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

FORM 10-K

|(Mark One)                                                    |                                                                                         
|------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                                             | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|For the fiscal year ended December 31, 2004                  
|o                                                             | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|For the transition period
from                             to

Commission File No. 0-23282

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

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

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

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

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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:Common Stock, $0.01 par value per share (Title of class)

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

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

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

As of June 30, 2004, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately
$111.8 million, based on the closing price on such date of the registrant's Common Stock on the NASDAQ National Market. As of March 1, 2005, 47,663,890 shares of Common Stock, $0.01 par value
per share were outstanding.



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Documents Incorporated by Reference

Portions of the registrant's Proxy Statement relating to the 2005 Annual Meeting of Stockholders of the registrant are incorporated by reference into
Part III of this Form 10-K.

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

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

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

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

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PART I

ITEM 1. BUSINESS

Overview

We are a leading provider of enabling technologies, platforms and systems to wireless and wireline telecommunications operators and network equipment and
application providers. Our products, which include systems building blocks, service delivery systems and personalized mobile entertainment applications, voice quality systems and a wireless backhaul
optimizer, address a wide range of our customers' needs as they seek to develop and deploy enhanced voice and data services and applications, and improve the quality and efficiency of communications
networks. Telecommunications operators use our products to improve customer acquisition and retention, diversify revenue streams and reduce operating costs and capital expenditures. Network equipment
and application providers use our products to help deploy leading technology solutions for their telecommunications and enterprise customers in a timely and cost-effective manner. We sell
our products worldwide through our direct sales force as well as through channel and system integrator partners. Our customers include leading telecommunications operators and network equipment and
application providers such as Vodafone, Ericsson, Logica CMG, Alcatel, Comverse, NTT DoCoMo, Avaya, Lucent Technologies, Huawei, Cisco, SFR Cegetel, Siemens, European Computer Telecommunications,
Microsoft and SER Solutions.

Industry Overview

The telecommunications industry is a large, rapidly evolving market that includes wireless and traditional wireline communications services, and the related
applications, equipment and infrastructure
needed to deliver voice, video and data over circuit, packet and broadband networks. Over the last 18 months, globally, most sectors of the industry have shown clear, but modest indications of
recovery from four years of low to no growth or decline. Several forces are driving this recovery, including growth in Internet traffic; strong consumer adoption of wireless services; the substitution
of mobile for fixed-line voice and data communications by both businesses and consumers; increased use of Internet Protocol (IP) networks; unceasing introduction of new technologies such
as WiMax (industry standard technologies, high speed, very long range wireless communications); the increasingly rapid change of communication devices such as handsets and information technology (IT)
products; and the deployment of third generation (3G) networks by operators around the world. Industry analysts concur that for operators, equipment manufacturers, system integrators, application and
content providers, the opportunities are strongest in mobile applications and services and related infrastructure. Nonetheless, these opportunities are not without challenges for market participants.

Telecommunications OperatorsWireless and Wireline

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



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Network Equipment and Application Providers

Network equipment providers, as well as application providers, who include systems integrators, original equipment manufacturers and independent software vendors,
provide network systems, applications and services to telecommunications operators and enterprises. These offerings include video communications, interactive voice response systems, automatic speech
recognition, media services, conferencing, unified communications, multimedia messaging, and content-based entertainment applications like ringtones and ringback tones. These offerings enable
telecommunications operators to rapidly deploy premium services for their customers. These offerings also help businesses reduce costs and improve employee communications, especially in light of
increased workforce mobility.

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



Our Solutions

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

Enable cost-effective and timely deployment of communications applications and services.Our system building block offerings
provide a comprehensive framework of enabling technologies for developing and deploying next-generation applications, such as IP conferencing, speech-activated services, mobile video and
content-based entertainment and information services. We also provide wireless telecommunications operators with a services delivery system that allows these operators to host

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multiple
voice and data applications from a variety of sources on the same system. These systems enable rapid and cost-effective deployment of customized, innovative services for their
subscriber segments.

Improve network service quality.Our voice quality offerings leverage our technical expertise in electrical echo
cancellation, acoustic echo control, noise reduction, adaptive level control and noise level compensation for both wireless and wireline deployments, thus allowing operators to provide improved
quality of service. These products are designed to provide better price performance and higher capacity relative to other alternatives. Our voice quality offerings, available as standalone systems,
embedded blades, and chips, are highly flexible and designed to integrate with all major telecommunications switch vendors.

Reduce network infrastructure expenditures.Our wireless backhaul optimizer allows mobile operators to save operating
expenses by reducing voice and data traffic (backhaul) expenses, principally those relating to T1 and E1 lines, between cell sites and the operators' switching sites while enabling accelerated
deployment of future services and infrastructure, including enhanced data global system mobile communications (GSM) environment (EDGE) and universal mobile telecommunications system (UMTS). Our
wireless backhaul optimizer uses aggregation and bandwidth reduction techniques to
provide up to 2:1 bandwidth savings by reducing the number of required leased line connections in the radio access network of GSM networks.

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

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

Products and Services

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

Platform Solutions

Our Platform Solutions business segment provides products that allow our customers to develop next-generation voice, data, and video applications and
services. Our comprehensive offering of systems building blocks, calledOpen Access, is composed of hardware and software elements. The hardware

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elements
consist principally of printed circuit boards that are used in computer systems or subsystems. The software elements consist primarily of media processing and switching functions, as well as
APIs and a complete application development environment. Utilizing technology from ourOpen Accessproducts, we have developed and market MyCaller, an
end-to-end ringback solution for mobile operators, andMobile
Place, a complete, open framework comprising a suite of applications and a subscriber and content management system aimed at the mobile entertainment market. Also using
technology from our Open Access products, we developed and market theVisionfamily of mobile video delivery systems.

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

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

Our Open Accessproducts include the following:



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System-level products for mobile applications include:



Voice Quality Systems

We provide carrier-grade voice quality and echo cancellation systems that allow both wireless and wireline telecommunications operators to bring superior voice
quality to their networks. Our voice quality products, which were built on pioneering innovations that originated at Bell Labs, include our patented Studio Sound software, which creates an improved
listening environment for all parties in a wireless telephone conversation and is statistically proven to increase customer ratings on overall voice quality. Our voice quality products are available
as a stand-alone system with multiple network interfaces or as embedded technology on blades (high-availability carrier-grade circuit boards), modules and chips. These products incorporate
electrical echo cancellation and acoustic echo
control technology to reduce or eliminate the echo inherent in long distance, wireless and voice over IP (VoIP) networks. Utilizing our custom technology and patented voice quality software, we are
able to provide a high density solution that dramatically improves the quality of voice conversations through noise reduction, automatic gain control, noise compression and dynamic speech restoration.
Our voice quality systems incorporate monitoring and measurement tools that give telecommunications operators the ability to observe and analyze the performance of their network via direct interaction
with our voice quality systems. Our voice quality products have been deployed in the networks of over 100 leading wireless and wireline telecommunications operators worldwide.

Our
Voice Quality Systems products include the following:



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Network Infrastructure



Launched in 2003,AccessGateis a wireless backhaul optimization system that utilizes patent-pending technology
designed to improve the efficiency of wireless networks. Our technology allows our mobile operator customers to carry up to twice as much voice and data traffic over backhaul connections in GSM
networks, thereby reducing their backhaul expenses without compromising voice or data quality and freeing up capacity for the delivery of new services.

Key
features of ourAccessGatesolution include:



NMS Services

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



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Growth Strategy

Our objective is to be the leading provider of technologies, platforms systems and solutions for telecommunications operators and network equipment and
application providers that enable our customers to develop and deploy communications services and applications quickly and cost-effectively and improve the quality and efficiency of
communications networks. Our strategy for achieving this objective includes the following elements:

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

Focus on wireless telecommunications and other high growth markets.In addition to adding new technologies and applications
to our existing products, we plan to aggressively market our new products designed for wireless operators,MyCaller,Mobile
Place, theVisionfamily of video solutions, andAccessGate. In collaboration
with system integration and content provider partners, we have been marketing and selling ourMyCallerringback solution to mobile operators and have
evolved the underlying platform into Mobile Place, a robust customer content relationship management system.Mobile Placeallows operators to deploy
multiple applications from multiple sources and track and use subscriber preferences and transactions for targeted marketing and selling. In addition, our AccessGatewireless backhaul optimizer
leverages the in-network expertise developed through our voice quality systems business to address a
significant market opportunity as mobile operators seek to reduce the costs of backhaul transport in their networks, particularly as they upgrade to 3G infrastructure and need to launch new services.

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

Strengthen and expand relationships with strategic customers.Our customer strategy is to establish and maintain
long-term working relationships with leading telecommunications operators and network equipment and application providers. We dedicate sales and technical services personnel to

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approximately
30 telecommunications operators and 20 network equipment and application providers worldwide. By focusing on large customers, we believe we can address a significant portion of our
market opportunity while controlling the cost and complexity of our marketing efforts. We work closely with our customers to design our products to integrate into their offerings. By working with
these customers early in their product design and development stages, we can gain valuable insights into future industry requirements and trends.

Partner to provide complete solutions to network operators and service providers.We have successfully established
go-to-market relationships with major system integrators and equipment manufacturers. We intend to continue to leverage the resources of these partners to extend our global
marketing and support capabilities. We have also begun to establish relationships with content providers and application developers to further strengthen our ability to provide complete solutions,
especially to mobile operators.

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

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

Customers

We
sell on a direct basis as well as through channel partners (which include value-added resellers, distributors, systems integrators and equipment providers) to telecommunications
operators and
network equipment and application providers. Our network equipment and application provider customers also sell our products to enterprises. We do not believe that any single end-user
customer accounted for more than 10% of 2004 revenues, but one channel partner Lucent Technologies ("Lucent") represented 11.7% of our 2004 revenues. Revenues from customers based outside North
America were 47% in 2004, 47% in 2003, and 37% in 2002. The tables below set forth a representative list of our customers and channel partners:

Telecommunications Operators

Network Equipment ProvidersHutchison Telecom
KDDI
NTT Communications
NTT DoCoMo
Nextel Partners
SFR Cegetel
Spacefon
Telefonica
Verizon Communications
Vodafone

Alcatel
Avaya
Cisco Systems
Comverse
Ericsson
Fujitsu
General Dynamics
Huawei

Lucent Technologies
Motorola
NEC
Nortel
Raytheon
Siemens


Channel Partners

Application ProvidersAvnet
Beijing Linkhead
Channel Access
Comnet Supply
Cyberpower
Hagemeyer HCOM
Integrys
Lucent Technologies
Logica CMG
Nekotec

Cisco/Latitude
CityOne
Eckoh Technologies
Edify
European Computer Telecommunications
Inter-Tel
Microsoft
SER Solutions
SigValue


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Sales and Marketing

We sell our products on a direct basis as well through system integration and channel partners. Our direct sales and marketing efforts for our three business
segments are focused on approximately 30 telecommunications operators and 20 network equipment and application providers. As of December 31, 2004, our sales and marketing organization consisted
of 85 employees in 18 offices worldwide, including
44 in North America, 19 in Europe and 22 in Asia. Historically, our direct sales force has been focused on selling systems building blocks offered by our Platform Solutions business to network
equipment and application providers. We have shifted the focus of some of our direct sales force to selling more complex system-level products to telecommunications operators and large network
equipment providers. As a result, we have recruited additional channel partners to assume primary responsibility for the sales of our systems building blocks products. On a selective and limited
basis, primarily in Asia, we also use channel partners to sell our Voice Quality products. In addition to performing a sales and marketing function, these channel partners provide pre- and
post-sales support, systems integration, fulfillment and credit services. For 2004, 49% of worldwide total company revenues were generated by direct sales, with 51% coming through channel
partners.

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

Manufacturing

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

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

Research and Product Development

We believe that the extension and enhancement of existing products, the development of new products and the development of open technologies proprietary to us are
critical to our future success. Therefore, we undertake direct research and development, engage in joint product development with selected partners and participate in the development of industry
standards where appropriate. Our research and development activities are primarily focused on opportunities relating to emerging wireless applications, network infrastructure efficiencies and emerging
IP-based services, including VoIP. During

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2004,
2003 and 2002, we spent $23.9 million, $30.3 million, and $38.2 million, or 24%, 35%, and 37%, respectively, of our revenue, on research and development. Our decrease in
spending over the past three years is primarily due to reductions in force. As of December 31, 2004, our current product development is conducted by 130 employees located at our headquarters in
Framingham, Massachusetts, and at our offices in Red Bank, New Jersey, Schaumburg, Illinois, St.-Hubert, Quebec and Herzalia, Israel.

Intellectual Property

Our success depends in part on proprietary technology and know-how. We rely primarily on a combination of trade secret and copyright laws and
restrictions on access to protect our trade secrets and proprietary rights. We hold several issued patents. In addition, we have filed a patent application relating to our AccessGate technology,
which, we believe, will be of strategic importance to our business if issued. We distribute our software products under license agreements, which grant customers a non-exclusive license to
use the software and contain certain terms and conditions prohibiting its unauthorized reproduction or transfer. We enter into confidentiality agreements with our suppliers and customers when we
disclose proprietary information to them. In addition, we enter into confidentiality agreements and assignment of invention agreements with our employees and consultants. Despite these precautions,
unauthorized third parties may copy aspects of our products or obtain information that we regard as proprietary. We believe that our products and technology do not infringe on any existing proprietary
rights of others.

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

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

Competition

Competition in the high growth markets that we target for our products is intense and diverse. There is always the potential for new competitors to enter the
markets we serve in the future. A significant number of our target customers, both telecommunications operators and network equipment and application providers, currently use in-house
development to provide products and solutions similar to our offerings. While we must compete against these companies' in-house efforts, we believe that a trend towards outsourcing this
type of development will continue to broaden our market opportunity. We also believe that the key competitive differentiators in these markets include product quality and functionality,
ease-of-use, integration capabilities, price performance, cost of ownership, speed of deployment and installation and technical support and service. Current third party
competitors for our product areas include:

Platform Solutions:



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Voice Quality Systems:

Ditech Communications Corporation and Tellabs, Inc.

Network Infrastructure:



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

Employees

As of December 31, 2004, we had 316 full-time employees, consisting of 61 in sales, 24 in marketing and business development, 130 in research
and development, 27 in services, 24 in operations and 50 in administration and finance. None of our employees are represented by a labor union. We have never experienced a work stoppage and consider
our relations with our employees to be good.

Additional Information

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

Forward-Looking Information

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

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Factors That May Affect Future Operating Results

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

We have experienced modest profitability in 2004 after experiencing operating losses in the recent past. We are not assured of continued profitability.

We
have experienced modest profitability in 2004. We experienced operating losses in each of the four preceding fiscal years. The past operating losses have adversely affected our
working capital, total assets and stockholders' equity. Our operating plan has established a cost structure that, based on expected revenue, will continue to contribute to our profitability. If
revenues do not increase in accordance with our current expectations, or if expenses are greater than we anticipate, we may experience losses again. Losses could force us to curtail our operations.

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

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



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

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

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The telecommunications industry is experiencing a modest turnaround from the slowdown of the preceding three years, but its sustainability could impact our ability to achieve
anticipated revenue levels.

In
2004, the telecommunications industry experienced a modest turnaround. In the several years prior to 2004, the telecommunications industry experienced a severe slowdown characterized
by economic uncertainty and substantial curtailment of infrastructure development and related capital spending. These broad-based industry conditions contributed to our operating losses and reduced
our ability to forecast future operating results. Despite the modest turnaround, there is continued uncertainty as to the future spending patterns of telecommunications operators and the other
enterprises that are the end-users of our products. If the adverse economic conditions in our industry were to continue or worsen, we may experience additional adverse effects on our
revenues, net income and cash flow.

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

We
currently operate in three areas of the communications market: (1) mobile and IP-based enhanced services; (2) voice quality systems for the global wireless
markets; and (3) wireless backhaul optimization. Although we expect growth in these areas, each of these market areas is characterized by emerging product categories and rapid technological
change, and we may fail to generate demand for our products at the levels we anticipate, which could limit our future revenues and harm our business.

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

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

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

In
concert with our greater emphasis on systems offerings, we shifted the primary sales method of our systems building blocks to indirect sales through channel partners and network
equipment providers. These channel partners are companies in the business of reselling communications products like those we produce to application developers, systems integrators and others. In the
past, we have sold the vast majority of these products directly with our own sales force. As a result, we are increasingly reliant on the effectiveness of channel partners' and network equipment
providers' sales, marketing, and distribution capabilities to generate and fulfill demand for our products. In 2004, 51% of our revenues were attributable to channel partners.

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

14

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

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

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

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

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

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

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

Many
of our customers, including the large network equipment and application providers on which we focus a significant portion of our sales and marketing efforts, have the technical and
financial ability to design and produce components replicating or improving on the functionality of most of our products. These organizations often consider in-house development of
technologies and products as an alternative to doing business with us. We cannot be certain that these customers will resolve these

15

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"make-buy"
decisions in favor of working with us, rather than attempting to develop similar technology and products internally or obtaining them through acquisition. If our customers
choose to produce internally rather than purchase from us, it will decrease the size of the market for our products.

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

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

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

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

Our supply agreement with Lucent ends May 29, 2005 and we may not be able to compensate for revenue from that source.

