 6,192 |   |   |   | 6,323 |   |   |   | 6,837 |   |   |   | 6,788 |   |   |
| Total operating expenses                                |       |                                                                  | 14,051     |   |   |   | 14,168 |   |   |   | 14,633 |   |   |   | 14,809 |   |   |   | 15,134 |   |   |   | 15,667 |   |   |   | 16,915 |   |   |   | 18,353 |   |   |
| Operating income  (loss)                                |       |                                                                  | 1,506      |   |   |   | 1,372 |   |   |   | 1,583 |   |   |   | 1,338 |   |   |   | (2,052 | ) |   |   | (142 | ) |   |   | 3,273 |   |   |   | 2,906 |   |   |
| Other income  (expense), net                            |       |                                                                  | (838       | ) |   |   | (320 | ) |   |   | (453 | ) |   |   | (21 | ) |   |   | 150 |   |   |   | 485 |   |   |   | 117 |   |   |   | 603 |   |   |
| Income (loss)  before income taxes                 |       |                                                                  | 668        |   |   |   | 1,052 |   |   |   | 1,130 |   |   |   | 1,317 |   |   |   | (1,902 | ) |   |   | 343 |   |   |   | 3,390 |   |   |   | 3,509 |   |   |
| Income tax expense  (benefit)                           |       |                                                                  | 25         |   |   |   | 16 |   |   |   | 24 |   |   |   | — |   |   |   | 200 |   |   |   | 285 |   |   |   | 63 |   |   |   | (180 | ) |   |
| Net income (loss)                                       |       |                                                                  | $          | 643 |   |   |   | $ | 1,036 |   |   |   | $ | 1,106 |   |   |   | $ | 1,317 |   |   |   | $ | (2,102 | ) |   |   | $ | 58 |   |   |   | $ | 3,327 |   |   |   | $ | 3,689 |   |   |
| Basic and diluted net  earnings (loss) per common share |       |                                                                  | $          | 0.02 |   |   |   | $ | 0.02 |   |   |   | $ | 0.02 |   |   |   | $ | 0.03 |   |   |   | $ | (0.02 |   |   |   | $ | 0.00 |   |   |   | $ | 0.07 |   |   |   | $ | 0.08 |   |   |

 

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**VALUATION AND QUALIFYING ACCOUNTS**

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

**Allowancefor Doubtful Accounts**

| ** ** | ** ** | **Balance at  Beginning of Year** | ** ** | **Additions** | ** ** | **Deductions(1)** | ** ** | **Balance at  End of Year** | ** ** |
|------------|------------|--------------------------------------------------|------------|---------------|------------|-------------------|------------|--------------------------------------------|------------|
| 12/31/03   |       |                                             | $          | 979           |       |              |       | $                                          | 124        |   |   |   | $ | (108 | ) |   |   | $ | 995 |   |   |
| 12/31/04   |       |                                             | $          | 995           |       |              |       | $                                          | 151        |   |   |   | $ | (142 | ) |   |   | $ | 1,004 |   |   |
| 12/31/05   |       |                                             | $          | 1,004         |       |              |       | $                                          | 23         |   |   |   | $ | (233 | ) |   |   | $ | 794 |   |   |

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(1)          Amounts includewrite-offs of accounts receivable deemed to be uncollectible.

**DeferredTax Valuation Allowance**

| ** ** | ** ** | **Balance at  Beginning of Year** | ** ** | **Additions** | ** ** | **Deductions** | ** ** | **Balance at  End of Year** | ** ** |
|------------|------------|--------------------------------------------------|------------|---------------|------------|----------------|------------|--------------------------------------------|------------|
| 12/31/03   |       |                                             | $          | (118,017      | )          |           | $          | (30,425                                    | )          |   | $ | — |   |   | $ | (148,442 | ) |
| 12/31/04   |       |                                             | $          | (148,442      | )          |           | $          | (5,039                                     | )          |   | $ | — |   |   | $ | (153,481 | ) |
| 12/31/05   |       |                                             | $          | (153,481      | )          |           | $          | —                                     |       |   | $ | 6,195 |   |   | $ | (147,286 | ) |

 

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**ITEM9.**   CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

**ITEM 9A.   CONTROLS AND 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, 2005, the end of the period coveredby this report, our disclosure controls and procedures were effective.

