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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



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

For the quarterly period ended September 30, 2008

OR



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

For the transition period from              to

Commission file number 001-33391

Veraz
Networks, Inc.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 94-3409691                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)

926 Rock Avenue, Suite 20

San Jose, California 95131

(408) 750-9400

(Address, including zip code, and telephone number, including area code, of registrants executive offices)

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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.    YES  þ    NO   ̈

Indicate by check mark whether
the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting
company in Rule 12b-2 of the Exchange Act. (Check one):



|                           |  |                      |  |                                               |  |                             
|-------------------------- |  | -------------------- |  | --------------------------------------------- |  | ----------------------------
|Large accelerated filer   ̈ |  | Accelerated filer   ̈ |  | Non-accelerated filer  þ                      |  | Smaller reporting company   ̈
|                           |  |                      |  | (Do not check if a smaller reporting
company) |  |                             

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).    YES   ̈    NO  þ

As of October 31, 2008, 42,385,875 shares of the Registrants common stock were outstanding.









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##### Table of Contents

VERAZ NETWORKS, INC AND SUBSIDIARIES

FORM 10-Q

For the Quarterly Period Ended September 30, 2008

INDEX



|                                                                                              |  |   
|--------------------------------------------------------------------------------------------- |  | --
|PART I. FINANCIAL INFORMATION                                                                
|ITEM 1. FINANCIAL STATEMENTS                                                                  |  |   
|                                                                                              | 
|Unaudited Condensed Consolidated Balance Sheets                                               |  | 3 
|Unaudited Condensed Consolidated Statements of Operations                                     |  | 4 
|Unaudited Condensed Consolidated Statements of Cash Flows                                     |  | 5 
|Notes to Unaudited Condensed Consolidated Financial Statements                                |  | 6 
|                                                                                              | 
|ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS |  | 18
|                                                                                              | 
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                             |  | 28
|                                                                                              | 
|ITEM 4. CONTROLS AND PROCEDURES                                                               |  | 29
|                                                                                             
|PART II. OTHER INFORMATION                                                                   
|                                                                                              | 
|ITEM 1A. RISK FACTORS                                                                         |  | 29
|                                                                                              | 
|ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                           |  | 46
|                                                                                              | 
|ITEM 6. EXHIBITS                                                                              |  | 46
|                                                                                              | 
|SIGNATURE                                                                                     |  | 47



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##### Table of Contents

VERAZ NETWORKS, INC AND SUBSIDIARIES

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Unaudited Condensed Consolidated Balance Sheets

(in thousands)



|                                           |  |                   |         |   |                  |   |         |  
|------------------------------------------ |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                           |  | September 30,2008 |         |   | December 31,2007 |  
|ASSETS                                     |  |                   |         |   |                  |   |         |  
|Current assets:                            |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                  |  | $                 | 29,795  |   |                  | $ | 52,232  |  
|Restricted cash                            |  |                   | 610     |   |                  |   | 610     |  
|Short-term investments                     |  |                   | 4,567   |   |                  |   | 5,354   |  
|Accounts receivable, net                   |  |                   | 33,645  |   |                  |   | 40,814  |  
|Inventories                                |  |                   | 12,380  |   |                  |   | 9,505   |  
|Prepaid expenses                           |  |                   | 2,132   |   |                  |   | 1,497   |  
|Deferred tax assets                        |  |                   | 1,367   |   |                  |   | 410     |  
|Other current assets                       |  |                   | 3,853   |   |                  |   | 5,776   |  
|Due from related parties                   |  |                   | 710     |   |                  |   | 686     |  
|                                           |  |                   |         |   |                  |   |         |  
|Total current assets                       |  |                   | 89,059  |   |                  |   | 116,884 |  
|Property and equipment, net                |  |                   | 5,489   |   |                  |   | 6,720   |  
|Other assets                               |  |                   | 122     |   |                  |   | 143     |  
|                                           |  |                   |         |   |                  |   |         |  
|Total assets                               |  | $                 | 94,670  |   |                  | $ | 123,747 |  
|                                           |  |                   |         |   |                  |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY       |  |                   |         |   |                  |   |         |  
|Current liabilities:                       |  |                   |         |   |                  |   |         |  
|Accounts payable                           |  | $                 | 4,022   |   |                  | $ | 11,066  |  
|Accrued expenses                           |  |                   | 12,155  |   |                  |   | 16,983  |  
|Income tax payable                         |  |                   | 168     |   |                  |   | 219     |  
|Current portion of loan payable, net       |  |                   | 613     |   |                  |   | 3,147   |  
|Deferred revenue                           |  |                   | 17,219  |   |                  |   | 14,354  |  
|Due to related parties                     |  |                   | 8,997   |   |                  |   | 10,438  |  
|                                           |  |                   |         |   |                  |   |         |  
|Total current liabilities                  |  |                   | 43,174  |   |                  |   | 56,207  |  
|                                           |  |                   |         |   |                  |   |         |  
|Stockholders equity:                      |  |                   |         |   |                  |   |         |  
|Common stock                               |  |                   | 42      |   |                  |   | 41      |  
|Additional paid-in capital                 |  |                   | 127,780 |   |                  |   | 124,081 |  
|Deferred stock-based compensation          |  |                   | (111    | ) |                  |   | (352    | )
|Accumulated other comprehensive loss       |  |                   | 114     |   |                  |   |        |  
|Accumulated deficit                        |  |                   | (76,329 | ) |                  |   | (56,230 | )
|                                           |  |                   |         |   |                  |   |         |  
|Total stockholders equity                 |  |                   | 51,496  |   |                  |   | 67,540  |  
|                                           |  |                   |         |   |                  |   |         |  
|Total liabilities and stockholders equity |  | $                 | 94,670  |   |                  | $ | 123,747 |  
|                                           |  |                   |         |   |                  |   |         |  