As
part of our acquisition of Lucent's voice quality business in December 2001, we entered into a three year supply agreement with Lucent in which Lucent agreed to purchase from
us, on an exclusive basis for Lucent's resale purposes, any of our products that Lucent requires which incorporate the acquired voice quality products. We extended the agreement to and it will expire
on May 29, 2005 but the exclusivity provisions are no longer in effect. Lucent incorporates our products into products it markets to others. We have opened discussions with Lucent regarding
further extension of the supply agreement or a replacement agreement. We are relying on sales to Lucent to continue to generate a significant portion of our near-term revenue for such
products and have incorporated this expectation in our operating plan. Revenues from Lucent for the year ended December 31, 2004 were approximately 11.7% of our total revenues. Accordingly, any
delays, reductions or other disruptions in Lucent's purchasing volume, any significant disputes we might become involved in regarding our commercial relationship with Lucent or a termination of this
supply agreement would have a significant and material adverse effect on our revenues.

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

We
do not have in-house manufacturing capabilities and currently rely on third-party contract manufacturers to assemble our systems building blocks and systems. Our
manufacturing requirements are primarily fulfilled by Plexus Corp. In addition, Plexus ships some of our products directly to our customers from its fabrication facility. Our supply agreement with
Plexus expires in October 2005 but automatically extends for consecutive one-year periods unless either party gives notice 120 days prior to the expiration date of the
then-current term. We also rely on other third parties to provide distribution and installation services. This reliance could subject us to product shortages or quality assurance problems,
which, in turn, could lead to an increase in the cost of manufacturing or assembling our products. Any problems that occur and persist in connection with the manufacture, delivery, quality or cost of
the assembly of our products could affect our ability to ship product and recognize revenue and harm our relationship with our customers.

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

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

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

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

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

If we are presented with appropriate opportunities, we may acquire businesses or technologies. We may not be able to identify, negotiate, or finance any future
acquisition successfully. If we engage in an

17

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acquisition
transaction, the process of integration may produce unforeseen operating difficulties and expenditures and may absorb significant attention of our management that would otherwise be
available for the ongoing development of our business. If we make future acquisitions, we may issue shares of stock that dilute other stockholders, incur debt, assume contingent liabilities, or create
additional expenses related to amortizing intangible assets, any of which might harm our financial results and cause our stock price to decline. Any financing that we might need for future
acquisitions may only be available to us on terms that restrict our business or that impose on us costs that reduce our net income.

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

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

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

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

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

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

Defects in our products or problems arising from the use of our products together with other vendors' products may result in lost revenues or customer relationships and could
be detrimental to our reputation.

Products as complex as ours may contain known or undetected errors or performance problems. Defects are frequently found during the period immediately following
introduction and initial implementation of new products or enhancements to existing products. Although we attempt to resolve errors before implementation, our products are not error-free.
These errors or performance problems could result in lost revenues or customer relationships and could be detrimental to our business and reputation generally. Additionally, reduced market acceptance
of our services due to errors or defects

18

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in
our technology would harm our business by reducing our revenues and damaging our reputation. In some of our contracts, we have agreed to indemnify our customers against certain liabilities arising
from defects in our products, but we do not carry insurance policies covering this type of liability. In addition, our customers generally use our products together with their own products and
products from other vendors. As a result, when a problem occurs in the network, it may be difficult to identify the source of the problem. These problems may cause us to incur significant warranty and
repair costs, divert the attention of our engineering personnel from our product development efforts, and cause significant customer relations problems. To date, defects in our products or those of
other vendors' products with which ours are used by our customers have not had a material negative effect on our business. However, we cannot be certain that a material negative effect will not occur
in the future.

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

Sales
to customers outside North America accounted for approximately 47% of our revenues in 2004, and we believe a material portion of our domestic sales results in the use of our
products outside North America. Because of our dependence upon international sales, we are subject to a number of risks, including volatility in currency exchange rates, political and economic
instability in other countries, the imposition of trade and tariff regulations by foreign governments and the difficulties in managing operations across disparate geographic areas. These or other
factors may limit our ability to sell our products in other countries, which could result in lost revenues and negatively impact our financial condition.

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

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

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

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

ITEM 2.    PROPERTIES

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

We
lease facilities in Red Bank, New Jersey, St. Hubert, Quebec, and Schaumburg, Illinois, in which we conduct design and engineering operations. We also lease a facility in Reading,
United Kingdom that serves as our European sales and service headquarters. In addition, we have short-term leases for 11 sales offices throughout North America, Europe and Asia.

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

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ITEM 3.    LEGAL PROCEEDINGS

From time to time, we are a party to various legal proceedings incidental to our business. However, we have no material legal proceedings currently pending.

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

None during the fourth quarter of 2004.

Executive Officers of the Registrant

The following table lists our executive officers as of December 31, 2004:

|Name                      |  | Age |  | Position                                                               
|------------------------- |  | --- |  | -----------------------------------------------------------------------
|Robert P. Schechter       |  | 56  |  | Chairman of the Board, President and Chief Executive Officer           
|William B. Gerraughty, Jr |  | 40  |  | Senior Vice President of Finance, Chief Financial Officer and Treasurer
|Colin Doherty             |  | 43  |  | Senior Vice President, Worldwide Sales and Marketing                   
|Gerrold Walker            |  | 54  |  | Vice President and General Manager, Platform Solutions                 
|R. Brough Turner          |  | 58  |  | Senior Vice President of Technology                                    
|Alex N. Braverman         |  | 45  |  | Vice President, Chief Accounting Officer and Corporate Controller      

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

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

Colin Dohertyjoined our Company as Senior Vice President of Worldwide Sales in February 2003. During 2002, Mr. Doherty
served as President and Chief Marketing Officer of Carrier Networks for Nortel Europe. Beginning in 1996, Mr. Doherty held various other executive positions with Nortel in both Latin America
and the U.S.

Gerrold Walkerjoined our Company in December 1999 as Vice President of Services. Since August 2002, Mr. Walker has
been the Vice President and General Manager of our Platforms Solutions business. Prior to joining our Company, Mr. Walker was Vice President and General Manager of SunExpress Europe, the Sun
MicroSystems after-market business unit.

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

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

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Mr. Braverman
was Controller of Artel Communications Corporation, a manufacturer of networking products.

PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Price Range of Common Stock

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

Year Ended December 31, 2003

High

LowFirst Quarter

$
2.10

$
1.35Second Quarter


2.12


0.70Third Quarter


2.75


1.52Fourth Quarter


6.66


2.15Year Ended December 31, 2004First Quarter

$
8.52

$
5.75Second Quarter


9.35


5.10Third Quarter


7.43


4.02Fourth Quarter


6.96


3.71


As
of March 1, 2005, we had approximately 201 stockholders of record of our common stock.

Dividend Policy

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

Issuance of Unregistered Securities

We acquired Inno Media Logic Company (IML) of St.-Hubert, Quebec in July 2000 for a combination of cash and stock. We and our wholly owned Canadian
subsidiaries issued to the stockholders of IML 982,296 shares of our common stock and shares exchangeable into an additional 1,653,004 shares of our common stock. As of December 31, 2004, an
aggregate of 1,377,500 additional shares of our common stock had been issued in exchange for exchangeable shares. The shares of our common stock and the exchangeable shares were issued, as to
acquirers in the United States, in reliance on the exemption set forth in Section 4(2) of the Securities Act of 1933 (the Act) and, as to acquirers outside the United States, pursuant to
Regulation S under the Act. We registered on Form S-3 under the Act, effective August 25, 2000, for public sale in the United States, all the shares of our common
stock which were or are to be issued to the former shareholders of IML.

Issuer Purchases of Equity Securities

None.

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ITEM 6.    SELECTED FINANCIAL DATA

Components of selected financial information consist of the following:

|                                                                                |                   | Year Ended December 31,
|------------------------------------------------------------------------------- | ----------------- | -----------------------
|
|
|Revenues                                                                        |                   | $                      
|Gross profit                                                                    |                   |                        
|Operating income (loss)                                                         |                   |                        
|Income (loss) before income taxes                                               |                   |                        
|Income tax expense (benefit)                                                    |                   |                        
|Net income (loss)                                                               |                   |                        
|Net earnings (loss) per share:                                                  |                   |                        
|                                                                                | Basic and diluted |                        
|Weighted average common shares used in computing net earnings (loss) per share: |                   |                        
|                                                                                | Basic             |                        
|                                                                                | Diluted           |                        

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

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

Overview

The Company operates in the telecommunications industry which is a large, rapidly evolving market. Our products, include systems building blocks, service delivery
systems and personalized mobile entertainment applications, voice quality systems and a wireless backhaul optimizer. We sell our products through channel partners, distributors, and system integrators
and directly to end users. We have established business in North America, Europe and Asia. Our product is manufactured by a third party manufacturer, Plexus. We frequently monitor our inventory
productivity to ensure optimum efficiency at Plexus. We have a supporting team of engineers developing and researching new products and technologies. Our research and development activities are
primarily focused on opportunities relating to emerging wireless applications, network infrastructure efficiencies and emerging IP-based services, including VoIP. We also employ marketing
and administrative personnel to support our business. Management monitors our revenues and costs of the business to ensure alignment with the current business and financial objectives. Management
continually monitors the activities of our competitors and analyzes the future of our industry to appropriately align our business focus. Management also reviews the risks presented by the volatile
telecommunications industry to ensure our actions are within the scope of our objectives.

During
2004, the Company has been focused on several key initiatives: achieving revenue growth, launching two new products, MyCaller and AccessGate, and returning to profitability. We
have had sequential and year-over-year revenue growth in the four quarters of 2004, primarily driven from our Platform Solutions (PS) business unit. Our growth in our PS
business unit has been from both direct and indirect sales, domestically and internationally and with both enterprise and carrier customers. In the second half of 2004, we obtained our first orders
for our MyCaller and AccessGate products. We

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recognized
our first revenues related to these recently introduced products in the fourth quarter of 2004. We have received additional orders during 2004 and expect to recognize revenue related to
these orders in 2005. The cost reduction efforts taken in 2003 coupled with efficiencies achieved with our third party manufacturer also helped us improve our gross margin. The cost reduction efforts
also enabled the Company to return to profitability in the first quarter of 2004, and our headcount and cost structure have remained stable throughout the year resulting in profitability in all four
quarters of 2004.

During
2004 we generated positive cash flow from operations, primarily due to our increased sales efforts and the effects of our reduction in force actions taken in 2003. We were also
able to raise $49.5 million in an underwritten public offering. We have used and may continue to use such proceeds for general corporate purposes, which may include working capital, capital
expenditures, potential acquisitions and repayment of our convertible subordinated notes due in 2005. In April 2004, the Company invested the net proceeds of this offering in interest-bearing,
investment-grade securities. We repaid $37.8 million of our convertible notes in 2004. Our remaining balance is due in October 2005. As of December 31, 2004, the Company has
$80.6 million in cash and short-term marketable securities and short-term debt of $19.9 million. We believe the Company has the available cash to execute its
strategy.

Management's
focus in 2005 is to continue to grow its existing business, particularly in the area of wireless operators and to increase volume of orders received and revenues related to
its new product initiatives. We are planning to launch our first video product offering in late 2005. Management will continue to monitor the business consistent with 2004 to achieve profitable
revenue growth.

Critical Accounting Policies

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

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

Revenue Recognition.We derive our revenue primarily from two sources: (1) sales of products, including hardware and
software licenses, and (2) services, including maintenance, support and professional services. Maintenance and support services consist of on-site support, telephone support, and
training. Professional services consist of consulting arrangements which may consist of hardware and/or software customization projects provided to customers through such contracts. We sell our
products and services through direct sales and through channel partners, which includes resellers and distributors. Our management must make and use judgments and estimates in connection with the
revenue recognized in any reporting period. Our products are generally shipped together as a bundled hardware and software solution. We have determined that the software sold in the bundled product is
essential to the functionality of the hardware and as such, we recognize revenue in accordance with the provisions of the American Institute of Certified Public Accountants Statement of Position (SOP)
97-2,

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Software Revenue Recognition, and related interpretations. We recognize revenue from the sale of products when persuasive evidence of an arrangement exists, delivery has
occurred, the fee is fixed or determinable, and collection is considered probable. We reduce revenue by provisions for estimated sales returns. We offer quarterly return rights to a limited number of
channel partners that allow the channel partner to rotate a percentage of its inventory based on its prior quarter purchases. We provide for these return rights each quarter in an amount equal to
estimated returns. On a quarterly basis, we review our estimates and compare our actual returns to our estimations. Our actual results have been in line with our expectations. We do not offer rights
of return on sales made through our direct sales force. An increase in our allowance for sales returns would reduce our revenue in the period for which the increase is recorded.

We
evaluate our revenue recognition policies based on the specific facts and circumstances related to each of our channel partners. When selling to resellers and distributors, we
generally do not recognize revenue upon shipment, since many of our distributors are thinly capitalized and their ability to pay is, in substance, contingent upon their resale of our product. In these
cases, we defer revenue until collectibility is reasonably assured. When revenue is deferred, if reliable reporting from the reseller or distributor exists, we will recognize that revenue when the
reseller or distributor sells the product to an end-user ("sell through"). Where reliable reporting does not exist, revenue will be recognized upon our receipt of payment, or in limited
circumstances, receipt of a letter of credit. We further monitor the payment history of our resellers and distributors and overall days sales outstanding.
We believe this revenue recognition policy minimizes the risk that product is shipped in excess of end-user demand and allows us to reasonably and reliably estimate product returns.

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

We
assess if collection is probable based on a number of factors, including past transaction history and the creditworthiness of the customer. If we determine that collection is not
probable, we do not record revenue until such time as collection becomes probable, which is generally upon the receipt of cash.

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

When
an arrangement involves multiple elements, such as products, maintenance and/or professional services, we allocate the entire sale price to each respective element based on vendor
specific objective evidence ("VSOE"). When arrangements contain multiple elements VSOE of fair value exists for all undelivered elements, we recognize revenue for the delivered elements using the
residual method. We base our determination of VSOE of fair value of each of the undelivered elements in multi-element arrangements on either the price we charge when the same element is sold
separately or the price established by the members of our management, who have the relevant authority to set prices, for an element not yet sold separately. For arrangements containing multiple
elements where VSOE of fair value does not exist for all undelivered elements, we defer revenue for the delivered and undelivered elements until VSOE of fair value exists or all elements have been
delivered.

Service
revenue represented 7.5%, 8.6% and 8.8% of revenue for the years ended December 31, 2002, 2003 and 2004, respectively. Service revenue is primarily comprised of
engineering services and

24

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maintenance
and support services. Engineering Professional services consist of hardware and/or software customization projects provided to customers through contracts. We recognize revenue allocated
to professional service elements as the services are performed for time and materials contracts. When the customization is essential to the functionality of the licensed software, then both the
software license and professional services revenue are recognized under the percentage of completion method, which requires revenue to be recognized as services are performed. We recognize revenue and
gross profit using labor hours as an input measure of progress to completion on these arrangements. Maintenance and support services, which are sold separately from products, consist of
on-site support, telephone support and training.We defer maintenance and support services revenue, whether sold separately or as part of a multiple element arrangement, and recognize it
ratably over the term of the maintenance contract, generally twelve months. When maintenance and support services are not sold separately we determine VSOE on maintenance and support services based on
substantive renewal price as a percentage of the sale price of arrangements.

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

Allowance for Sales Returns.We evaluate and track returns on a continual basis. We record allowances for estimated sales
returns and allowances on product revenue in the same period as the related revenue is recorded. In evaluating the returns, we consider the type of product return, the time of return compared to the
original date of sale and the value of product return. Over the past two years the return rate has been approximately 1% of product revenue. The results of monitoring the return rate and its effect on
inventory levels have not identified significant increases or excess inventory levels in the distribution channels as a result of returns. Our policies and practices allow the Company to make a
reasonable estimate of its returns and allow for timely identification of necessary changes in estimates. We must make judgments and estimates in connection with establishing the allowances for
estimated sales returns in any reporting period. The amount and timing of our revenue for any reporting period may materially differ if actual sales returns and allowances differ from our estimates.

Allowance for Doubtful Accounts.We maintain an allowance for doubtful accounts based upon our historical experience and any
specifically identified customer collection issues. We monitor and analyze accounts receivable and the composition of the accounts receivable aging, historical bad debts, and current economic trends,
regional factors and other known factors when evaluating the adequacy of the allowance for doubtful accounts. Based upon the analysis and estimates of the uncollectibility of our accounts receivable,
we record an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable becomes doubtful. Actual results could differ from the allowances for
doubtful accounts recorded, and this difference may have a material effect on our financial position and results of operations.

Allowance for Excess and Obsolete Inventories.We value our inventories at the lower of cost (first-in,
first-out method) or market. We regularly review our inventories and record reserves for excess and obsolete inventory based primarily on our estimated forecast of product demand and
production requirements for the next 12 months. Actual excess and obsolete inventory could differ from the allowance for excess and obsolete inventories.

Long-lived Assets and Goodwill.In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impariment or Disposal of Long-lived Assets, known as SFAS No. 144, we are required to evaluate the carrying value of our
long-lived assets and certain intangible assets. SFAS No. 144 first requires an assessment of whether circumstances currently exist which sugggest the carrying value of long-lived asets may not
be recoverable. At December 31, 2004, we did not beleive any such conditions existed. Had these conditions existed, we would assess the recoverability of the carrying value of our long-lived
assets based on estimated undiscounted cash flows to be generated from such assets. In assessing the recoverability of these assets, we would have projected

25

---



estimated
enterprise-level cash flows based on various operating assumptions such as average revenue per unit, disconnect rates, and sales and workforce productivity ratios. If the projection of
undiscounted cash flows did not exceed the carrying value of the long-lived assets, we would be required to record an impairment charge to the extent the carrying value exceeded the fair value of such
assets.