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

As disclosed in our quarterly report on Form 10-Qfor the quarter ended September 30, 2005, we identified our failure tomaintain effective controls over the completeness and accuracy of ourrecognition of product revenues and the associated deferred revenue account asa material weakness in our internal controls over financial reporting. Thiscontrol deficiency resulted in the restatement of our consolidated financialstatements for the quarter ended June 30, 2005, as reflected in our Form 10-Q/Afiled with the Securities and Exchange Commission on November 9, 2005.

During the third and fourth quarters of 2005, theCompany took corrective actions to remediate the material weakness identifiedabove. These corrective actions included the hiring of additional accountingpersonnel, changing the reporting responsibilities within the accounting groupand streamlining the process of gathering relevant sales and accountingdocuments and information as they relate to revenue transactions.

Other than as describedabove, there were no changes in our internal control over financial reporting,as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f),that occurred during the fiscal quarter ended December 31, 2005 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

**C.   Management’sReport on Internal Control Over Financial Reporting**

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and15d-15(f). Our management, including our principal executive officer andprincipal financial officer, conducted an evaluation of the effectiveness ofour internal control over financial reporting as of December 31, 2005based on the framework in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Based on its evaluation under the framework in *Internal Control—Integrated Framework*, ourmanagement concluded that our internal control over financial reporting waseffective as of December 31, 2005. Our management’s assessment of theeffectiveness of our internal control over financial reporting as of December 31,2005 has been audited by PricewaterhouseCoopers LLP, an independent registeredpublic accounting firm, as stated in their report which is included in thisAnnual Report on Form 10-K.

**ITEM 9B.   OTHER INFORMATION**

None.

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**PART III**

**ITEM10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

Thefollowing table lists our directors as of December 31, 2005:

| **Name**                    | ** ** | ** ** | ** ** | **Age**                                                       | ** ** | **Position** |
|-----------------------------|------------|------------|------------|---------------------------------------------------------------|------------|--------------|
| Robert P. Schechter         |       | 57         |       | Chairman of the Board, President and Chief Executive  Officer |
| William E. Foster(2)        |       | 61         |       | Director                                                      |
| Ofer Gneezy(1)              |       | 54         |       | Director                                                      |
| W. Frank King,  Ph.D.(1)(3) |       | 66         |       | Director                                                      |
| Pamela D. A. Reeve(1)(3)    |       | 56         |       | Director                                                      |
| Ronald W. White(2)          |       | 65         |       | 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.

*RobertP. Schechter*has served as the Company’s President andChief Executive Officer since 1995 and as Chairman of the Board since 1996.From 1987 to 1994, Mr. Schechter held various senior executive positionswith Lotus Development Corporation, and from 1980 to 1987 he was a partner ofCoopers and Lybrand LLP. Mr. Schechter is also a director of MapInfoCorporation, a developer of location-based software services and solutions,Moldflow Corporation, a provider of software solutions for optimizing thedesign and manufacture of plastic products, Unica Corporation, a developer ofEnterprise Marketing Management Software solutions and Avici Systems, Inc.,a provider of carrier-class routing solutions for the Internet.

*WilliamE. Foster*has served as a director of our Companysince 2000. Mr, Foster has been, since 1997, a private investor. In 1980, Mr. Fosterco-founded Stratus Computer, Inc., a manufacturer of fault-tolerantcomputer systems and served as its Chairman and Chief Executive Officer until 1997.Prior to 1980, Mr. Foster spent 14 years in the computer industry,serving as Vice President of Software for Data General Corporation and inmanagement and technical positions with Hewlett Packard Company. Mr. Fosteris a director of several privately held companies.

*OferGneezy*has served as a director of our Company since2000. Mr. Gneezy was a co-founder, and has been, since 1996, President,Chief Executive Officer and a director of iBasis, Inc., a provider ofInternet-based communications services for international carriers. From 1994 to1996, Mr. Gneezy served as President of Acuity Imaging, Inc., amultinational company focused on the industrial automation industry. From 1980to 1994, he was an executive of Automatix Inc. (a predecessor to Acuity Imaging),an industrial automation company, most recently serving as its President andChief Executive Officer.