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements



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##### Table of Contents

VERAZ NETWORKS, INC AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Operations

(in thousands, except per share data)



|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|---------------------------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | ---- | - | ------ |  | - | ------- | - |  | - | ------ | -
|                                                                       |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30, |     
|                                                                       |  | 2008                            |        |                                | 2007 |   | 2008   |  |   | 2007    |  
|Revenues:                                                              |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|IP Products                                                            |  | $                               | 15,080 |                                |      | $ | 19,409 |  | $ | 45,520  |   |  | $ | 58,428 |  
|DCME Products                                                          |  |                                 | 2,215  |                                |      |   | 6,485  |  |   | 5,030   |   |  |   | 16,115 |  
|Services                                                               |  |                                 | 5,660  |                                |      |   | 6,269  |  |   | 16,556  |   |  |   | 16,233 |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Total revenues                                                         |  |                                 | 22,955 |                                |      |   | 32,163 |  |   | 67,106  |   |  |   | 90,776 |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Cost of Revenues:                                                      |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|IP Products                                                            |  |                                 | 5,344  |                                |      |   | 9,792  |  |   | 18,527  |   |  |   | 24,625 |  
|DCME Products                                                          |  |                                 | 878    |                                |      |   | 2,355  |  |   | 1,958   |   |  |   | 5,642  |  
|Services                                                               |  |                                 | 3,148  |                                |      |   | 3,067  |  |   | 10,982  |   |  |   | 8,820  |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Total cost of revenues                                                 |  |                                 | 9,370  |                                |      |   | 15,214 |  |   | 31,467  |   |  |   | 39,087 |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Gross profit                                                           |  |                                 | 13,585 |                                |      |   | 16,949 |  |   | 35,639  |   |  |   | 51,689 |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Operating Expenses:                                                    |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Research and development, net                                          |  |                                 | 5,612  |                                |      |   | 7,571  |  |   | 20,747  |   |  |   | 23,175 |  
|Sales and marketing                                                    |  |                                 | 8,158  |                                |      |   | 7,017  |  |   | 22,957  |   |  |   | 19,956 |  
|General and administrative                                             |  |                                 | 3,528  |                                |      |   | 2,361  |  |   | 12,155  |   |  |   | 7,082  |  
|Restructuring charges                                                  |  |                                 | 794    |                                |      |   |       |  |   | 794     |   |  |   |       |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Total operating expenses                                               |  |                                 | 18,092 |                                |      |   | 16,949 |  |   | 56,653  |   |  |   | 50,213 |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Income (loss) from operations                                          |  |                                 | (4,507 | )                              |      |   |       |  |   | (21,014 | ) |  |   | 1,476  |  
|Other income (expenses), net                                           |  |                                 | (1,061 | )                              |      |   | 545    |  |   | 226     |   |  |   | 650    |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Income (loss) before income taxes                                      |  |                                 | (5,568 | )                              |      |   | 545    |  |   | (20,788 | ) |  |   | 2,126  |  
|Provision (benefit) for income taxes                                   |  |                                 | (155   | )                              |      |   | 213    |  |   | (689    | ) |  |   | 842    |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Net income (loss)                                                      |  |                                 | (5,413 | )                              |      |   | 332    |  |   | (20,099 | ) |  |   | 1,284  |  
|Deemed dividend on Series D convertible preferred stock                |  |                                 |       |                                |      |   |       |  |   |        |   |  |   | (5,980 | )
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Net income (loss) allocable to common stockholders                     |  | $                               | (5,413 | )                              |      | $ | 332    |  | $ | (20,099 | ) |  | $ | (4,696 | )
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Net income (loss) allocable to common stockholders per share  basic   |  |                                 | (0.13  | )                              |      |   | 0.01   |  |   | (0.48   | ) |  |   | (0.15  | )
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Net income (loss) allocable to common stockholders per share  diluted |  |                                 | (0.13  | )                              |      |   | 0.01   |  |   | (0.48   | ) |  |   | (0.15  | )
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Weighted-average shares outstanding:                                   |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Basic                                                                  |  |                                 | 42,233 |                                |      |   | 40,684 |  |   | 41,877  |   |  |   | 31,545 |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  
|Diluted                                                                |  |                                 | 42,233 |                                |      |   | 46,175 |  |   | 41,877  |   |  |   | 31,545 |  
|                                                                       |  |                                 |        |                                |      |   |        |  |   |         |   |  |   |        |  