Income Taxes.The preparation of our consolidated financial statements requires us to estimate our income taxes in each of
the jurisdictions in which we operate, including those outside the United States which may be subject to certain risks that ordinarily would not be expected in the United States. A change in our
estimate of income by jurisdiction could cause a change in our annual effective tax rate. The income tax accounting process involves our estimating our actual current exposure together with assessing
temporary differences resulting from differing treatment of certain items for tax and accounting purposes. These differences result in the recognition of deferred tax assets and liabilities. We must
then record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.

Management
judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets.
We have recorded a valuation allowance of $160.0 million as of December 31, 2004 due to uncertainties related to our ability to utilize some of our deferred tax assets, primarily
consisting of net operating losses carried forward. We base the valuation allowance on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax
assets will be recoverable. If actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust our valuation allowance, which could materially impact
our consolidated financial position and results of operations.

Restructuring and Other Related Charges.During 2002 and 2003, we initiated consolidation of certain operations in order to
enhance operational efficiency and reduce expenses, and recorded significant restructuring charges in connection with these actions. We continue to monitor and assess our facility obligations, real
estate markets and our operating expenses. These restructuring charges and our continued analysis of our facilities require us to make estimates based upon real estate market conditions, rental rates,
future corporate requirements, general economic conditions and future estimated cash flows. We review exit costs in each of these circumstances on a case-by-case basis to
determine whether a restructuring charge is required to be recorded in accordance with SFAS No. 146,Accounting for Costs Associated with Exit or Disposal
Activities. The provisions of SFAS No. 146 require us to record an estimate of the fair value of the exit costs based on certain facts, circumstances and assumptions,
including remaining minimum lease payments, potential sublease income and specific provisions included in the underlying lease agreements. We base estimates related to anticipated sublease market
rates for excess facilities on assumptions regarding the time period required to locate and contract with suitable subtenants and base these assumptions on market trend information analysis.
Subsequent to recording a reserve, changes in market or other conditions may result in changes to assumptions upon which the original reserve was recorded that could result in an adjustment to the
reserve and, depending on the circumstances, such adjustment could be material. We continue to monitor and assess our facility obligations, real estate markets and our operating expenses.

26

---



Results of Operations

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

|                                  |                                         | Year Ended December 31, |      
|--------------------------------- | --------------------------------------- | ----------------------- | -----
|
|Revenues                          |                                         | 100.0                   | %    
|Cost of revenues                  |                                         | 56.3                    |      
|                                  |                                         |                         |      
|                                  | Gross profit                            |                         | 43.7 
|Operating expenses:               |                                         |                         |      
|                                  | Selling, general and administrative     |                         | 53.9 
|                                  | Research and development                |                         | 37.2 
|                                  | Impairment charges                      |                         | 64.7 
|                                  | Restructuring and other related charges |                         | 4.9  
|                                  |                                         |                         |      
|                                  | Total operating expenses                |                         | 160.7
|                                  |                                         |                         |      
|Operating income (loss)           |                                         | (117.0                  | )    
|Other income (expense), net       |                                         | 19.6                    |      
|                                  |                                         |                         |      
|Income (loss) before income taxes |                                         | (97.4                   | )    
|                                  |                                         |                         |      
|Income tax expense (benefit)      |                                         | (1.4                    | )    
|                                  |                                         |                         |      
|Net income (loss)                 |                                         | (96.0                   | )%   
|                                  |                                         |                         |      

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

Cost of revenues.Cost of revenues consists primarily of product cost; cost of services provided to our customers and
overhead associated with testing and fulfillment operations. The Company's manufacturing process is outsourced to a contract manufacturer. In 2002 and 2003, the Company also had amortization of
acquired completed technology and impairment charges in "Cost of revenues". No similar charges were recorded in 2004.

Selling, general and administrative expenses.Selling, general and administrative expenses consist primarily of salaries,
commissions and related personnel expenses for those engaged in our sales, marketing, promotional, public relations, executive, accounting and administrative activities. In 2002 and 2003, the
amortization of intangible assets and non-cash compensation were included in selling, general and administrative costs. There were no such charges in 2004.

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

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

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

27

---



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

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

Revenues

|               |  | Year Ended December 31, |     
|-------------- |  | ----------------------- | ----
|
|
|
|PS             |  | $                       | 66.5
|VQS            |  |                         | 20.5
|NI             |  |                         | 0.1 
|               |  |                         |     
|Total revenues |  | $                       | 87.1
|               |  |                         |     

Our
revenue growth is attributable to an increase in revenues from the PS business unit, recognition of initial revenues from the NI business unit offset by a decrease in revenues in the
VQS business unit. The PS business unit revenue growth, reflected through volume increases in both channel partner and direct sales, resulted from improvement in capital spending by enterprise and
telecommunications companies in our markets. The improved capital spending trend in the telecommunications equipment market has been driven by wireless operators, and that has been an area of
particular focus for our sales efforts. We also recognized initial revenues of approximately $0.3 million from MyCaller in the fourth quarter of 2004. We expect PS revenue to perform
consistently with 2004 and to record revenues related to the initial orders from the MyCaller product offering throughout 2005.

The
decrease in VQS business unit revenues is primarily due to a continued decline in 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. We anticipate no royalty fees in 2005.

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

The
NI business unit has had modest revenues to date. We recognized initial revenues of approximately $0.3 million from AccessGate sales in the fourth quarter of 2004. Currently
Accessgate is

28

---



launched
in field trials and we expect to record revenues related to the initial orders from these trials throughout 2005.

|               |  | Year Ended December 31, |     
|-------------- |  | ----------------------- | ----
|
|
|
|North America  |  | $                       | 46.6
|International  |  |                         | 40.5
|               |  |                         |     
|Total revenues |  | $                       | 87.1
|               |  |                         |     

We
have experienced growth in both our North American and International markets with Europe having the highest sales growth in 2004. Our revenue growth, reflected through volume
increases in both channel partner and direct sales, resulted from improvement in capital spending by enterprise and telecommunications companies in our markets. We recognized our first revenues from
MyCaller and AccessGate in our European 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 have experienced the
benefit of these changes in 2004. We expect revenues from our PS business in Europe and North America to modestly increase in 2005. We further expect that our European market will begin to see more
revenue associated with the MyCaller and AccessGate products in 2005.

Cost of Revenues

|                       |  | Year Ended December 31, |     
|---------------------- |  | ----------------------- | ----
|
|
|
|Product                |  | $                       | 25.8
|Service                |  |                         | 7.3 
|Overhead               |  |                         | 6.9 
|Other                  |  |                         | 8.3 
|                       |  |                         |     
|Total cost of revenues |  | $                       | 48.3
|                       |  |                         |     

Our
cost of revenues decreased approximately 21% since 2003 primarily due to reductions in force that occurred during 2003 and a one-time impairment charge related to the
amortization and impairment of completed technology related to past acquisitions of $8.3 million. Product costs increased slightly as a result of increased volume in our PS business offset by
efficiencies achieved with our contract manufacturer. Service costs and overhead costs decreased due to reductions in force. We expect that our costs will increase in 2005 as a result of costs
associated with the sales of our new products, MyCaller and Accessgate. We expect service costs and overhead costs to increase slightly as a result of increases in payroll related costs due to salary
increases.

29

---



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 gross margin, from 2003 to 2004, were primarily driven by increased volume in our PS business, product mix, cost reduction actions and efficiencies achieved with our
contract manufacturer. We expect gross margins to be consistent in our established businesses. A slight decrease in gross margin may occur in 2005 as a result of costs incurred with the sales of our
new products and increases in payroll related costs due to salary increases.

Selling, General and Administrative

Year Ended December 31,2003

2004(In millions)Selling, general and administrative

$37.6

$33.8As a percentage of revenues

43.1
%
33.3
%


Selling,
general and administrative expenses decreased 10.1% during the year ended December 31, 2004 compared to the same period of 2003. The primary reason for the decrease in
selling, general and administrative expense is the realization of cost savings from the reductions-in-force during 2003. Additionally, included in selling, 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 prior acquisitions. These expenses did not reoccur in the year ended December 31, 2004. The decrease is offset by expenses incurred during 2004 associated with approximately
$2.2 million of commissions of escalated sales and approximately $0.7 million of professional fees related to our compliance with Sarbanes Oxley. In 2005, we expect to see a modest
increase in selling, general and administrative expense associated with payroll related costs and marketing efforts related to our new products.

Research and Development

Year Ended December 31,2003

2004(In millions)Research and development

$30.3

$23.9As a percentage of revenues

34.8
%
23.5
%


Research
and development expense decreased 21.2% during the year ended December 31, 2004 compared to the same period of 2003. The decrease is attributable to cost savings from
reductions-in-force in 2003. The Company is currently investing research and development expenditures in both MyCaller and AccessGate with the expectation that those products
will contribute more meaningfully to revenues in 2005. Research and development spending and headcount have been stable throughout 2004. In 2004, we incurred approximately $6.0 million of
research and development expense each quarter. Our research and development activities are primarily focused on opportunities relating to emerging wireless applications, network infrastructure
efficiencies and emerging IP-based services,

30

---



including
VoIP. In 2005, we expect a modest increase in research and development expense associated with increases in payroll related costs.

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
assets and amortizable intangible assets associated with past acquisitions. Due to lower actual and forecasted revenues, as compared to the previous budget for the business units that included these
intangible assets, the estimated value of goodwill, indefinite-lived intangible assets and amortizable intangible assets acquired in past acquisitions had decreased. Based on the results of the
impairment analyses performed on the goodwill, indefinite-lived intangible assets and amortizable intangible assets, these assets were written down to their estimated fair value.

Restructuring and 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 year ended 2003 resulted in the recording of total restructuring and other related charges of $6.9 million. These charges consist of
$4.8 million of involuntary severance related costs, $0.4 million of lease termination costs, $1.6 million write down of fixed assets, and a $0.1 million charge for a write
down of an IML facility to fair market value (as the asset was 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 from the elimination of approximately 140 positions at the Company's
facilities in the United States, Canada, Europe and Asia based on terminations that were announced in January, April, July and

31

---



October
of 2003 and involved all areas of the Company. The following table sets forth activity relating to restructuring and other related charges during the twelve months of 2004:

Employee
Related

Facility
Related

Other

Total(In thousands)Restructuring accrual balance at December 31, 2003

$
1,515

$
1,692

$
121

$
3,328Cash payments


(1,413
)

(496
)

(110
)

(2,019
)Restructuring accrual balance at December 31, 2004

$
102

$
1,196


11

$
1,309


The
remaining accrual balances for employee related and facility related charges are expected to be settled in cash over the next one and four years, respectively.

Other Income (Expense), Net

Year Ended December 31,2003

2004(In millions)Interest income

$
0.7

$
1.2Interest 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 interest expense in 2004 compared to 2003 is attributed to the repurchase and retirement of outstanding convertible debt throughout 2003 and 2004. The increase in
interest income earned for the year ended December 31, 2004 compared to 2003 is primarily due to an increase in our cash, cash equivalents and marketable securities. The Company completed an
underwritten public stock offering that raised $49.5 million in March of 2004. In 2003, we recognized 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 par value. However, in 2004, due to the close proximity of the market and par value of our notes, we recognized a loss of $0.6 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 ended December 31, 2004 and 2003 was $66,000 and $115,000, respectively. Income tax expense is primarily due to state and foreign taxes.

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

32

---



Based
upon available evidence, management believes that the realization of certain deferred tax assets is more unlikely than not and, accordingly has established a full valuation
allowance against those assets. During fiscal 2004, the deferred tax asset valuation allowance increased by $11.6 million, primarily as the result of additional net operating loss carryforwards
and the amortization of intangible assets. We will continue to assess the valuation allowance and to the extent it is determined that such allowance is no longer required, the tax benefit of the
remaining net deferred tax assets will be recognized in the future. Approximately $6.5 million of the valuation allowance for deferred tax assets relates to benefits for stock option
deductions, which, when realized, will be allocated directly to additional paid-in capital. We did not release any of our valuation allowances in 2004.

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

Revenues

Year Ended December 31,2002

2003Amount

% of total

Amount

% of total

Change($ In millions)



($ In millions)PS

$
73.8

71.9
%
$
66.5

76.4
%
(9.8
)%VQS


28.9

28.1


20.5

23.5

(29.1
)NI







0.1

0.1

Total revenues

$
102.7

100.0
%
$
87.1

100.0
%
(15.1
)


Total
revenues of $87.1 million for the year ended December 31, 2003 decreased 15.1% from $102.7 million for the year ended December 31, 2002. PS revenues of
$66.5 million for 2003 decreased 9.8% from $73.8 million for 2002. VQS revenues of $20.5 million for 2003 decreased 29.1% from $28.9 million for 2002. VQS revenue for 2003
included a $3.1 million software royalty fee from Lucent compared to $0.4 million for 2002. NI revenue was $0.1 million for 2003 and $0.0 in 2002. The decrease across the PS and
VQS business units was primarily attributable to continued softness in capital spending by enterprise and telecommunications operators in North America.

Year Ended December 31,2002

20032002
Amount

% of total

2003
Amount

% of total

Change($ In millions)



($ In millions)North America

$
64.6

62.9
%
$
46.6

53.5
%
(27.9
)%International


38.1

37.1


40.5

46.5

6.6Total revenues

$
102.7

100.0
%
$
87.1

100.0
%
(15.1
)


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

Revenues
from Lucent, our primary VQS reseller to telecommunications operators, represented 15.6% and 27.4% of total revenues for 2003 and 2002, respectively. Revenues from Channel
Access, a Carlo Gavazzi Group company and our primary PS channel partner in North America, represented 12.6% in 2003 and less than 10% of total revenues in 2002.

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

33

---



Gross Profit

Year Ended December 31,2002

2003(In millions)Revenues

$
102.7

$
87.1Cost of revenues


57.8


48.3Gross profit

$
44.9

$
38.8As a percentage of revenues


43.7
%

44.5
%


Gross
profit for 2003 of $38.8 million decreased 13.6% from $44.9 million for 2002. Gross profit represented 44.5% and 43.7% of revenues for 2003 and 2002, respectively.
Our cost of revenues for 2003 consisted primarily of product cost of $25.8 million, cost of services provided to our customers of $7.3 million and overhead associated with testing and
fulfillment operations of $6.9 million. Additionally, included in cost of revenues for 2003 were $0.9 million of completed technology amortization and
$7.4 million in impairment charges to reduce the carrying value of completed technology related to past acquisitions.

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

Selling, General and Administrative

Year Ended December 31,2002

2003(In millions)Selling, general and administrative

$
55.4

$
37.6As a percentage of revenues


53.9
%

43.1
%


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

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

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

34

---



Research and Development

Year Ended December 31,2002

2003(In millions)Research and development

$
38.2

$
30.3As a percentage of revenues


37.2
%

34.8
%


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

Impairment Charges

Year Ended December 31,2002

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

$
6.0

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


36.4


10.3Fixed assets associated with the VQS and PS business units





4.0Goodwill and intangible assets related to VQS


30.1


4.066.5


18.3Total impairment charges

$
72.5

$
25.7


During
the year ended December 31, 2003, we recorded impairment charges totaling approximately $25.7 million, based on the declining historical and forecasted operating
results as they related to earlier estimates. The value of goodwill and intangible assets related to MMI, Mobilee and the VQS business unit had decreased. Based on the results of the impairment
analyses performed on the goodwill and intangible assets, these assets were written down to their estimated fair value.

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

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

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

35

---



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

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

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

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

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

In
addition to this charge, a $3.1 million charge is included in the 2002 consolidated statement of operations classification, "Cost of revenues," as it relates to the
write-down of VQS-acquired completed technology.

Restructuring and Other Related Charges

Year Ended December 31,2002

2003(In millions)Involuntary severance related costs

$
2.8

$
4.8Lease termination costs


1.4


0.4Write-down of fixed assets


0.7


1.6Other


0.1


0.1Total restructuring and other related charges

$
5.0

$
6.9


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

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

At
December 31, 2002, we leased a facility in Schaumburg, Illinois that was no longer occupied. At December 31, 2002, we had accrued a total of $1.4 million related
to the termination of this lease. On

36

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January 31,
2003, we entered into a lease termination agreement with the landlord of the facility and paid $1.5 million to the landlord to completely terminate any future rights or
obligations under the lease. The $0.1 million excess payment amount over the established accrual was recorded as restructuring and other related charges in 2003.

A
sublease in the Tustin, California facility was unexpectedly terminated in 2003. As a result, we recorded a charge for $0.3 million in 2003 representing the value of remaining
sublease payments we expected to receive. At December 31, 2003, the remaining accrued balance for all lease termination costs was approximately $1.7 million and is included in the
consolidated balance sheet classification, "Accrued expenses and other liabilities."

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

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

During
2003, we recorded a charge of $0.1 million for legal and placement costs as a result of the reductions in force. The accrued balance for these charges was approximately
$0.1 million and is included in the consolidated balance sheet classification, "Accrued expenses and other liabilities."