*W.Frank King, Ph.D.*has served as a director of ourCompany since 1997. Dr. King has been, since 1998, a private investor.From 1992 to 1998, he was Chief Executive Officer and a director of PSWTechnologies, Inc., a provider of software services. From 1988 to 1992, Dr. Kingwas a Senior Vice President of Development of Lotus Development Corporation andfor the previous 19 years served in various positions with IBM Corporation,including his last position as Vice President Development for the entry systemdivision. He is a director of eOn Communications Corporation., a provider oftelecommunications applications, Concero Inc., formerly known as PSWTechnologies, Inc., and iBasis, Inc., a provider of Internet-basedcommunications services

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*PamelaD. A. Reeve*has served as a director of our Companysince 1997. Ms. Reeve has been, since 2004, a management consultant. Ms.Reeve served from 1993 to 2004 as Chief Executive Officer and a director and,from 1989 to 1993, as President, Chief Operating Officer and a director ofLightbridge, Inc., a provider of products and services which enablewireless telecommunications carriers to improve customer acquisition andretention processes. From 1978 to 1989, she was with The Boston ConsultingGroup, a management consulting firm. Ms. Reeve is a director of AmericanTower Corporation, a provider of infrastructure facilities and services to thewireless, Internet and broadcasting industries.

*RonaldW. White*has served as a director of our Company since1988. Mr. White, has been, since 2002, a consultant and private investor.From 1997 until 2002, he was a partner of Argo Global Capital, a venturecapital firm. From 1983 until 2002, he was a partner of Advanced TechnologyDevelopment Fund, also a venture capital firm. Mr. White is a director ofAirNet Communications, a provider of infrastructure solutions for commercialGSM customers and government agencies.

Thefollowing table lists our executive officers as of December 31, 2005:

| **Name**                 | ** ** | ** ** | ** ** | **Age**                                                                                 | ** ** | **Position** |
|--------------------------|------------|------------|------------|-----------------------------------------------------------------------------------------|------------|--------------|
| Robert P. Schechter      |       | 57         |       | Chairman of the Board,  President and Chief Executive Officer                           |
| Herbert Shumway          |       | 58         |       | Treasurer, Senior Vice President of Finance and  Operations and Chief Financial Officer |
| R. Brough Turner         |       | 59         |       | Senior Vice President of  Technology                                                    |
| Gerrold Walker           |       | 55         |       | Vice President and  General Manager, Platform Solutions                                 |
| Daniel Daly              |       | 49         |       | Vice President and  General Manager, Network Infrastructure                             |
| Paul J. Deeley, Jr. |       | 35         |       | Vice President, Corporate Controller and Chief  Accounting Officer                      |

 

*RobertP. Schechter*has served as the Company’s President andChief Executive Officer since 1995 and as Chairman of the Board since 1996.From 1987 to 1994, Mr. Schechter held various senior executive positionswith Lotus Development Corporation, and from 1980 to 1987 he was a partner ofCoopers and Lybrand LLP. Mr. Schechter is also a director of MapInfoCorporation, a developer of location-based software services and solutions,Moldflow Corporation, a provider of software solutions for optimizing thedesign and manufacture of plastic products, Unica Corporation, a developer ofEnterprise Marketing Management Software solutions and Avici Systems, Inc.,a provider of carrier-class routing solutions for the Internet.

*HerbertShumway*joined our Company in 2000 as Vice Presidentof Supply Chain Operations. Prior to his current position, Mr. Shumwayserved as Vice President, Operations, which included Corporate Quality,Technical Services, and Information Technology. Mr. Shumway continues toserve in this capacity in addition to his other responsibilities. Mr. Shumwayhas over 20 years experience in the high-tech industry, including executivepositions in operations and business development with Compaq Computer andDigital Equipment Corporation.

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

*GerroldWalker*joined our Company in December 1999 asVice President of Services. Since August 2002, Mr. Walker has beenthe Vice President and General Manager of our Platforms Solutions business.Prior to joining our Company, Mr. Walker was Vice President and GeneralManager of SunExpress Europe, the Sun MicroSystems after-market business unit.

*DanielDaly*joined our Company in 1995 and is currentlyresponsible for NMS’s AccessGate product offerings. Prior to joining NMS, hewas Director of Engineering in the Communication Recording Systems 

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division at the Dictaphonesubsidiary of Pitney Bowes, and held various engineering and managementpositions in the Communications Division of Wang Laboratories, Inc.

*Paul J. Deeley Jr.*joinedour Company in June 2005 as Vice President, Corporate Controller and ChiefAccounting Officer. Prior to joining the Company, Mr. Deeley, a CPA, heldsenior financial positions in a number of technology and services companies,including Hill Holliday Connors Cosmopulos, Inc. and AMR Research. Mr. Deeleybegan his career in public accounting at Ernst & Young.