Related Party Transactions

The Unaudited Condensed Consolidated Statements of Operations shown above include the following related party transactions:



|                                                          |  |                                 |       |                                |   |       |  |      |       |  |   |      
|--------------------------------------------------------- |  | ------------------------------- | ----- | ------------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                                                          |  | Three Months EndedSeptember 30, |       | Nine Months EndedSeptember 30,
|                                                          |  | 2008                            |       | 2007                           |   | 2008  |  | 2007
|Revenues:                                                 |  |                                 |       |                                |   |       |  |      |       |  |   |      
|IP Products, related party sales                          |  | $                               | 7     |                                | $ | 116   |  | $    | 66    |  | $ | 225  
|DCME Products, related party sales                        |  |                                 |      |                                |   | 131   |  |      |      |  |   | 410  
|Cost of Revenues:                                         |  |                                 |       |                                |   |       |  |      |       |  |   |      
|IP Products, costs arising from related party purchases   |  |                                 |      |                                |   | 138   |  |      | 184   |  |   | 154  
|DCME Products, costs arising from related party purchases |  |                                 | 800   |                                |   | 2,087 |  |      | 1,782 |  |   | 5,150
|Services, costs arising from related party purchases      |  |                                 | 45    |                                |   |      |  |      | 135   |  |   |     
|Operating Expenses:                                       |  |                                 |       |                                |   |       |  |      |       |  |   |      
|Research and development                                  |  |                                 | 135   |                                |   | 544   |  |      | 858   |  |   | 1,757
|Sales and marketing                                       |  |                                 | 1,679 |                                |   | 1,261 |  |      | 3,234 |  |   | 3,687
|General and administrative                                |  |                                 | 61    |                                |   | 72    |  |      | 193   |  |   | 278  
|Other Income:                                             |  |                                 |       |                                |   |       |  |      |       |  |   |      
|Other income                                              |  |                                 |      |                                |   | 113   |  |      |      |  |   | 113  

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements



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##### Table of Contents

VERAZ NETWORKS, INC AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)