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

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

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

As
a result of the reduction in headcount, we had certain fixed assets that were no longer being utilized. These fixed assets consisted primarily of computer equipment, furniture and
fixtures, and machinery and equipment, and they have been disposed of or set aside for disposal. The total charge

37

---



for
the fixed assets that was recorded as restructuring and other related charges in 2002 was approximately $0.7 million.

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

Other Income (Expense), Net

Year Ended December 31,2002

2003(In millions)Interest income

$
2.2

$
0.7Interest expense


(5.8
)

(3.7
)Gain on extinguishment of debt


20.8


2.1Other


2.9


(0.7
)Total other income (expense), net

$
20.1

$
(1.6
)


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

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

The
decrease in interest expense in 2003 compared to 2002 was due to the repurchase of convertible debt during 2002 and 2003. The decrease in interest income in 2003 compared to 2002 was
due to a decrease in interest rates available on cash and cash equivalents combined with the decrease in our cash and cash equivalents as a result of the repurchase of convertible debt and operating
losses.

Income Tax Expense (Benefit)

Year Ended December 31,2002

2003(In millions)Income tax expense (benefit)

$
(1.4
)
$
0.1


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

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

38

---



of
tax credits that were composed of federal research and development credits and state and local credits. These credits began to expire in 2003.

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

Liquidity and Capital Resources

December 31,2003

2004(In millions)Cash, cash equivalents and marketable securities

$
59.9

$
80.6Working capital


58.6


60.9


As
of December 31, 2004, our principal sources of liquidity included cash and cash equivalents of $80.6 million. As of December 31, 2004, our working capital was
approximately $60.9 million. During the year ended 2004, we completed the sale of 9.2 million shares of common stock in an underwritten public offering resulting in net proceeds of
$49.5 million. The Company retired $37.8 million of long-term debt and intends to use the remaining net proceeds from the sale of the stock for general corporate purposes,
which may include working capital, capital expenditures, potential acquisitions and repayment of our remaining convertible subordinated notes due in October 2005. The majority of proceeds were
invested in short-term and long-term marketable securities. As of December 31, 2004 our total investments were $57.1 million of which $10.3 million
represents cash equivalents and $46.8 million represents short-term securities. Cash provided by the issuance of common stock related to employee stock option exercises and employee
stock purchases for the year ended December 31, 2004 was $4.2 million. We had no significant capital spending or purchase commitments other than facilities leases and open purchase
orders in the ordinary course of business.

At
December 31, 2004, we believe that our available cash and cash equivalents will be sufficient to meet our operating expenses, capital requirements and contractual obligations
for at least the next 12 months. Based on our operating plan, we expect to maintain, or build, our cash balance and to have significant cash balances in the long-term. Material
risks to cash flow from operations include
delayed or reduced cash payments accompanying sales of product. There can be no assurance that changes in our plans or other events affecting our operations will not result in materially accelerated
or unexpected expenditures.

Effective
October 11, 2000, the Company issued $175.0 million of convertible subordinated notes (the "Notes"). The Notes are convertible into shares of our common stock at
any time after 90 days following the last day of the original issuance of the Notes and before the close of business on the business day immediately preceding the maturity date, at a conversion
price of $63.125 per share, subject to specified adjustments. The Notes bear interest at a rate of 5% per year which is payable semiannually on April 15 and October 15 of each year,
commencing on April 15, 2001. The Notes, which are unsecured obligations of the Company, will mature on October 15, 2005, unless previously redeemed or repurchased, and have no sinking
fund requirement. Since the issuance of the notes, the Company has repurchased $155.1 million of the notes. At December 31, 2004, the Company had $19.9 million of remaining Notes
outstanding.

39

---



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

Cash
Flow:

Year Ended December 31,2002

2003

2004(In millions)Net income (loss)

$
(98.5
)
$
(56.0
)
$
4.1Depreciation and amortization of long-lived assets


17.5


9.5


3.9Foreign exchanges translation loss (gain) on intercompany debt


(3.8
)

(1.5
)

(0.2
)Loss on impairment of long-lived assets


72.5


27.7


0.1Loss (gain) on extinguishment of debt


(20.7
)

(2.1
)

0.3Other non-cash charges included in net income (loss)


5.7


1.2


0.5Increase (decrease) in operating assets and liabilities


3.2


4.7


(1.0
)Net cash provided by (used in) operating activities

$
(24.1
)
$
(16.5
)
$
7.7Net cash provided by (used in) investing activities

$
37.3

$
26.8

$
(49.6
)Net cash provided by (used in) financing activities

$
(39.9
)
$
(8.2
)
$
15.4


The
Company's return to profitability has resulted in positive cash flow from operations for the year ended December 31, 2004. Cash provided by (used in) operations for the year
ended December 31, 2002, 2003, and 2004 was $(24.1) million, $(16.5) million and $7.7 million, respectively. The change in operating assets and liabilities was primarily attributable to
the changes in accounts receivable and deferred revenue. Accounts receivable balances have increased proportionately to our increase in revenue since the prior years. The increase in deferred revenue
is attributable to initial shipments of MyCaller and AccessGate.

Cash
provided by (used in) investing activities for the years ended December 31, 2002, 2003 and 2004 was $37.3 million, $26.8 million and $(49.6) million,
respectively. Cash was used for purchases of property and equipment of $7.7 million, $2.4 million and $2.5 million for the years ended December 31, 2002, 2003 and 2004,
respectively. Cash was used to purchase additional marketable securities totaling $150.0 million, $23.9 million and $61.5 million in the years ended December 31, 2002, 2003
and 2004, respectively. The Company received proceeds from the maturity of marketable securities of $198.0 million, $53.1 million and $14.3 million in the years ended
December 31, 2002, 2003 and 2004, respectively. The Company used $3.0 million for acquisitions in 2002. There was no cash used for acquisitions in 2003 or 2004.

Cash
provided by (used in) financing activities for the years ended December 31, 2002, 2003 and 2004 was $(39.9) million, $(8.2) million, and $15.4 million, respectively.
In the year ended December 31, 2002, we used cash of $37.9 million to extinguish $59.4 million face value of convertible debt and related accrued interest, while additional
proceeds of $0.8 million were provided through the exercise of employee stock options and employee stock purchases. In 2002, we also used cash to repurchase $2.8 million of common stock
through our repurchase plan. In the year ended December 31, 2003, we used cash of $9.3 million to extinguish $11.3 million face value of convertible debt and related accrued
interest, while additional proceeds of $1.0 million were provided through the

40

---



exercise
of employee stock options and employee stock purchases. In the year ended December 31, 2004, we used cash of $38.5 to extinguish $37.8 million face value of convertible debt and
related accrued interest, $49.5 million of cash was provided through the sale of 9.2 million shares of common stock, while additional proceeds of $4.2 million were provided
through the exercise of employee stock options and employee stock purchases.

Off-Balance Sheet Arrangements and Contractual Obligations

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

Contractual Obligations

|                                               |  | Payments Due by Period
|---------------------------------------------- |  | ----------------------
|
|
|Property and equipment leases                  |  | $                     
|Open purchase orders                           |  |                       
|Convertible notes and related accrued interest |  |                       
|                                               |  |                       
|Total contractual obligations                  |  | $                     
|                                               |  |                       

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

The
Company's agreement with Plexus requires that Plexus turn its NMS-related inventory eight times per year. If this condition is not met, the Company must purchase enough
material to bring Plexus up to eight turns. This is assessed on a quarterly basis. At December 31, 2004, the Company had satisfied the eight turn goal in all preceding quarters. As such, we
have not included any amounts in the table of contractual obligations related to a commitment with Plexus at December 31, 2004. The Company can only ascribe value to such commitment when the
Company has not met the condition as determined at a specific point in time, based on future facts and circumstances. Plexus is the Company's only third-party contract manufacturer. As such, NMS is
not party to any other such arrangements.

Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, "Inventory Costsan Amendment of ARB No. 43, Chapter 4" ("SFAS 151").
SFAS 151 amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight handling costs, and wasted materials (spoilage) should be recognized as
current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The
provisions of this Statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of the provisions of SFAS 151 is not expected to
have a material impact on our financial position or results of operations.

41

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In
December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123(R), "Share-Based Payment", which is a revision of SFAS No. 123 and supersedes APB
Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be
expensed over the applicable vesting period. Pro forma disclosure of the income statement effects of share-based payments is no longer an alternative. SFAS No. 123(R) is effective for all
stock-based awards granted on or after July 1, 2005. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date.
Compensation expense for the unvested awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of
SFAS No. 123. The Company is currently assessing the impact of adopting SFAS 123(R) to its consolidated results of operations.

In
December 2004, the FASB issued FASB Staff Position No. FAS 109-1 ("FAS 109-1"), "Application of FASB Statement No. 109, "Accounting
for Income Taxes," to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 ("AJCA"). The AJCA introduces a special 9% tax deduction on qualified
production activities. FAS 109-1 clarifies that this tax deduction should be accounted for as a special tax deduction in accordance with Statement 109. We do not expect the adoption
of these new tax provisions to have a material impact on our consolidated financial position, results of operations or cash flows.

In
December 2004, the FASB issued FASB Staff Position No. FAS 109-2 ("FAS 109-2"), "Accounting and Disclosure Guidance for the Foreign
Earnings Repatriation Provision within the American Jobs Creations Act of 2004." The AJCA introduces a limited time 85% dividends received deduction on the repatriation of certain foreign earnings to
a U.S. taxpayer (repatriation provision), provided certain criteria are met. FAS109-2 provides accounting and disclosure guidance for the repatriation provision. Although
FAS 109-2 is effective immediately, we do not expect to be able to complete our evaluation of the repatriation provision until after Congress or the Treasury Department provides
additional clarifying language on key elements of the provision. In January 2005, the Treasury Department began to issue the first of a series of clarifying guidance documents related to this
provision. We expect to complete our evaluation of the effects of the repatriation provision within the first two fiscal quarters of 2005. We do not expect to repatriate any amounts under this
provision. While we estimate that the related potential range of additional income tax is zero, this estimation is subject to change following technical correction legislation that we believe is
forthcoming from Congress. The amount of additional income tax would be reduced by the part of the eligible dividend that is attributable to foreign earnings on which a deferred tax liability had been
previously accrued.

42

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Quarterly Information (Unaudited)

|                                                       |                                         | Quarter Ended            |        
|------------------------------------------------------ | --------------------------------------- | ------------------------ | -------
|
|
|
|Revenues                                               |                                         | $                        | 20,812 
|Cost of revenues                                       |                                         |                          | 10,885 
|                                                       |                                         |                          |        
|Gross profit                                           |                                         |                          | 9,927  
|Operating expenses:                                    |                                         |                          |        
|                                                       | Selling, general and administrative     |                          |        
|                                                       | Research and development                |                          |        
|                                                       | Impairment charges                      |                          |        
|                                                       | Restructuring and other related charges |                          |        
|                                                       |                                         |                          |        
|                                                       |                                         | Total operating expenses |        
|                                                       |                                         |                          |        
|Operating income (loss)                                |                                         |                          | (10,922
|Other income (expense), net                            |                                         |                          | (735   
|                                                       |                                         |                          |        
|Income (loss) before income taxes                      |                                         |                          | (11,657
|Income tax expense (benefit)                           |                                         |                          | (74    
|                                                       |                                         |                          |        
|Net income (loss)                                      |                                         | $                        | (11,583
|                                                       |                                         |                          |        
|Basic and diluted net earnings (loss) per common share |                                         | $                        | (0.32  
|                                                       |                                         |                          |        

|                                  |                                         | Quarter Ended            |     
|--------------------------------- | --------------------------------------- | ------------------------ | ----
|
|
|Revenues                          |                                         | 100.0                    | %   
|Cost of revenues                  |                                         | 52.3                     |     
|                                  |                                         |                          |     
|                                  | Gross profit                            |                          | 47.7
|                                  |                                         |                          |     
|Operating expenses:               |                                         |                          |     
|                                  | Selling, general and administrative     |                          | 53.8
|                                  | Research and development                |                          | 42.1
|                                  | Impairment charges                      |                          |    
|                                  | Restructuring and other related charges |                          | 4.3 
|                                  |                                         |                          |     
|                                  |                                         | Total operating expenses |     
|                                  |                                         |                          |     
|Operating income (loss)           |                                         | (52.5                    | )   
|Other income (expense), net       |                                         | (3.5                     | )   
|                                  |                                         |                          |     
|Income (loss) before income taxes |                                         | (56.0                    | )   
|Income taxes expense (benefit)    |                                         | (0.3                     | )   
|                                  |                                         |                          |     
|Net income (loss)                 |                                         | (55.7                    | )%  
|                                  |                                         |                          |     

Revenue has increased modestly on a sequential basis through 2003 and 2004. This growth is attributable to the increase in the PS business unit
revenues.

Our
cost of revenues as a percentage of revenues have fluctuated between 44.7% to 80.3% for each quarter included in the two-year period ended December 31, 2004.
During the second quarter of 2003, cost of revenues were 80%, due in part to the inclusion of a $7.4 million impairment charge related to prior acquisitions. In 2004, our cost of revenue as a
percentage of revenue has remained relatively stable between the ranges of 36.2% to 38.5%. The improvement in gross margin in 2004 is primarily driven by increased volume, product mix, cost reduction
actions and efficiencies achieved with our contract manufacturer.

43

---



On
a sequential basis, the dollar amounts of our selling, general and administrative expenses generally decreased from the first quarter of 2003 through the second quarter of 2004. The
primary reason for that decrease in selling, general and administrative expense is the realization of cost savings from the reductions-in-force during 2003. Selling, general
and administrative expenses increased in the second half of 2004 primarily due to an increase in commissions expense in our PS business unit, expenses related to our efforts in complying with the
Sarbanes-Oxley Act of 2002, and expenses related to a restructured lease.

Our
research and development expenses decreased from 2003 to 2004 primarily due to cost savings from reductions-in-force in 2003. The research and development
expenses have been stable in 2004 and the Company is currently investing research and development expenditures in both MyCaller and AccessGate with the expectation that those products will more
significantly contribute to revenues in 2005.

During
the fourth quarter of fiscal 2003, we recorded two foreign currency transaction adjustments, netting to $0.3 million, which decreased loss before income taxes, reversed a
vacation accrual, which resulted in a decrease to loss before income taxes of $0.9 million, and made an adjustment to decrease overhead costs capitalized in inventories totaling
$0.8 million, which increased cost of revenues and, therefore, loss before income taxes. There weren't any similar adjustments in 2004.

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

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

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

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. Our investment portfolio of cash equivalents,
marketable securities and non-marketable securities are subject to interest rate fluctuations, but we believe this risk is immaterial due to the short-term nature of these
investments. At December 31, 2004, we had $19.9 million of long-term debt outstanding. A hypothetical 10% decrease in our weighted-average borrowing rate at
December 31, 2004 would not have materially affected the year-end carrying value of the debt. Our exposure to currency exchange rate fluctuations has been moderate due to the fact
that the revenues are billed primarily in U.S. dollars.

44

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Report of Independent Registered Public Accounting Firm

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

We
have completed an integrated audit of NMS Communications Corporation's 2004 consolidated financial statements and of its internal control over financial reporting as of
December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our
opinions, based on our audits, are presented below.