**ITEM 11.   EXECUTIVE COMPENSATION**

The information appearingunder the caption “Executive Compensation” (other than the informationappearing under the captions “Compensation Committee Report on ExecutiveCompensation” and “Comparison of Cumulative Total Stockholder Return”) of ourProxy Statement for our Annual Meeting of Stockholders to be held April 27,2006 is incorporated herein by reference.

**ITEM12.**   SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information appearingunder the caption “Stock Ownership of Directors, Executive Officers andPrincipal Stockholders” and “Equity Compensation Plans” of our Proxy Statementfor our Annual Meeting of Stockholders to be held April 27, 2006 isincorporated herein by reference.

**ITEM13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

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

**ITEM14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES**

The information appearingunder the caption “Information Regarding Independent Registered PublicAccounting Firm”, is incorporated herein by reference to our Proxy Statementfor our Annual Meeting of Stockholders to be held April 27, 2006.

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**PART IV**

**ITEM15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

**(a)   (1) FINANCIAL STATEMENTS**

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

Report of Independent Registered Public AccountingFirm.

Consolidated Balance Sheets as of December 31,2004 and 2005.

Consolidated Statements of Operations for the YearsEnded December 31, 2003, 2004 and 2005.

Consolidated Statements of Stockholders’ Equity forthe Years Ended December 31, 2003, 2004 and 2005.

Consolidated Statements of Cash Flows for the YearsEnded December 31, 2003, 2004 and 2005.

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 |       |              | 69         |   |   |
|                                                       |            |                   |            |  |  |

 

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 signaturepage, is incorporated herein by reference.

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**Signatures**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, as amended, the Registrant has duly caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

|        | 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 |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed 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,  2006 |      |
| Robert P.  Schechter                    |     | Chairman of the Board of Directors (Principal  Executive Officer) |       |                 |      |
| /s/  HERBERT SHUMWAY          |     | Senior Vice President of  Finance, Chief                          |       | March 16,  2006 |      |
| Herbert Shumway                         |     | Financial Officer and Treasurer (Principal Financial  Officer)    |       |                 |      |
| /s/  PAUL J. DEELEY, JR. |     | Vice President, Chief  Accounting                                 |       | March 16,  2006 |      |
| Paul J.  Deeley, Jr.               |     | Officer and Controller                                            |       |                 |      |
| /s/  WILLIAM E. FOSTER        |     | Director                                                          |       | March 16,  2006 |      |
| William E. Foster                       |     |                                                              |       |                 |      |
| /s/  OFER GNEEZY              |     | Director                                                          |       | March 16,  2006 |      |
| Ofer Gneezy                             |     |                                                              |       |                 |      |
| /s/  W. FRANK KING, PH.D.     |     | Director                                                          |       | March 16,  2006 |      |
| W. Frank King,  Ph.D.                   |     |                                                              |       |                 |      |
| /s/  PAMELA D. A. REEVE       |     | Director                                                          |       | March 16,  2006 |      |
| Pamela D. A.  Reeve                     |     |                                                              |       |                 |      |
| /s/  RONALD W. WHITE          |     | Director                                                          |       | March 16,  2006 |      |
| Ronald W. White                         |     |                                                              |       |                 |      |

 

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***Exhibit Index***

TheCompany will furnish to any stockholder who so requests, a copy of this annualreport on Form 10-K, as amended, including a copy of any exhibitlisted below, provided that The Company may require payment of a reasonable feenot to exceed our cost of furnishing such exhibit.

|         | **No.** | ** **                                                                                                                                                                                                                                                             | ** ** | **Title** | ** ** | ** ** |
|---------|---------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|------------|
| 2.6*    |    | Merger Agreement dated  as of May 18, 2000 by and among the Registrant, NMS 3758982 Canada Inc.,  Michel Laurence, Michel Brule, Stephane Tremblay, and Investissements Novacap  Inc. (filed with the Registrant’s Form 8-K dated July 20,  2000). |
| 2.7*    |    | Asset Purchase  Agreement dated October 15, 2001 by and between the Registrant and  Lucent Technologies Inc. (filed with the Registrant’s Form 10-Q  for the quarter ended September 30, 2001).                                                    |
| 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).                                                                                                              |
| 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).                                                                                                                           |

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| 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). |
| 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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