|                                                                                            |  |                                |         |   |      |   |         |  
|------------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                            |  | Nine Months EndedSeptember 30, |        
|                                                                                            |  | 2008                           |         |   | 2007 |  
|Cash flows from operating activities:                                                       |  |                                |         |   |      |   |         |  
|Net income (loss)                                                                           |  | $                              | (20,099 | ) |      | $ | 1,284   |  
|Adjustments to reconcile net income (loss) to net cash used in operating activities:        |  |                                |         |   |      |   |         |  
|Depreciation                                                                                |  |                                | 2,579   |   |      |   | 2,768   |  
|Loss on disposal of property and equipment                                                  |  |                                | 37      |   |      |   |        |  
|Stock-based compensation                                                                    |  |                                | 3,328   |   |      |   | 1,592   |  
|Provision for doubtful accounts                                                             |  |                                | 1,282   |   |      |   | (16     | )
|Amortization of debt issuance cost and accretion of loan payable                            |  |                                | 162     |   |      |   | 338     |  
|Deferred income taxes                                                                       |  |                                | (944    | ) |      |   | (176    | )
|Non-cash restructuring charges                                                              |  |                                | 37      |   |      |   |        |  
|Net changes in operating assets and liabilities:                                            |  |                                |         |   |      |   |         |  
|Accounts receivable                                                                         |  |                                | 5,887   |   |      |   | (16,166 | )
|Sold accounts receivable                                                                    |  |                                |        |   |      |   | 11,071  |  
|Inventories                                                                                 |  |                                | (2,875  | ) |      |   | 4,948   |  
|Prepaid expenses and other current assets                                                   |  |                                | 1,288   |   |      |   | (1,604  | )
|Due from related parties                                                                    |  |                                | (24     | ) |      |   | 592     |  
|Accounts payable                                                                            |  |                                | (6,913  | ) |      |   | 3,087   |  
|Accrued expenses                                                                            |  |                                | (4,828  | ) |      |   | (738    | )
|Income tax payable                                                                          |  |                                | (51     | ) |      |   | 284     |  
|Deferred revenue                                                                            |  |                                | 2,865   |   |      |   | (13,443 | )
|Due to related parties                                                                      |  |                                | (1,441  | ) |      |   | (2,574  | )
|                                                                                            |  |                                |         |   |      |   |         |  
|Net cash used in operating activities                                                       |  |                                | (19,710 | ) |      |   | (8,753  | )
|                                                                                            |  |                                |         |   |      |   |         |  
|Cash flows from investing activities:                                                       |  |                                |         |   |      |   |         |  
|Restricted cash                                                                             |  |                                |        |   |      |   | (106    | )
|Maturities and sales of short-term investments                                              |  |                                | 9,573   |   |      |   | (6,624  | )
|Purchases of short-term investments                                                         |  |                                | (8,781  | ) |      |   | 400     |  
|Purchases of property and equipment, net                                                    |  |                                | (1,553  | ) |      |   | (2,474  | )
|Other assets                                                                                |  |                                | 8       |   |      |   | 57      |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Net cash used in investing activities                                                       |  |                                | (753    | ) |      |   | (8,747  | )
|                                                                                            |  |                                |         |   |      |   |         |  
|Cash flows from financing activities:                                                       |  |                                |         |   |      |   |         |  
|Proceeds from the exercise of stock options                                                 |  |                                | 613     |   |      |   | 400     |  
|Proceeds from sale of common stock in connection with the Companys initial public offering |  |                                |        |   |      |   | 54,000  |  
|Payment of underwriting discounts and other offering costs                                  |  |                                |        |   |      |   | (5,818  | )
|Proceeds from sale of Series D convertible preferred stock                                  |  |                                |        |   |      |   | 3,449   |  
|Issuance cost for Series D convertible preferred stock                                      |  |                                |        |   |      |   | (37     | )
|Payment of offering costs                                                                   |  |                                |        |   |      |   |         |  
|Redemption of redeemable preferred stock                                                    |  |                                |        |   |      |   | (14     | )
|Repayment of loan                                                                           |  |                                | (2,696  | ) |      |   | (847    | )
|                                                                                            |  |                                |         |   |      |   |         |  
|Net cash (used in) provided by financing activities                                         |  |                                | (2,083  | ) |      |   | 51,133  |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Effect of exchange rate changes                                                             |  |                                | 109     |   |      |   |        |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                        |  |                                | (22,437 | ) |      |   | 33,633  |  
|Cash and cash equivalents at beginning of period                                            |  |                                | 52,232  |   |      |   | 23,189  |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                  |  | $                              | 29,795  |   |      | $ | 56,822  |  
|                                                                                            |  |                                |         |   |      |   |         |  

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements



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##### Table of Contents

VERAZ NETWORKS, INC AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

NOTE 1  THE COMPANY

Veraz Networks, Inc. (the Company) was incorporated under the laws of the
State of Delaware on October 18, 2001. The Company is a provider of voice infrastructure solutions to established and emerging wireline and wireless service providers. Service providers use the products to transport, convert and manage voice
traffic over both legacy Time-Division Multiplexing (TDM) and Internet Protocol (IP) networks, while enabling voice over IP, or VoIP, and other multimedia services. The Companys ControlSwitch softswitch solution and I-Gate 4000 family of media
gateway products, enable service providers to deploy IP networks and efficiently migrate from their legacy circuit-switched networks to IP networks.