Consolidated financial statements and financial statement schedule

In our opinion, the consolidated financial statements listed in the accompanying index appearing under Item 15(a)(1) present fairly, in all material respects, the
financial position of NMS Communications Corporation and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule
listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial
statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements
and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, management's assessment, included in Management's Report on Internal Control Over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established inInternal ControlsIntegrated
Frameworkissued by 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, 2004, based on criteria established in Internal ControlIntegrated
Frameworkissued by the COSO. The Company's management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and operating effectiveness of

45

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internal
control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A
company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

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

PricewaterhouseCoopers
LLP
Boston, Massachusetts
March 16, 2005

46

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NMS Communications Corporation  Consolidated Balance Sheets

|                                        |                                                                                                                                                                                                                                                 | December 31, |       
|--------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------ | ------
|
|
|Assets                                  |                                                                                                                                                                                                                                                 |              |       
|Current assets:                         |                                                                                                                                                                                                                                                 |              |       
|                                        | Cash and cash equivalents                                                                                                                                                                                                                       |              | $     
|                                        | Marketable securities                                                                                                                                                                                                                           |              |       
|                                        | Accounts receivable, net of allowance for doubtful accounts of $995 and $1,004, respectively                                                                                                                                                    |              |       
|                                        | Inventories                                                                                                                                                                                                                                     |              |       
|                                        | Prepaid expenses and other assets                                                                                                                                                                                                               |              |       
|                                        |                                                                                                                                                                                                                                                 |              |       
|                                        | Total current assets                                                                                                                                                                                                                            |              |       
|                                        |                                                                                                                                                                                                                                                 |              |       
|Property and equipment, net             |                                                                                                                                                                                                                                                 |              | 7,219 
|Other assets                            |                                                                                                                                                                                                                                                 |              | 2,147 
|                                        |                                                                                                                                                                                                                                                 |              |       
|                                        | Total assets                                                                                                                                                                                                                                    |              | $     
|                                        |                                                                                                                                                                                                                                                 |              |       
|Liabilities and Stockholders' Equity    |                                                                                                                                                                                                                                                 |              |       
|Current liabilities:                    |                                                                                                                                                                                                                                                 |              |       
|                                        | Accounts payable                                                                                                                                                                                                                                |              | $     
|                                        | Accrued expenses and other liabilities                                                                                                                                                                                                          |              |       
|                                        | Deferred revenue                                                                                                                                                                                                                                |              |       
|                                        | Short-term debt obligations                                                                                                                                                                                                                     |              |       
|                                        |                                                                                                                                                                                                                                                 |              |       
|                                        | Total current liabilities                                                                                                                                                                                                                       |              |       
|Long-term debt less current portion     |                                                                                                                                                                                                                                                 |              | 57,742
|                                        |                                                                                                                                                                                                                                                 |              |       
|                                        | Total liabilities                                                                                                                                                                                                                               |              |       
|                                        |                                                                                                                                                                                                                                                 |              |       
|Commitments and contingencies (note 15) |                                                                                                                                                                                                                                                 |              |       
|Stockholders' equity:                   |                                                                                                                                                                                                                                                 |              |       
|                                        | Preferred stock, $0.01 par value, 3,000,000 shares authorized at December 31, 2003 and 2004, respectively, no shares issued and outstanding                                                                                                     |              |       
|                                        | Common stock, $0.01 par value, 125,000,000 shares authorized; 36,738,402 and 47,369,352 shares issued at December 31, 2003 and 2004, respectively, and 36,685,958 and 47,369,352 shares outstanding at December 31,
2003 and 2004, respectively |              |       
|                                        | Additional paid-in capital                                                                                                                                                                                                                      |              |       
|                                        | Accumulated deficit                                                                                                                                                                                                                             |              |       
|                                        | Accumulated other comprehensive loss                                                                                                                                                                                                            |              |       
|                                        | Deferred compensation                                                                                                                                                                                                                           |              |       
|                                        | Treasury stock, at cost, 52,444 and 0 shares at December 31, 2003 and 2004, respectively                                                                                                                                                        |              |       
|                                        |                                                                                                                                                                                                                                                 |              |       
|                                        | Total stockholders' equity                                                                                                                                                                                                                      |              |       
|                                        |                                                                                                                                                                                                                                                 |              |       
|                                        | Total liabilities and stockholders' equity                                                                                                                                                                                                      |              | $     
|                                        |                                                                                                                                                                                                                                                 |              |       

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

47

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NMS Communications Corporation  Consolidated Statements of Operations

|                                  |                                             | Year Ended December 31, |         
|--------------------------------- | ------------------------------------------- | ----------------------- | --------
|
|
|Revenues                          |                                             | $                       | 102,693 
|Cost of revenues                  |                                             |                         | 57,786  
|                                  |                                             |                         |         
|Gross profit                      |                                             |                         | 44,907  
|Operating expenses:               |                                             |                         |         
|                                  | Selling, general and administrative         |                         |         
|                                  | Research and development                    |                         |         
|                                  | Impairment charges                          |                         |         
|                                  | Restructuring and other related charges     |                         |         
|                                  |                                             |                         |         
|                                  | Total operating expenses                    |                         |         
|                                  |                                             |                         |         
|Operating income (loss)           |                                             |                         | (120,106
|Other income (expense):           |                                             |                         |         
|                                  | Interest income                             |                         |         
|                                  | Interest expense                            |                         |         
|                                  | Gain (loss) on extinguishment of debt       |                         |         
|                                  | Other                                       |                         |         
|                                  |                                             |                         |         
|                                  | Other income (expense), net                 |                         |         
|                                  |                                             |                         |         
|Income (loss) before income taxes |                                             |                         | (99,975 
|                                  | Income tax expense (benefit)                |                         |         
|                                  |                                             |                         |         
|Net income (loss)                 |                                             | $                       | (98,539 
|                                  |                                             |                         |         
|                                  | Basic earnings (loss) per common share      |                         | $       
|                                  |                                             |                         |         
|                                  | Weighted average basic shares outstanding   |                         |         
|                                  |                                             |                         |         
|                                  | Diluted earnings (loss) per common share    |                         | $       
|                                  |                                             |                         |         
|                                  | Weighted average diluted shares outstanding |                         |         
|                                  |                                             |                         |         

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

48

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NMS Communications Corporation  Consolidated Statements of Stockholders' Equity

|                           |                                                          | Common
Stock |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|-------------------------- | -------------------------------------------------------- | ------------ | ----- | - | --- | -- | - | ------- | ------ | - | -------- | ------- | - | ------ | ------ | - | ------
|
|
|
|Balance, December 31, 2001 |                                                          | 36,729       |       | $ | 367 |    | $ | 366,969 |        | $ | (192,289 | )       | $ | (383   | )      | $ | (9,049
|                           |                                                          |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|                           | Exercise of common stock options and warrants            |              |       |   |     |    |   |         | (195   | ) |          |         |   |        |        |   |       
|                           | Issuance of common stock under employee purchase plan    |              |       |   |     |    |   |         | (848   | ) |          |         |   |        |        |   |       
|                           | Stock issued under Mobilee merger agreement              |              | 9     |   |     |   |   |         | (78    | ) |          |         |   |        |        |   |       
|                           | Stock forfeited under IML merger agreement               |              | (135  | ) |     | (1 | ) |         | 1      |   |          |         |   |        |        |   |       
|                           | Amortization of deferred compensation                    |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|                           | Termination of options issued at below FMV               |              |       |   |     |    |   |         | (3,131 | ) |          |         |   |        |        |   |       
|                           | Stock repurchase                                         |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|                           | Payment from officer option exercise                     |              |       |   |     |    |   |         | 58     |   |          |         |   |        |        |   |       
|                           | Change in market value of securities available for sale  |              |       |   |     |    |   |         |        |   |          |         |   |        | (113   | ) |       
|                           | Foreign currency translation adjustment                  |              |       |   |     |    |   |         |        |   |          |         |   |        | (2,208 | ) |       
|                           | Net loss                                                 |              |       |   |     |    |   |         |        |   |          | (98,539 | ) |        |        |   |       
|                           |                                                          |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|Balance, December 31, 2002 |                                                          | 36,603       |       | $ | 366 |    | $ | 362,776 |        | $ | (290,828 | )       | $ | (2,704 | )      | $ | (2,531
|                           |                                                          |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|                           | Issuance of common stock under employee purchase plan    |              |       |   |     |    |   | $       | (855   | ) |          |         |   |        |        |   |       
|                           | Amortization of deferred compensation                    |              |       |   |     |    |   |         |       |   |          |         |   |        |        |   |       
|                           | Termination of options issued at below FMV               |              |       |   |     |    |   |         | (1,786 | ) |          |         |   |        |        |   |       
|                           | Exercise of common stock options and warrants            |              |       |   |     |    |   |         | (716   | ) |          |         |   |        |        |   |       
|                           | Adjustment of forfeited stock under IML merger agreement |              | 135   |   |     | 1  |   |         | (1     | ) |          |         |   |        |        |   |       
|                           | Foreign currency translation adjustment                  |              |       |   |     |    |   |         |        |   |          |         |   |        | 378    |   |       
|                           | Net loss                                                 |              |       |   |     |    |   |         |        |   |          | (56,006 | ) |        |        |   |       
|                           |                                                          |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|Balance, December 31, 2003 |                                                          | 36,738       |       | $ | 367 |    | $ | 359,418 |        | $ | (346,834 | )       | $ | (2,326 | )      | $ | (102  
|                           |                                                          |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|                           | Issuance of common stock under employee purchase plan    |              | 149   |   |     | 2  |   |         | 535    |   |          |         |   |        |        |   |       
|                           | Amortization of deferred compensation                    |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|                           | Exercise of common stock options and warrants            |              | 1,282 |   |     | 13 |   |         | 3,620  |   |          |         |   |        |        |   |       
|                           | Issuance of common stock under secondary offering        |              | 9,200 |   |     | 92 |   |         | 49,416 |   |          |         |   |        |        |   |       
|                           | Change in market value of securities available for sale  |              |       |   |     |    |   |         |        |   |          |         |   |        | (108   | ) |       
|                           | Foreign currency translation adjustment                  |              |       |   |     |    |   |         |        |   |          |         |   |        | 134    |   |       
|                           | Net income                                               |              |       |   |     |    |   |         |        |   |          | 4,102   |   |        |        |   |       
|                           |                                                          |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       
|Balance, December 31, 2004 |                                                          | 47,369       |       | $ | 474 |    | $ | 412,989 |        | $ | (342,732 | )       | $ | (2,300 | )      | $ |      
|                           |                                                          |              |       |   |     |    |   |         |        |   |          |         |   |        |        |   |       

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

49

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NMS Communications Corporation  Consolidated Statements of Cash Flows

|                                                                                               |                                                                              | Years Ended December 31,               |                                                
|---------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | -------------------------------------- | -----------------------------------------------
|
|
|Cash flow from operating activities:                                                           |                                                                              |                                        |                                                
|                                                                                               | Net income (loss)                                                            |                                        | $                                              
|Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: |                                                                              |                                        |                                                
|                                                                                               | Depreciation and amortization of property and equipment                      |                                        |                                                
|                                                                                               | Amortization of goodwill and other intangibles                               |                                        |                                                
|                                                                                               | Foreign exchange translation gain on intercompany debt                       |                                        |                                                
|                                                                                               | Loss on impairment and disposal of property and equipment                    |                                        |                                                
|                                                                                               | Loss on impairment of goodwill and other intangibles                         |                                        |                                                
|                                                                                               | Loss on investments                                                          |                                        |                                                
|                                                                                               | Loss (gain) on extinguishment of long-term debt                              |                                        |                                                
|                                                                                               | Write-off and amortization of debt issuance costs                            |                                        |                                                
|                                                                                               | Deferred stock compensation expense amortized                                |                                        |                                                
|                                                                                               | Changes in operating assets and liabilities, net of effects of acquisitions: |                                        |                                                
|                                                                                               |                                                                              | Accounts receivable                    |                                                
|                                                                                               |                                                                              | Inventories                            |                                                
|                                                                                               |                                                                              | Prepaid expenses and other assets      |                                                
|                                                                                               |                                                                              | Accounts payable                       |                                                
|                                                                                               |                                                                              | Deferred revenue                       |                                                
|                                                                                               |                                                                              | Accrued expenses and other liabilities |                                                
|                                                                                               |                                                                              |                                        |                                                
|                                                                                               |                                                                              |                                        | Cash (used in) provided by operating activities
|                                                                                               |                                                                              |                                        |                                                
|Cash flow from investing activities:                                                           |                                                                              |                                        |                                                
|                                                                                               | Purchases of property and equipment                                          |                                        |                                                
|                                                                                               | Purchases of marketable securities                                           |                                        |                                                
|                                                                                               | Proceeds from the maturity of marketable securities                          |                                        |                                                
|                                                                                               | Acquisitions of businesses, net of cash acquired                             |                                        |                                                
|                                                                                               |                                                                              |                                        |                                                
|                                                                                               |                                                                              |                                        | Cash provided by (used in) investing activities
|                                                                                               |                                                                              |                                        |                                                
|Cash flow from financing activities:                                                           |                                                                              |                                        |                                                
|                                                                                               | Repurchase of long-term debt                                                 |                                        |                                                
|                                                                                               | Proceeds from issuance of common stock                                       |                                        |                                                
|                                                                                               | Repurchase of common stock                                                   |                                        |                                                
|                                                                                               |                                                                              |                                        |                                                
|                                                                                               |                                                                              |                                        | Cash (used in) provided by financing activities
|                                                                                               |                                                                              |                                        |                                                
|Effect of exchange rate changes on cash                                                        |                                                                              |                                        | (468                                           
|                                                                                               |                                                                              |                                        |                                                
|Net increase (decrease) in cash and cash equivalents                                           |                                                                              |                                        | (27,242                                        
|                                                                                               |                                                                              |                                        |                                                
|Cash and cash equivalents, beginning of year                                                   |                                                                              |                                        | 84,010                                         
|                                                                                               |                                                                              |                                        |                                                
|Cash and cash equivalents, end of year                                                         |                                                                              | $                                      | 56,768                                         
|                                                                                               |                                                                              |                                        |                                                
|Supplemental cash flow information:                                                            |                                                                              |                                        |                                                
|                                                                                               | Interest paid                                                                |                                        | $                                              
|                                                                                               | Taxes paid                                                                   |                                        |                                                
|Noncash transactions:                                                                          |                                                                              |                                        |                                                
|                                                                                               | Acquisition of business:                                                     |                                        |                                                
|                                                                                               | Fair value of assets acquired, net of cash acquired                          |                                        |                                                

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

50

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Notes to Consolidated Financial Statements

1Summary of Significant Accounting Policies

Business Description

NMS Communications Corporation is a provider of enabling technologies, platforms and systems to wireless and wireline telecommunications operators and network
equipment and application providers. The Company's products, which include systems building blocks, service delivery systems and personalized mobile entertainment applications, voice quality systems
and a wireless backhaul optimizer, address a wide range of customers' needs as they seek to develop and deploy enhanced voice and data services and applications, and improve the quality and efficiency
of communications networks. Telecommunications operators use the Company's products to improve customer acquisition and retention, diversify revenue streams and reduce operating costs and capital
expenditures. Network equipment and application providers use the Company's products to help deploy leading technology solutions for their telecommunications and enterprise customers in a timely and
cost-effective manner. The Company sells its products worldwide through its direct sales force as well as through channel partners and system integrator partners. The Company's customers
include leading telecommunications operators and network equipment and application providers such as Vodafone, Ericsson, Logica CMG, Alcatel, Comverse, NTT DoCoMo, Avaya, Lucent Technologies, Huawei,
Cisco, SFR Cegetel, Siemens, European Computer Telecommunications, Microsoft and SER Solutions.

Principles of Consolidation

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

Reclassifications

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

Use of Estimates

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

Foreign Currency Translation

Assets and liabilities of the Company's subsidiaries operating outside the United States, which operate in a functional currency other than U.S. dollars, are
translated into U.S. dollars using year-end exchange rates. Revenues and expenses are translated at the average exchange rates effective during the year. Foreign currency translation gains
and losses are included as a component of accumulated other comprehensive income (loss) within stockholders' equity. Gains and losses resulting from foreign currency transactions are included in other
income (expense), net. The foreign currency translation gain or loss generated by the remeasurement of our intercompany debt at each reporting period is recorded

51

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as
a component of 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 two sources: sales of products, including hardware and software licenses, and services, including maintenance,
support and professional services. Maintenance and support services consist of on-site support, telephone support, system hosting and training. Professional services consist of consulting
arrangements which may consist of hardware and/or software customization projects provided to customers through such contracts. The Company sells its products and services through direct sales and
through channel partners, which includes resellers and distributors and system integrators. Management must make and use judgments and estimates in connection with the revenue recognized in any
reporting period. The Company's products are generally shipped together as a bundled hardware and software solution. The software sold in the bundled product is essential to the functionality of the
hardware and as such, the Company recognizes revenue in accordance with the provisions of the American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, Software Revenue Recognition, and related interpretations. The Company recognizes revenue from the sale of products when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is considered probable.

When
selling to resellers and distributors, the Company defers revenue until collectibility is reasonably assured. When revenue is deferred, if reliable reporting from the reseller or
distributor exists, the Company will recognize that revenue when the reseller or distributor sells the product to an end-user ("sell through"). Where reliable reporting does not exist,
revenue will be recognized upon our receipt of payment, or in limited circumstances, receipt of a letter of credit.

For
arrangements with customers that include acceptance provisions in arrangements with customers, the Company recognizes revenue upon the customer's acceptance of the product, which
occurs upon the earlier of receipt of a written customer acceptance or expiration of the contractual acceptance period.

In
accordance with Statement of Financial Accounting Standards ("SFAS") No. 48, "Revenue Recognition when Right of Return Exists," the Company recognizes revenue upon shipment of
product to its stocking distributors, net of estimated returns. The Company offers quarterly return rights to a limited number of channel partners that allow the channel partner to rotate a percentage
of its inventory based on its prior quarter purchases. The Company provides for these return rights each quarter in an amount equal to estimated returns. The Company does not offer rights of return on
sales made through direct sales force.

When
an arrangement involves multiple elements, such as products, maintenance and/or professional services, the Company allocates the entire sale price to each respective element based
on vendor specific objective evidence ("VSOE"). When arrangements contain multiple elements and VSOE of fair value exists for all undelivered elements, the Company recognizes revenue for the delivered
elements using the residual method. The Company bases its determination of VSOE of fair value of each of the undelivered elements in multi-element arrangements on either the price the Company charges
when the same element is sold separately or the price established by the members of our management, who have the relevant authority to set prices, for an element not yet sold separately. For
arrangements containing multiple elements where VSOE of fair value does not exist for all undelivered elements, the Company defers revenue for the delivered and undelivered elements until VSOE of fair
value exists or all elements have been delivered.

The
Company defers maintenance and support services revenue, whether sold separately or as part of a multiple element arrangement, and recognizes it ratably over the term of the
maintenance contract, generally twelve months. When maintenance and support services are not sold separately the

52

---



Company
determines VSOE on maintenance and support services by establishing a substantive renewal price as a percentage of the sale price in its arrangements.

The
Company recognizes revenue allocated to professional service elements as the services are performed. When the customization is essential to the functionality of the licensed
software, then both the software license and professional services revenue are recognized under the percentage of completion method, which requires revenue to be recognized as a percentage of the
project completed. The Company recognizes revenue and gross profit using labor hours as an input measure of progress to completion on these arrangements.

Maintenance
and support services and professional service revenue represents 7.5%, 8.6% and 8.8% of revenue for the years ended December 31, 2002, 2003 and 2004, respectively

When
there are shipping and handling fees, The Company invoices customers for such fees. The Company recognizes the invoiced amounts as revenue. The related costs are recognized in cost
of revenue.

Cash Equivalents

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

Accounts Receivable

The Company's accounts receivable balances are composed of trade receivables. The Company has recorded receivables associated with product and services that have
been delivered but not yet accepted; such receivables represented approximately $0.4 million and $2.5 million of the accounts receivable balance as of December 31, 2003 and 2004,
respectively.

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

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

Investments

The Company classifies all of its investments in marketable securities as available-for-sale securities. These securities are stated at
market value, with unrealized gains and losses reflected in other comprehensive loss in stockholders' equity. The
amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion are included in interest income. Realized gains and
losses on marketable securities are included in earnings and are derived using the specific identification method for determining the cost of securities. The Company periodically evaluates the
carrying value of its investments for other than temporary impairment.

Advertising

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

53

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Inventories

Inventories are valued at the lower of cost (first-in, first-out method) or market. Inventories consist of raw materials work in process,
finished goods and inventory at customer sites. Inventory at customer sites represents inventory associated with product that has not yet been accepted by the customer. Valuation allowances related to
excess and obsolete inventory are based primarily on estimated forecast of product demand and production requirements over the next twelve months.

Property and Equipment

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

Machinery and equipment

3 yearsComputer software and equipment

3-5 yearsFurniture and fixtures

5 yearsTelecommunications computer equipment

5 yearsBuilding

20 yearsLeasehold improvements

Shorter of the lease term or economic life


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

Long-lived Assets and Goodwill

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

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

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

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

54

---



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

Research and Development

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

Capitalized Software Development Costs

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

Financial Instruments

The Company's financial instruments include cash, marketable securities, accounts receivable, debt and accounts payable. The fair value of marketable securities,
accounts receivable and accounts payable are equal to their carrying value at December 31, 2003 and 2004. Fair value of long-term debt at December 31, 2003 and 2004 is
approximately $53.4 million and $19.7 million, respectively. Long-term debt is recorded at its face value.

Income Taxes

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

Stock Option and Stock Purchase Plans

As more fully described in Note 14 to the consolidated financial statements, the Company has stock option and stock purchase plans authorizing various
types of stock-based awards that may be granted to officers and employees. In the consolidated financial statements, the Company applied Accounting Principles Board Opinion No. 25 "Accounting
for Stock Issued to Employees," and related interpretations in accounting for its stock option and employee stock purchase plans. All options granted under the various plans administered by the
Company have a vesting life not to exceed four years, and these options have an expiration date of up to ten years from the date of grant.

In
accordance with SFAS No. 123, "Accounting for Stock- Based Compensation," the fair value of each stock-based award has been estimated on the date of grant using the
Black-Scholes option-pricing model. The weighted average fair value at date of grant for stock options granted during the years ended December 31, 2002, 2003 and 2004 was $3.41, $1.31, and
$6.30 respectively. The weighted average fair value of employee stock purchases during the years ended December 31, 2002, 2003 and

55

---



2004
was $0.79, $0.41 and $3.60, respectively. The following table summarizes the weighted average assumptions used in the Black-Scholes option-pricing model:

2002

2003

2004Risk Free Interest Rate

3.8%

3.0%

3.4%Expected Life

5 years

5 years

5 yearsExpected Volatility

115%

115%

115%Expected Dividend Yield

0%

0%

0%


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

|                                                                                                          |                                                                     | Year Ended December 31, |         
|--------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------- | ----------------------- | --------
|
|
|Net income (loss), as reported                                                                            |                                                                     | $                       | (98,539 
|Add: Stock-based employee compensation expense included in net income (loss)                              |                                                                     |                         | 3,387   
|Less: Total stock-based employee compensation expense determined under Black-Scholes option pricing model |                                                                     |                         | (37,091 
|                                                                                                          |                                                                     |                         |         
|Pro forma net loss                                                                                        |                                                                     | $                       | (132,243
|                                                                                                          |                                                                     |                         |         
|Weighted average basic shares outstanding                                                                 |                                                                     |                         | 36,069  
|                                                                                                          |                                                                     |                         |         
|Weighted average diluted shares outstanding                                                               |                                                                     |                         | 36,069  
|                                                                                                          |                                                                     |                         |         
|Earnings (loss) per share:                                                                                |                                                                     |                         |         
|                                                                                                          | Basic and diluted net earnings (loss) per common share, as reported |                         | $       
|                                                                                                          | Basic and diluted net loss per common share, pro forma              |                         | $       

Basic and Diluted Net Earnings (Loss) Per Common Share

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

The
following table sets forth the computation of basic and diluted earnings (loss) per share for the year ended December 31, 2002, 2003 and 2004:

2002

2003

2004(In thousands, except per share data)Numerator:Net income (loss)

$
(98,539
)
$
(56,006
)
$
4,102Denominator:Basic weighted average shares outstanding


36,069


36,430


44,709Diluted weighted average shares outstanding


36,069


36,430


46,894Net earnings (loss) per share:Basic and diluted

$
(2.73
)
$
(1.54
)
$
0.09


56

---



The number of options that were excluded from the calculation of diluted earnings (loss) per common share, as their inclusion would have been
anti-dilutive at December 31, 2002, 2003 and 2004 were 8,674,691, 8,901,814 and 4,321,213, respectively. Additional common stock equivalents related to the Company's Convertible
Notes of 1,094,130, 914,726 and 315,289 and at December 31, 2002, 2003 and 2004, respectively, have been excluded from the calculation of diluted earnings per common share as their inclusion
would have been anti-dilutive.

Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, "Inventory Costsan Amendment of ARB No. 43, Chapter 4" ("SFAS 151").
SFAS 151 amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight handling costs, and wasted materials (spoilage) should be recognized as
current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The
provisions of this Statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of the provisions of SFAS 151 is not expected to
have a material impact on our financial position or results of operations.

In
December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123(R), "Share-Based Payment", which is a revision of SFAS No. 123 and supersedes APB
Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be
expensed over the applicable vesting period. Pro forma disclosure of the income statement effects of share-based payments is no longer an alternative. SFAS No. 123(R) is effective for all
stock-based awards granted on or after July 1, 2005. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date.
Compensation expense for the unvested awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of
SFAS No. 123. The Company is currently assessing the impact of adopting SFAS 123(R) to its consolidated results of operations.

In
December 2004, the FASB issued FASB Staff Position No. FAS 109-1 ("FAS 109-1"), "Application of FASB Statement No. 109, "Accounting
for Income Taxes," to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act
of 2004 ("AJCA"). The AJCA introduces a special 9% tax deduction on qualified domestic production activities. FAS 109-1 clarifies that this tax deduction should be accounted for as
a special tax deduction in accordance with Statement 109. We do not expect the adoption of these new tax provisions to have a material impact on our consolidated financial position, results of
operations or cash flows.

In
December 2004, the FASB issued FASB Staff Position No. FAS 109-2 ("FAS 109-2"), "Accounting and Disclosure Guidance for the Foreign
Earnings Repatriation Provision within the American Jobs Creations Act of 2004." The AJCA introduces a limited time 85% dividends received deduction on the repatriation of certain foreign earnings to
a U.S. taxpayer (repatriation provision), provided certain criteria are met. FAS109-2 provides accounting and disclosure guidance for the repatriation provision. Although
FAS 109-2 is effective immediately, we do not expect to be able to complete our evaluation of the repatriation provision until after Congress or the Treasury Department provides
additional clarifying language on key elements of the provision. In January 2005, the Treasury Department began to issue the first of a series of clarifying guidance documents related to this
provision. We expect to complete our evaluation of the effects of the repatriation provision within the first two fiscal quarters of 2005. We do not expect to repatriate any amounts under this
provision. While we estimate that the related potential range of additional income tax is zero, this estimation is subject to change following technical correction legislation that we believe is
forthcoming from Congress. The amount of additional income tax would be reduced by the part of the eligible dividend that is attributable to foreign earnings on which a deferred tax liability had been
previously accrued.

57

---



2Risks and Uncertainties

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

3Goodwill and Other Intangibles

As of December 31, 2003 and 2004, there is no goodwill or long-lived intangible assets on the Company's balance sheet. Amortization expense
related to intangible assets was $8.0 million and $2.0 million for the year ended December 31, 2002 and 2003, respectively. There was no amortization expense recorded in 2004.

Impairment Charges

Year Ended
December 31,2002

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

$
6.0

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


36.4


10.3Fixed assets associated with the VQS and PS business unit





4.0Goodwill and intangible assets related to VQS


30.1


4.066.5


18.3Total impairment charges

$
72.5

$
25.7


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

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

58

---



fixed
assets had decreased. Based on the results of the impairment analysis performed, these assets were written-down to their fair value.

In
addition to this charge, a $3.1 million charge is included in costs of revenues, as it relates to the write-down of VQS-acquired completed technology.

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

The
total impairment charge included $10.3 million to reduce the carrying value of the goodwill and indefinite-lived intangible assets related to the MMI and Mobilee acquisitions
to estimated fair value. The balance of the 2003 impairment charge of $8.0 million resulted from a reduction in the carrying values of the amortizable intangible assets and fixed assets related
to the VQS, MMI and Mobilee acquisitions. Of these costs, $3.9 million is related to the reduction in carrying value of a VQS supply agreement and $0.1 million is related to the
reduction in carrying value of VQS trademarks and patents. Fixed assets associated with the VQS and PS business units were also written down to their 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 of acquired
completed technology from the Mobilee, MMI and VQS acquisitions, respectively, and are included in cost of revenues within the statement of operations for 2003.

59

---



4Restructuring and Other Related Charges Accruals

The following table sets forth restructuring and other related charges accrual activity during the years ended December 31, 2002, 2003 and 2004,
respectively:

|                                                   |  | Employee
Related |        | Facility
Related |   | Impaired
Assets |   | Other |        | Total |  
|-------------------------------------------------- |  | ---------------- | ------ | ---------------- | - | --------------- | - | ----- | ------ | ----- | -
|
|Restructuring accrual balance at December 31, 2001 |  | $                | 1,758  |                  | $ | 3,144           |   | $     |       |       | $
|Restructuring and other related charges            |  |                  | 2,848  |                  |   | 1,404           |   |       | 704    |       |  
|Non-cash utilization                               |  |                  |       |                  |   |                |   |       | (704   | )     |  
|Cash payments                                      |  |                  | (3,806 | )                |   | (1,414          | ) |       |       |       |  
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  
|Restructuring accrual balance at December 31, 2002 |  | $                | 800    |                  | $ | 3,134           |   | $     |       |       | $
|Restructuring and other related charges            |  |                  | 4,786  |                  |   | 494             |   |       | 1,590  |       |  
|Non-cash utilization                               |  |                  |       |                  |   |                |   |       | (1,590 | )     |  
|Cash payments                                      |  |                  | (4,071 | )                |   | (1,936          | ) |       |       |       |  
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  
|Restructuring accrual balance at December 31, 2003 |  | $                | 1,515  |                  | $ | 1,692           |   | $     |       |       | $
|Cash payments                                      |  |                  | (1,413 | )                |   | (496            | ) |       |       |       |  
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  
|Restructuring accrual balance at December 31, 2004 |  | $                | 102    |                  | $ | 1,196           |   | $     |       |       |  
|                                                   |  |                  |        |                  |   |                 |   |       |        |       |  

Year Ended
December 31,2002

2003(In millions)Involuntary severance related costs

$
2.8

$
4.8Lease termination


1.4


0.4Write-down of fixed assets


0.7


1.6Other


0.1


0.1Total restructuring and other related charges

$
5.0

$
6.9


2003

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

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

A
sublease in the Tustin, CA facility was unexpectedly terminated in 2003. As a result the Company recorded a charge for $0.3 million in 2003 representing the value of remaining
sublease payments the Company had expected to receive. At December 31, 2004, the remaining accrued balance related to their facilities, was approximately $1.2 million and is included in
the consolidated balance sheet classification, "Accrued expenses and other liabilities."

60

---



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

During
2003, the Company decided to place certain office buildings in St. Hubert, Canada for sale, as those buildings were no longer used by the Company. The Company classified the
buildings as held-for-sale and wrote down the value of these buildings to estimated fair market value, less cost to sell, and recorded a $1.0 million restructuring loss
that is included as a component of "Restructuring and other related charges" in the statement of operations. In 2004, the Company sold the building and recognized a loss of $0.1 million on such
sale. The charge for the loss is included as a component of "other expense" in the statement of operations.

2002

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

During
2002, the Company updated its estimates of the sub-lease rental income based on current market conditions and determined the difference from the committed lease
payments was larger than originally estimated. As a result, the Company recorded additional restructuring and related charges of approximately $1.4 million related to these idle leased
facilities. At December 31, 2002, the remaining accrued balance for this charge, including the charge that was originally booked in 2001, was approximately $1.6 million and is included
in the consolidated balance sheet classification, "Accrued expenses and other liabilities."

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

5Business and Credit Concentration

At December 31, 2004, two customers, Avaya and a channel partner in the United States, represented 22.4% and 12.2%, respectively, of the Company's
outstanding net accounts receivable balance. At December 31, 2003, no customer accounted for 10% or more of the Company's accounts receivable balance.

During
2004, one customer, Lucent represented 11.7% of the Company's total revenues. During 2003, two customers, Lucent and a channel partner in the United States, represented 15.6% and
12.6%, respectively, of the Company's total revenues. Revenues from Lucent represented 27.4% of total revenues for the year ended December 31, 2002.

61

---



6Investments

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

December 31, 2003Amortized Cost

Unrealized Gains

Unrealized Losses

Fair
Value(In thousands)Money market mutual funds

$
5,064

$


$


$
5,064Corporate securities


26,460








26,460$
31,524

$


$


$
31,524Included in cash and cash equivalents


31,524








31,524Marketable securities

$


$


$


$



December 31, 2004Amortized Cost

Unrealized Gains

Unrealized Losses

Fair
Value(In thousands)Money market fund

$
10,349

$


$


$
10,349U.S. government and agency bonds


46,923





(108
)

46,815$
57,272

$


$
(108
)
$
57,164Included in cash and cash equivalents


10,349








10,349Marketable securities

$
46,923

$


$
(108
)
$
46,815


At
December 31, 2004, all marketable securities were due to mature within one year. Proceeds from sale of securities for the years ended December 31, 2002, 2003 and 2004
were $197.9 million, $53.1 million and $14.3 million, respectively. There were no gross realized gains or losses from sale of securities for the years ended December 31,
2002, 2003 and 2004.

The
Company has made equity investments in certain privately held entities. The Company accounts for these investments under the cost method of accounting since the Company does not have
the ability to exercise significant influence over these entities and there is not a readily determinable market value for these investments. The Company periodically evaluates the carrying value of
these investments for other than temporary impairment. During 2002, the Company recorded charges of approximately $0.4 million, respectively, to reflect the other than temporary decline in fair
value of these equity investments. The investee companies for which the charge was recorded had experienced a significant decline in operating and financial results in comparison to the results
forecasted at the time the investment was made. The Company determined the amount of the charge by estimating the fair value of the underlying company based on a market approach which includes
analysis of market price multiples of companies engaged in lines of business similar to the companies being evaluated. This charge is included in the consolidated statement of operations
classification "Other expense." The Company did not realize any gains or losses related to equity investments for the years ended December 31, 2002 and 2003. In 2004, the Company realized a
gain of $0.1 million associated with an equity investment whose carrying value had been reduced to zero in prior years.

62

---



7Inventories

December 31,2003

2004(In thousands)Raw materials

$
1,021

$
161Work in process


196


323Finished goods


1,325


1,207Inventories at customer sites


651


1,755Inventory

$
3,193

$
3,446


8Property and Equipment

Property and equipment consist of the following:

December 31,2003

2004(In thousands)Computer equipment

$
15,211

$
16,834Computer software


9,417


9,452Furniture and fixtures


2,818


2,898Machinery and equipment


3,367


3,651Leasehold improvements


5,151


5,39435,964


38,229Less accumulated depreciation


(28,745
)

(32,082
)$
7,219


6,147


Depreciation
and amortization expense related to property and equipment was $9.5 million, $7.5 million and $3.9 million for the years ended December 31, 2002,
2003 and 2004, respectively.