NOTE 2  BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements include the accounts of Veraz
Networks, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying interim condensed consolidated financial statements as of September 30, 2008 and for the three and nine months ended September 30, 2008 and 2007 are unaudited. These financial statements and notes should be read
in conjunction with the audited consolidated financial statements and related notes, together with managements discussion and analysis of financial condition and results of operations, contained in the Companys Annual Report on Form 10-K
for the year ended December 31, 2007.

The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America (GAAP) pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). They do not include all of the financial information and footnotes
required by GAAP for complete financial statements. In the opinion of management, the unaudited condensed consolidated financial statements and notes have been prepared on the same basis as the audited consolidated financial statements in the
Companys Annual Report on Form 10-K for the year ended December 31, 2007, and include adjustments (consisting of normal recurring adjustments) necessary for the fair presentation of the Companys financial position as of
September 30, 2008, results of operations for the three and nine months ended September 30, 2008 and 2007 and cash flows for the nine months ended September 30, 2008 and 2007. The three and nine months ended September 30, 2008,
includes additional expense of $0.5 million which is the correction of an error in the estimate for employment related taxes. The Company has determined that the amount is immaterial to the estimated loss for the full fiscal year. The interim
periods are not necessarily indicative of the results to be expected for any other interim period or the full year.

In
September 2006, the Financial Accounting Standards Board FASB issued Statement of Financial Accounting Standard No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes guidelines
for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS
157 was effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position, or FSP, SFAS No. 157-2, Effective Date of FASB Statement No.157, (SFAS 157-2), which delayed the
effective date of SFAS 157 to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value
in the financial statements on a recurring basis (at least annually). We adopted SFAS 157 for financial assets and we are evaluating our impact for non-financial assets, but it is not expected to have a material impact on our consolidated financial
position, annual results of operations or cash flows. See Note 4 for details on our fair value measurements for financial assets.

In
February 2007, the FASB issued Statement of Financial Accounting Standard No.159, The Fair Value Option for Financial Assets and Financial Liabilities,(SFAS 159). Under SFAS 159, companies may elect to measure certain
financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS 159 is effective for fiscal years beginning
after November 15, 2007. We adopted SFAS 159 for fiscal 2008. However, we did not elect to apply the fair value option to any financial instruments or other items upon adoption of SFAS 159 or during the three and nine months ended
September 30, 2008. Therefore, the adoption of SFAS 159 did not impact our consolidated financial position, results of operations or cash flows.



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NOTE 3  SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies of the Company are as follows:

(a) Use of Estimates

The preparation of condensed consolidated financial statements and
related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed
consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Significant items subject to such estimates and assumptions include account receivables valuation, deferred tax asset valuation, revenue
recognition, contingencies, and stock options valuation. Actual results could differ materially from those estimates.

(b)
Concentrations

The substantial majority of the manufacturing of the Companys hardware products occurs in Israel. In addition,
a substantial portion of the Companys operations is located in Israel, which includes the Companys entire media gateway research and development team. The continued threat of terrorist activity or other acts of war or hostility against
Israel have created uncertainty throughout the Middle East. To the extent this results in a disruption of the Companys operations or delays of its manufacturing capabilities or shipments of its products, then the Companys business,
operating results and financial condition could be adversely affected.

Two customers, Vimpelcom and Sky2net Limited, contributed to 14%
and 12% of the Companys revenues in the three months ended September 30, 2008, respectively. Two customers, Excel Communications and OSS Corporation, contributed to 12% and 10% of the Companys revenues in the three months ended
September 30, 2007. No customer accounted for 10% the Companys revenues in both of the nine months ended September 30, 2008 and September 30, 2007. One customer, Pradec Enterprise, accounted for 10% or more of the Companys
accounts receivable and due from related parties as of September 30, 2008 and none at December 31, 2007.

(c) Revenue
Recognition

DCME product revenues consists of revenues from the sale of the DCME hardware products. IP product revenues consists of
revenues from the sale of the I-Gate family of media gateway hardware products, the ControlSwitch family of softswitch modules, and the Secure Communications Software. Services revenue consists of revenues from separately-priced maintenance and
extended warranty contracts, post-contract customer support (PCS), installation training and other professional services.