63

---



9Income Taxes

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

|                                                            |                                  | Year Ended December 31, |         
|----------------------------------------------------------- | -------------------------------- | ----------------------- | --------
|
|
|Current income tax expense (benefit):                       |                                  |                         |         
|                                                            | Federal                          |                         | $       
|                                                            | State                            |                         |         
|                                                            | Foreign                          |                         |         
|                                                            |                                  |                         |         
|                                                            |                                  |                         | (1,436  
|                                                            |                                  |                         |         
|Deferred income tax expense (benefit):                      |                                  |                         |         
|                                                            | Federal                          |                         |         
|                                                            | State                            |                         |         
|                                                            | Foreign                          |                         |         
|                                                            |                                  |                         |         
|                                                            |                                  |                         |        
|                                                            |                                  |                         |         
|                                                            |                                  | $                       | (1,436  
|                                                            |                                  |                         |         
|Deferred tax assets (liabilities) consist of the following: |                                  |                         |         
|                                                            | Net operating loss carryforwards |                         | $       
|                                                            | Tax credit carryforwards         |                         |         
|                                                            | Inventories                      |                         |         
|                                                            | Accrued expenses                 |                         |         
|                                                            | Intangible assets                |                         |         
|                                                            | Other                            |                         |         
|                                                            |                                  |                         |         
|                                                            |                                  | $                       | 118,658 
|                                                            |                                  |                         |         
|Fixed assets                                                |                                  |                         | (641    
|                                                            |                                  |                         |         
|Valuation allowance:                                        |                                  |                         | (118,017
|                                                            |                                  |                         |         
|Net deferred taxes                                          |                                  | $                       |        
|                                                            |                                  |                         |         

For
U.S. federal income tax purposes, the Company has net operating loss carryforwards available to reduce taxable income of approximately $147.2 million at December 31,
2004, a portion of which may be limited under Internal Revenue Code Section 382. These carryforwards will begin to expire in 2019. The Company also has a foreign net operating loss carryforward
of approximately $55.5 million. The Company has $6.1 million of tax credits that are composed of federal research and development credits, foreign tax credits and state and local
credits. These credits began to expire in 2004.

Management
believes that the realization of certain deferred tax assets is more unlikely than not and, accordingly, has established a full valuation allowance. During fiscal 2004, the
deferred tax asset valuation allowance increased by $11.6 million, primarily as the result of additional net operating loss carryforwards and the amortization of intangible assets. The Company
will continue to assess the valuation allowance and to the extent it is determined that such allowance is no longer required, the tax benefit of the remaining net deferred tax assets will be
recognized in the future. Approximately $6.5 million of the valuation allowance for deferred tax assets relates to benefits for stock option deductions, which, if realized, will be allocated
directly to additional paid-in capital.

64

---



US income taxes were not provided on cumulative undistributed foreign earnings for certain non-US subsidiaries of approximately $1.5 million. The company intends to
reinvest these earnings indefinitely outside the US in its operations.

|                                                              |  | Year Ended December 31, |  
|------------------------------------------------------------- |  | ----------------------- | -
|
|Computed expected tax expense at U.S. federal statutory rate  |  | 34.0                    | %
|State income taxes, net of U.S. federal tax expense (benefit) |  | 3.1                     |  
|Tax rate and tax law differential of foreign operations       |  | 2.0                     |  
|U.S. federal research and development credits                 |  | 0.1                     |  
|Change in valuation allowance                                 |  | (35.7                   | )
|Nondeductible intangibles                                     |  | (3.7                    | )
|Nondeductible expenses                                        |  | (0.1                    | )
|Other                                                         |  | 1.7                     |  
|                                                              |  |                         |  
|Effective tax rate                                            |  | 1.4                     | %
|                                                              |  |                         |  

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

|         |  | Year Ended December 31, |        
|-------- |  | ----------------------- | -------
|
|
|Domestic |  | $                       | (52,373
|Foreign  |  |                         | (47,602
|         |  |                         |        
|         |  | $                       | (99,975
|         |  |                         |        

10Accrued Expenses and Other Liabilities

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

December 31,2003

2004(In thousands)Accrued compensation and related expenses

$
2,838

$
4,692Accrued interest expense


613


212Income taxes payable


703


178Deferred rent


1,273


1,814Accrued restructuring and other related charges


3,328


1,308Other liabilities


3,263


2,502$
12,018

$
10,706


11Indebtedness

Convertible Notes

Effective October 11, 2000, the Company issued $175.0 million of convertible subordinated notes (the "Notes"). The Notes are convertible into shares
of NMS common stock at any time after 90 days following the last day of the original issuance of the notes and before the close of business on the business day immediately preceding the
maturity date, at a conversion price of $63.125 per share, subject to specified adjustments. The Notes bear interest at a rate of 5% per year which is payable semiannually on April 15 and
October 15 of each year, commencing on April 15, 2001. The Notes, which are unsecured obligations of the Company, will mature on October 15, 2005, unless previously

65

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redeemed
or repurchased, and have no sinking fund requirement. The Company is subject to certain covenants under the related indenture. As of December 31, 2004 the Company is in compliance with
such covenants. The Company incurred debt issuance costs aggregating $5.7 million, which have been deferred and are being amortized using the effective interest rate method as a component of
interest expense over the term of the Notes. The unamortized issuance costs, $0.7 million and $0.1 million at December 31, 2003 and 2004, respectively, are included in the
consolidated balance sheet caption "Other assets."

For
the years ended December 31, 2002, 2003 and 2004, the Company paid $37.9 million, $9.3 million and $38.5, respectively, to extinguish $59.4 million,
$11.3 million and $37.8 million, respectively, of face value of the Notes. As a result in the years ended December 31, 2002, 2003 and 2004, the Company wrote off
$1.2 million, $0.2 million and $0.9 million, respectively, of unamortized debt issuance costs and recorded a related loss (gain) of $(20.8) million, $(2.1) million and
$0.3 million, respectively in other income and expense on the income statement.

12Profit Sharing Plans

The Company has established a 401(k) cash or deferred profit sharing plan covering all eligible full-time employees of the Company. Contributions to
the 401(k) plan are made by the participants to their individual accounts through payroll withholding. Additionally, the plan provides for the Company to make profit sharing contributions to the plan
in amounts at the discretion of management. The Company currently matches contributions each pay period at 50% of the employee's contributions up to 6% of employee's compensation, not to exceed the
federal limit of $12,000 per calendar year. The employer contribution for the years ended December 31, 2002, 2003 and 2004 was $0.9 million, $0.8 million and $0.5 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 an underwritten public offering at $5.75 per share. The net
proceeds of the offering were $49.5 million. In April 2004, the Company invested the net proceeds of this offering in interest-bearing, investment-grade securities.

Stock Repurchase Program

During 2001, the Board of Directors approved a stock repurchase program authorizing the Company to repurchase up to 2,500,000 shares of its outstanding common
stock for an aggregate purchase price not to exceed $5.0 million. The Company made no repurchases during 2003 and 2004 but as of December 31, 2003, the Company had repurchased 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 in conjunction with the exercise of stock options in 2004. There were no treasury shares outstanding as of December 31, 2004.

Preferred Stock

Under its restated certificate of incorporation the Company has authorized 3,000,000 shares of preferred stock, par value $0.01 per share. On December 31,
2003 and 2004, the Company had no shares of preferred stock issued and outstanding. In connection with its stockholder rights plan, 15,000 of such shares have been designated "Series A Junior
Preferred Stock", none of which are issued and outstanding. The Company's board of directors has the authority to issue preferred stock in one or more classes or series and to fix the rights,
preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, exchange rights, voting rights, terms of redemption,

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redemption
prices, liquidation preferences and the number of shares constituting any class or series or the designation of such class or series, without any further action by the stockholders.
Preferred stock, if issued, will not be entitled to any preemptive or similar rights.

14Stock Option and Stock Purchase Plans

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

1993 Stock Option Plan

In October 1993, the Company's Board of Directors adopted the 1993 Stock Option Plan (the "1993 Plan"). The 1993 Plan permits both incentive and
non-statutory options to be granted to employees, directors and consultants. Options granted under the 1993 Plan generally vest over 4 years. The expiration dates of options granted
under the 1993 Plan do not exceed 10 years. In March 1998, the Board of Directors adopted and in April 1998, the Company's stockholders approved (i) an increase in the
number of shares available under the 1993 Plan from 3,000,000 to 3,800,000 and (ii) a requirement that the exercise price of options granted under the 1993 Plan be at least equal to the fair
market value of the Company's common stock on the date of grant. In March 2000, the Board of Directors superseded the 1993 Plan with the 2000 Plan and no further grants under the 1993 Plan will
be made after the adoption of the 2000 Plan. Options granted previously under the 1993 Plan will continue to be governed by the terms of the 1993 Plan. As of December 31, 2004 there are
1,235,296 options outstanding under the 1993 Plan. The outstanding options under the 1993 Plan are fully vested as of December 31, 2004.

1993 Non-Employee Directors Stock Option Plan

In October 1993, the Company's Board of Directors adopted the 1993 Non-Employee Directors Stock Option Plan (the "Directors Plan") which
provides for the purchase of up to 240,000 shares of common pursuant to the grant of non-statutory stock options to directors who are not employees of the Company. Option granted under the
Directors Plan generally vest over 4 years. The expiration dates of options granted under the Directors Plan do not exceed 10 years. In March 1996 the Board of Directors adopted
and in May 1996 the Company's stockholders approved (i) an increase in the number of shares for which options shall be granted to newly elected non-employee directors from
20,000 to 30,000 and (ii) an increase in the number of shares for which options shall be granted to incumbent non-employee directors from 4,000 to 10,000. In March 1999, the
Board of Directors adopted and in April 1999, the Company's stockholders approved an increase in the number of shares available under the Directors Plan from 240,000 to 480,000 shares. The
exercise price of the options may not be less than 100% of the fair market value of the Company's common stock on the date of the grant. In March 2000, the Board of Directors superseded the
Directors Plan with the 2000 Plan and no further grants under the Directors Plan will be made after the adoption of the 2000 Plan. As of December 31, 2004, 280,000 shares had been granted at
prices ranging from $2.44 to $24.63 per share. As of December 31, 2004, there are 113,410 options outstanding under the Directors Plan. The outstanding options under the Directors Plan are
fully vested as of December 31, 2004. Options granted previously under the Directors Plan will continue to be governed by the terms of the Directors Plan.

1995 Non-Statutory Stock Option Plan

In October 1995, the Company's Board of Directors adopted the 1995 Non-Statutory Stock Option Plan (the "1995 Plan"). The 1995 Plan permits
non-statutory options to be granted to non-executive officer employees and consultants of the Company. The aggregate number of shares which may be

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issued
under the 1995 Plan, as amended, is 6,350,000. The exercise price of non-statutory options may not be less than 100% of the fair market value of the company's common stock on the
date of grant. Options granted under the 1995 Plan generally vest over 2 years. Options granted to new hires generally vest over 3 years. The expiration dates of options granted under
the 1995 Plan do not exceed 10 years. As of December 31, 2004, there are 3,246,335 options outstanding under the 1995 Plan.

2000 Equity Incentive Plan

In March 2000, the Company's Board of Directors adopted and in April 2000 the Company's stockholders approved the 2000 Equity Incentive Plan (the
"2000 Plan"). The 2000 Plan provides for the grant of incentive stock options and stock appreciation rights to employees and non-statutory stock options, stock bonuses, rights to purchase
restricted stock and other awards based on the Company's common stock (collectively, "Stock Awards") to employees, non-employee directors and consultants. The aggregate number of shares
which may be issued under the 2000 Plan is 5,000,000 plus any shares of the Company's common stock represented by options granted under the 1993 Plan and the Directors Plan (both of which are
superseded by the 2000 Plan) which are forfeited, expire or are canceled. The exercise price of non-statutory and incentive stock options may not be less than 50% and 100%, respectively,
of the fair market value of the company's common stock on the date of grant. Options granted under the 2000 Plan generally vest over 2 years. Options granted to new hires generally vest over
3 years. The expiration dates of options granted under the 2000 Plan do not exceed 10 years. As of December 31, 2004, there are 4,031,351 options outstanding under the 2000 Plan.

2003 Employee Stock Purchase Plan

In March 2003, the Board of Directors adopted and in April 2003 the Company's stockholders approved the 2003 Employee Stock Purchase Plan (the "Purchase Plan").
The Purchase Plan permits employees and officers of the Company to participate in periodic plan offerings, in which payroll deductions may be used to purchase shares of common stock. The purchase
price is 85% of the lower of the fair market value at the date the offering commences or terminates. The Company has reserved 750,000 shares for the Purchase Plan. During 2004, 76,750 shares and
72,281 shares were issued under the Purchase Plan at a weighted average price of $3.49 per share and $3.71 per share, respectively.

A
summary of the transactions under all stock option plans for the three years ended December 31, 2004 is as follows:

|                                   |  | Year Ended
December 31, 2002 |   | Year Ended
December 31, 2003 |       | Year Ended
December 31, 2004
|---------------------------------- |  | ---------------------------- | - | ---------------------------- | ----- | ----------------------------
|
|Outstanding at beginning of period |  | 9,615,378                    |   | $                            | 15.51 |                             
|Granted                            |  | 1,730,554                    |   |                              | 3.91  |                             
|Exercised                          |  | (86,977                      | ) |                              | 3.09  |                             
|Forfeited or expired               |  | (2,584,264                   | ) |                              | 23.84 |                             
|                                   |  |                              |   |                              |       |                             
|Outstanding at end of period       |  | 8,674,691                    |   |                              | 10.84 |                             
|                                   |  |                              |   |                              |       |                             
|Exercisable at end of period       |  | 5,958,070                    |   |                              | 12.85 |                             
|                                   |  |                              |   |                              |       |                             

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The
following table summarizes outstanding stock options as of December 31, 2004:

|Range of Exercise Prices |  | Number
Outstanding |  | Weighted
Average
Remaining
Contractual
Life |  | Weighted
Average
Exercise Price |       | Number
Exercisable |           | Average
Exercise Price
|------------------------ |  | ------------------ |  | ------------------------------------------- |  | ------------------------------- | ----- | ------------------ | --------- | ----------------------
|$0.01  $5.00            |  | 4,941,093          |  | 3.0                                         |  | $                               | 2.79  |                    | 3,621,747 |                       
|$5.01  $10.00           |  | 2,536,659          |  | 3.1                                         |  |                                 | 7.03  |                    | 1,246,159 |                       
|$10.01  $20.00          |  | 249,164            |  | 2.7                                         |  |                                 | 14.63 |                    | 249,164   |                       
|$20.01  $30.00          |  | 88,718             |  | 3.9                                         |  |                                 | 24.39 |                    | 88,718    |                       
|$30.01  $40.00          |  | 460,031            |  | 0.6                                         |  |                                 | 32.75 |                    | 460,031   |                       
|$40.01  $50.00          |  | 322,027            |  | 0.7                                         |  |                                 | 45.90 |                    | 322,027   |                       
|$50.01  $60.00          |  | 8,500              |  | 0.8                                         |  |                                 | 56.97 |                    | 8,500     |                       
|$70.01  $80.00          |  | 20,200             |  | 0.6                                         |  |                                 | 72.53 |                    | 20,200    |                       
|                         |  |                    |  |                                             |  |                                 |       |                    |           |                       
|                         |  | 8,626,392          |  | 2.8                                         |  | $                               | 8.02  |                    | 6,016,546 |                       
|                         |  |                    |  |                                             |  |                                 |       |                    |           |                       

As
of December 31, 2004, a total of 10,307,167 shares of common stock have been reserved for issuance upon the exercise of stock options.

Option Forfeiture

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

15Commitments and Contingencies

Leases

The Company leases its current corporate headquarters office facilities under non-cancelable leases extending to May 31, 2012. The Company
occupies other facilities under leases, which expire within one to five years. Rental expenses under all operating lease agreements in effect during the years ended December 31, 2002, 2003 and
2004 amount to approximately $4.5 million, $4.0 million and $5.2 million, respectively.

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

At
December 31, 2004, commitments under operating leases for minimum future payments consist of the following, of which $1.2 million of these future operating lease
payments have been accrued as

69

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part
of the Company's restructuring and other related charges and will not impact the Company's results of operations in future periods:

Year ending December 31,

(In thousands)2005

$
4,4642006


4,0902007


3,5142008


3,2142009


2,930Thereafter


6,784$
24,996


Litigation

During the third quarter of 2004, Connectel LLC filed a motion to withdraw its infringement claims against the Company. In a memorandum to the Court, Connectel
agreed not to sue the Company on the patents at issue based on either the Company's past or current products. The Company made no payments in connection with this dismissal.

The
Company is party to various legal proceedings incidental to its business. However, the Company has no material legal proceedings currently pending.

Purchase Commitments

The Company's agreement with Plexus requires that Plexus turn its NMS-related inventory eight times per year. If this condition is not met, the
Company must purchase enough material to bring Plexus up to eight turns. This is assessed on a quarterly basis. At December 31, 2003 and 2004, the Company had met the eight turn goal in all
preceding quarters. As such, the Company does not have any contractual obligations related to a commitment with Plexus at December 31, 2003 and 2004. The Company can only ascribe value to such
commitment when the Company has not met the condition as determined at a specific point in time, based on future facts and circumstances. Plexus is the Company's only third-party contract
manufacturer. As such, NMS is not party to any other such arrangements.

Guarantees

The Company's hardware products are generally sold with a 18-24 month warranty period. Parts and labor are covered under the terms of the warranty
agreement. The warranty provision is based on historical experience by product, configuration and geographic region.

Changes
in the warranty reserves were as follows:

December 31,2003

2004(In thousands)Beginning balance

$
363

$
332Provisions for warranty


175


250Consumptions of reserves


(206
)

(240
)Ending balance

$
332

$
342


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As
noted above, the Company's products are generally sold with a 18-24 month warranty. Accordingly, current warranty provisions are related to the past one and a half
to two years' revenues and warranty consumption is associated with current and prior year's revenues.

Indemnification

The Company entered into indemnification agreements with certain of its customers in its ordinary course of business. Pursuant to these agreements the Company
agrees that, subject to certain limitations, in the event its products infringe upon any proprietary right of a third party, it will indemnify its customer against any loss, expense or liability from
any damages that may be awarded against the Customer. There have been no claims brought against the Company under such arrangements in the past five years.

16Segment and Geographic Information

Our three business segments are comprised of the Platform Solutions (PS) business unit, the Voice Quality Systems (VQS) business unit and the Network
Infrastructure (NI) business unit. The PS business unit consists of products and services, which we refer to as systems building blocks, that provide connectivity to communications networks, call
processing, real-time media processing, APIs and other application development software tools. Also included in this business unit are a multi-application enhanced services delivery system
and a personalized mobile entertainment application called MyCaller. The VQS business unit consists of our voice quality enhancement and echo cancellation products, systems and services. The NI
business unit consists of our wireless backhaul optimizer product, AccessGate, that can lower carriers' operating expenses in TDMA, GSM, universal mobile telecommunications system (UMTS) and EDGE
networks by reducing the number of radio access network leased lines through advanced optimization techniques, without affecting voice and data quality. The Company made two changes to its segment
reporting in 2003. First, the Company expanded its segment reporting in the first quarter of 2003 to include information specific to Network Infrastructure. Second, in the third quarter the Company
combined the Network Solutions business unit into its PS business unit.

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The
following table presents the Company's revenues and operating loss, by business unit and by geographic segment. The Company has not recorded any significant revenues for the NI
business units.

|(In thousands)                         |      | VQS |   | NI     |   | PS |        | Corporate |   | Total  |  
|-------------------------------------- | ---- | --- | - | ------ | - | -- | ------ | --------- | - | ------ | -
|Revenues:                              |      |     |   |        |   |    |        |           |   |        |  
|                                       | 2004 |     | $ | 16,412 |   | $  | 313    |           | $ | 84,787 |  
|                                       | 2003 |     |   | 20,505 |   |    | 93     |           |   | 66,549 |  
|                                       | 2002 |     |   | 28,905 |   |    |       |           |   | 73,788 |  
|Income (loss) from operations:         |      |     |   |        |   |    |        |           |   |        |  
|                                       | 2004 |     | $ | 1,265  |   | $  | (9,663 | )         | $ | 21,564 |  
|                                       | 2003 |     |   | (370   | ) |    | (5,267 | )         |   | (1,119 | )
|                                       | 2002 |     |   | (1,390 | ) |    | (3,779 | )         |   | (4,584 | )
|Total assets:                          |      |     |   |        |   |    |        |           |   |        |  
|                                       | 2004 |     | $ | 2,763  |   | $  | 1,624  |           | $ | 15,022 |  
|                                       | 2003 |     |   | 4,171  |   |    | 345    |           |   | 9,870  |  
|                                       | 2002 |     |   | 21,648 |   |    |       |           |   | 26,959 |  
|Long-lived assets:                     |      |     |   |        |   |    |        |           |   |        |  
|                                       | 2004 |     | $ | 102    |   | $  | 657    |           | $ | 1,133  |  
|                                       | 2003 |     |   | 106    |   |    | 252    |           |   | 1,581  |  
|                                       | 2002 |     |   | 12,877 |   |    |       |           |   | 16,943 |  
|Capital expenditures:                  |      |     |   |        |   |    |        |           |   |        |  
|                                       | 2004 |     | $ | 48     |   | $  | 571    |           | $ | 787    |  
|                                       | 2003 |     |   | 248    |   |    | 172    |           |   | 1,388  |  
|                                       | 2002 |     |   | 1,339  |   |    | 138    |           |   | 5,036  |  
|Depreciation and amortization expense: |      |     |   |        |   |    |        |           |   |        |  
|                                       | 2004 |     | $ | 48     |   | $  | 80     |           | $ | 2,225  |  
|                                       | 2003 |     |   | 584    |   |    | 95     |           |   | 4,150  |  
|                                       | 2002 |     |   | 1,079  |   |    | 169    |           |   | 6,203  |  

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

As
of December 31, 2004 the Company had operations established in 12 countries outside the United States and its products are sold throughout the world. The Company is exposed to
the risk of changes in social, political and economic conditions inherent in foreign operations and the Company's results of operations and the value of its foreign assets are affected by fluctuations
in foreign currency exchange rates. The following table presents the Company's revenues, operating income (loss), total assets, long-lived assets, capital expenditures, and depreciation
and amortization expense by geographic region. Revenues by geographic region are presented by attributing revenues from external customers on the basis of where products are sold. "Rest of World" is
Latin America and properly reflects how the regions are analyzed by senior management. In the previously issued financial statements, the "Rest of World" was comprised of Latin America and Canada. For
the years ended December 31, 2004, 2003

72

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and
2002, the loss from operations for "North America" includes all impairment losses and acquisition related amortization expenses.

|(In thousands)                         |      | North America |   | Europe   |   | Asia |        | Rest of World |   | Total  | 
|-------------------------------------- | ---- | ------------- | - | -------- | - | ---- | ------ | ------------- | - | ------ | 
|Revenues:                              |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2004 |               | $ | 53,401   |   | $    | 20,446 |               | $ | 26,602 | 
|                                       | 2003 |               |   | 46,597   |   |      | 15,252 |               |   | 24,086 | 
|                                       | 2002 |               |   | 64,640   |   |      | 14,038 |               |   | 23,391 | 
|Income (loss) from operations:         |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2004 |               | $ | (21,395  | ) | $    | 9,055  |               | $ | 17,222 | 
|                                       | 2003 |               |   | (67,054  | ) |      | (2,880 | )             |   | 14,405 | 
|                                       | 2002 |               |   | (124,082 | ) |      | (8,862 | )             |   | 12,286 | 
|Total assets:                          |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2004 |               | $ | 97,950   |   | $    | 6,618  |               | $ | 3,859  | 
|                                       | 2003 |               |   | 76,683   |   |      | 6,616  |               |   | 3,029  | 
|                                       | 2002 |               |   | 140,294  |   |      | 10,664 |               |   | 4,125  | 
|Long-lived assets:                     |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2004 |               | $ | 6,018    |   | $    | 110    |               | $ | 19     | 
|                                       | 2003 |               |   | 7,088    |   |      | 54     |               |   | 77     | 
|                                       | 2002 |               |   | 40,736   |   |      | 723    |               |   | 270    | 
|Capital expenditures:                  |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2004 |               | $ | 2,264    |   | $    | 94     |               | $ | 10     | 
|                                       | 2003 |               |   | 2,371    |   |      | 58     |               |   | 7      | 
|                                       | 2002 |               |   | 7,492    |   |      | 51     |               |   | 130    | 
|Depreciation and amortization expense: |      |               |   |          |   |      |        |               |   |        | 
|                                       | 2004 |               | $ | 3,786    |   | $    | 38     |               | $ | 74     | 
|                                       | 2003 |               |   | 8,562    |   |      | 734    |               |   | 217    | 
|                                       | 2002 |               |   | 16,840   |   |      | 603    |               |   | 89     | 

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17Quarterly Information (Unaudited)

|                                                       |                                         | Quarter Ended |        
|------------------------------------------------------ | --------------------------------------- | ------------- | -------
|
|
|
|Revenues                                               |                                         | $             | 20,812 
|Cost of revenues                                       |                                         |               | 10,885 
|                                                       |                                         |               |        
|Gross profit                                           |                                         |               | 9,927  
|Operating expenses:                                    |                                         |               |        
|                                                       | Selling, general and administrative     |               |        
|                                                       | Research and development                |               |        
|                                                       | Impairment charges                      |               |        
|                                                       | Restructuring and other related charges |               |        
|                                                       |                                         |               |        
|                                                       | Total operating expenses                |               |        
|                                                       |                                         |               |        
|Operating income (loss)                                |                                         |               | (10,922
|Other income (expense), net                            |                                         |               | (735   
|                                                       |                                         |               |        
|Income (loss) before income taxes                      |                                         |               | (11,657
|Income tax expense (benefit)                           |                                         |               | (74    
|                                                       |                                         |               |        
|Net income (loss)                                      |                                         | $             | (11,583
|                                                       |                                         |               |        
|Basic and diluted net earnings (loss) per common share |                                         | $             | (0.32  
|                                                       |                                         |               |        

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

During
the fourth quarter of fiscal 2003, The Company (1) recorded two foreign currency transaction adjustments, netting to $0.3 million, which decreased loss before income
taxes, (2) reversed a vacation accrual, which resulted in a decrease to loss before income taxes of $0.9 million, and (3) made an adjustment to decrease overhead costs capitalized
in inventories totaling $0.8 million, which increased cost of revenues and, therefore, loss before income taxes.

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

None.

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VALUATION AND QUALIFYING ACCOUNTSSchedule II  (In thousands)

Allowance for Doubtful Accounts

|         |  | Balance at
Beginning of Year |       | Additions |   | Deductions(1) |  | Balance at
End of Year
|-------- |  | ---------------------------- | ----- | --------- | - | ------------- |  | ----------------------
|12/31/02 |  | $                            | 1,178 |           | $ | 123           |  | $                     
|12/31/03 |  | $                            | 979   |           | $ | 124           |  | $                     
|12/31/04 |  | $                            | 995   |           | $ | 151           |  | $                     

---

Deferred Tax Valuation Allowance

|         |  | Balance at
Beginning of Year |          | Additions |   | Deductions |   | Balance at
End of Year |  
|-------- |  | ---------------------------- | -------- | --------- | - | ---------- | - | ---------------------- | -
|12/31/02 |  | $                            | (74,649  | )         | $ | (43,368    | ) | $                      | 
|12/31/03 |  | $                            | (118,017 | )         | $ | (30,425    | ) | $                      | 
|12/31/04 |  | $                            | (148,442 | )         | $ | (5,039     | ) | $                      | 

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ITEM 9A.    CONTROLS AND PROCEDURES

A. Evaluation of Disclosure Controls and Procedures

Based on the evaluation of our disclosure controls and procedures (as defined in the Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the "Exchange Act")) required by Exchange Act Rules 13a-15(b) or 15d-15(b), our Chief Executive Officer and our Chief
Financial Officer have concluded that as of December 31, 2004, the end of the period covered by this report, our disclosure controls and procedures were effective.

B. Changes in Internal Control Over Financial Reporting

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, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.

C. Management's Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act
Rules 13a-15(f) and 15d-15(f). Our management, including our principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of
our internal control over financial reporting as of December 31, 2004 based on the framework inInternal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation under the framework inInternal ControlIntegrated
Framework, our
management concluded that our internal control over financial reporting was effective as of December 31, 2004. Our management's assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2004 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included in this
Annual Report on Form 10-K.

PART III

ITEM 10.    DIRECTORS OF THE REGISTRANT

The following table lists our directors as of December 31, 2004:

|Name                    |  | Age |  | Position                                                    
|----------------------- |  | --- |  | ------------------------------------------------------------
|Robert P. Schechter     |  | 56  |  | Chairman of the Board, President and Chief Executive Officer
|William E. Foster(2)    |  | 60  |  | Director                                                    
|Ofer Gneezy(1)          |  | 53  |  | Director                                                    
|W. Frank King, Ph.D.(1) |  | 65  |  | Director                                                    
|Pamela D. A. Reeve(1)   |  | 55  |  | Director                                                    
|Ronald W. White(2)      |  | 64  |  | Director                                                    

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

Robert P. Schechterhas served as our President and Chief Executive Officer since 1995 and as Chairman of the Board since 1996. From 1987
to 1994, Mr. Schechter held various senior executive

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positions
with Lotus Development Corporation, and from 1980 to 1987 he was a partner of Coopers and Lybrand LLP. Mr. Schechter is also a director of MapInfo Corporation, a developer of
location-based software services and solutions, Moldflow Corporation, a provider of software solutions for optimizing the design and manufacture of plastic products and Avici Systems, Inc., a
provider of purpose-built carrier-class routing solutions for the Internet.

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

Ofer Gneezyhas served as adirector of our Company since2000. He was a co-founder, and has been, since 1997, President, Chief
Executive Officer and a director of iBasis, Inc., a provider of
Internet-based communications services for international carriers. From 1994 to 1996, Mr. Gneezy served as President of Acuity Imaging, Inc., a multinational company focused on the
industrial automation industry. From 1980 to 1994, he was an executive of Automatix Inc. (a predecessor to Acuity Imaging), an industrial automation company, most recently serving as its
President and Chief Executive Officer.

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

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

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

ITEM 11. EXECUTIVE COMPENSATION

The information appearing under the caption "Executive Compensation" (other than the information appearing under the captions "Compensation Committee Report on
Executive Compensation" and "Comparison of Cumulative Total Stockholder Return") of our Proxy Statement for our Annual Meeting of Stockholders to be held April 29, 2005 is incorporated herein
by reference.

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

The information appearing under the caption "Stock Ownership of Directors, Executive Officers and Principal Stockholders" and "Equity Compensation Plans" of our
Proxy Statement for our Annual Meeting of Stockholders to be held April 29, 2005 is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

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

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information is incorporated herein by reference to our definitive 2005 Proxy Statement.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)   (1) FINANCIAL STATEMENTS

The following are included in Part II of this report:

|Report of Independent Registered Public Accounting Firm.                                              |  | 
|----------------------------------------------------------------------------------------------------- |  | 
|Consolidated Balance Sheets as of December 31, 2003 and 2004.                                         |  | 
|Consolidated Statements of Operations for the Years Ended December 31, 2002, 2003 and 2004.           |  | 
|Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2002, 2003 and 2004. |  | 
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2003 and 2004.           |  | 
|Notes to the Consolidated Financial Statements.                                                       |  | 

(a)   (2) FINANCIAL STATEMENT SCHEDULES

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

|                                                |  | Page No.
|----------------------------------------------- |  | --------
|Schedule II  Valuation and Qualifying Accounts |  | 75      

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

(a)   (3) EXHIBITS

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

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Signatures

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

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

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

|Signature                                               |  | Title                                                                                                   |  | Date          
|------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------- |  | --------------
|                                                        |  |                                                                                                         |  |               
|/s/ROBERT P. SCHECHTERRobert P. Schechter               |  | President, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer) |  | March 16, 2005
|/s/WILLIAM B. GERRAUGHTY, JR.William B. Gerraughty, Jr. |  | Senior Vice President of Finance, Chief Financial Officer and Treasurer (Principal Financial Officer)   |  | March 16, 2005
|/s/ALEX N. BRAVERMANAlex N. Braverman                   |  | Vice President, Chief Accounting Officer and Controller                                                 |  | March 16, 2005
|/s/WILLIAM E. FOSTERWilliam E. Foster                   |  | Director                                                                                                |  | March 16, 2005
|/s/OFER GNEEZYOfer Gneezy                               |  | Director                                                                                                |  | March 16, 2005
|/s/W. FRANK KING, PH.D.W. Frank King, Ph.D.             |  | Director                                                                                                |  | March 16, 2005
|/s/PAMELA D. A. REEVEPamela D. A. Reeve                 |  | Director                                                                                                |  | March 16, 2005
|/s/RONALD W. WHITERonald W. White                       |  | Director                                                                                                |  | March 16, 2005

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Exhibit Index

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

|No.     |  | Title                                                                                                                                                                                                                                         
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.6*    |  | Merger Agreement dated as of May 18, 2000 by and among the Registrant, NMS 3758982 Canada Inc., Michel Laurence, Michel Brule, Stephane Tremblay, and Investissements Novacap Inc. (filed with the Registrant's Form 8-K
dated July 20, 2000).
|2.7*    |  | Asset Purchase Agreement dated October 15, 2001 by and between the Registrant and Lucent Technologies Inc. (filed with the Registrant's Form 10-Q for the quarter ended September 30, 2001).                                                  
|3.1*    |  | Fourth Restated Certificate of Incorporation of the Registrant (filed with the Registrant's Form 10-K for the year ended December 31, 1995).                                                                                                  
|3.2*    |  | By-laws of Registrant, as amended (filed with the Registrant's registration statement on Form S-1 (#33-72596)).                                                                                                                               
|3.4*    |  | Certificate of Amendment to Fourth Restated Certificate of Incorporation of the Registrant (filed with the Registrant's Form 8-K dated May 4, 2001).                                                                                          
|4.1*    |  | Specimen Certificate for the Common Stock (filed with the Registrant's registration statement on Form S-1 (#33-72596)).                                                                                                                       
|4.2*    |  | Indenture dated as of October 11, 2000 by and between the Registrant and State Street Bank and Trust Company (filed with the Registrant's Form 8-K dated October 12, 2000).                                                                   
|4.3*    |  | First Supplemental Indenture dated as of October 11, 2000 by and between the Registrant and State Street Bank and Trust Company (filed with the Registrant's Form 8-K dated October 12, 2000).                                                
|4.4*    |  | Form of Global Note (filed with the Registrant's Form 8-K dated October 12, 2000).                                                                                                                                                            
|10.1#*  |  | Employment agreement dated as of January 28, 2005 by and between the Registrant and D'anne Hurd (filed with the Registrant's Form 8-K dated February 15, 2005).                                                                               
|10.2#*  |  | Severance Protection Agreement dated as of January 28, 2005 by and between the Registrant and D'anne Hurd (filed with the Registrant's Form 8-K dated February 15, 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)).                                                                                         
|10.19#* |  | 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 (filed with the Registrant's registration statement on Form S-8 (333-40940)).                                                                                                                                      
|        |  |                                                                                                                                                                                                                                               

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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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