As discussed in
Note 5, the Company is the exclusive distributor of DCME products under the DCME Agreement with ECI, a related party. The Company has determined that revenues from sales of DCME products should be reported on a gross basis after considering the
indicators included in Emerging Issues Task Force Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent(EITF Issue No. 99-19). Specifically, the Company is the primary obligor, maintains the general
inventory risk, and determines the product specifications based on the customers order.

Revenue from standalone sales of DCME
products is recognized in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition(SAB 104). When sales of DCME are bundled with installation services, the hardware and services are accounted for as separate units of
accounting as the deliverables meet the separation criteria in EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables.Revenue for each deliverable is recognized in accordance with SAB 104.

All of the Companys IP products may be sold in a bundled arrangement that includes PCS, installation, training, and other professional services.
The Companys media gateway hardware, when sold in a bundled arrangement, is referred to as a static trunking solution, and when sold in a bundled arrangement that includes the Companys softswitch module software is referred to as a VoIP
solution. When the Companys Secure Communications Software is sold in a bundled arrangement with DCME hardware, it is referred to as a Secure Communications solution.

In sales of static trunking solutions, VoIP solutions or Secure Communications solutions, the software is considered more than incidental to the
arrangement and essential to the functionality of the hardware. Therefore, all revenue from these arrangements is recognized in accordance with American Institute of Certified Public Accountants (AICPA) Statement of Position 97-2, Software
Revenue Recognition(SOP 97-2), as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions.



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In accordance with both SAB 104 and SOP 97-2, the Company recognizes revenue when all of the following
criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable, and (iv) collectibility is probable. The Company evaluates each of the four criteria as
follows:

(i) Persuasive evidence of an arrangement exists

The Companys customary practice is to have a written contract, which is signed by both the customer and the Company, or a purchase
order or other written or electronic order documentation for those customers who have previously negotiated a standard arrangement with the Company.

(ii) Delivery has occurred

For standalone sales of DCME products, revenue is recognized
when title and risk of loss have passed to the customer, which is typically at time of shipment. Revenue is recognized for installation services, if any, as the services are performed.

Sales of static trunking solutions typically do not require customer acceptance. Prior to the fourth quarter of 2007, where evidence of
customer acceptance was required before recognizing revenue for static trunking solutions, the Company did not consider delivery of the hardware, software and services to have occurred until evidence of acceptance was received from the customer.
Beginning in the fourth quarter of 2007, the Company commenced recognizing revenue allocated to the hardware and software in static trunking solutions upon delivery of the hardware and software using the residual method and revenue allocated to the
installation services as the services are performed. In those circumstances the static trunking solution arrangement requires specific non-standard terms or specifications, such as special customization of the hardware and software, the Company
defers revenue recognition until formal customer acceptance is received or it can be objectively demonstrated that those specifications have been attained, whichever occurs first.

VoIP solution arrangements typically require evidence of customer acceptance of the implementation of the VoIP solution in the
customers network, including the ability of the network to carry live data traffic. As a result, delivery of the software, hardware and services is not considered to have occurred until evidence of acceptance is received from the customer. For
most arrangements, the Company has established vendor specific objective evidence (VSOE) for the related PCS based on stated renewal rates. Therefore, upon customer acceptance, the Company recognizes revenue using the residual method. For
arrangements in which the Company is unable to establish VSOE for its PCS, the entire arrangement fee is deferred and recognized ratably over the PCS term after delivery and acceptance of the software, hardware and services.

For sales of Secure Communications solutions, delivery of the DCME hardware and Secure Communications Software is considered to have
occurred when title and risk of loss has passed to the customer, which is typically at time of shipment. Installation services are generally not sold as part of a Secure Communications solution and are not considered essential to the functionality
of the hardware or software. For sales of Secure Communication solutions that include installation but do not include PCS, the Company recognized revenue upon completion of those installation services prior to the third quarter of 2006 as these
services did not have VSOE. Generally, sales of Secure Communication solutions do not include a stated renewal rate for PCS. Under those arrangements the entire arrangement fee is deferred and recognized ratably over the PCS term, which always
exceeds the period over which the installation services are performed. In the event an arrangement has a stated renewal rate for PCS, then the Company uses that rate as VSOE for the PCS.

The Company has established VSOE of fair value for IP services. The Company limits its assessment of VSOE of fair value to the price
charged when the same element is sold separately. Accordingly, assuming all other revenue recognition criteria are met, revenue is recognized upon delivery of the hardware and software using the residual method.

The Company sells its products through its direct sales force and channel partners. For products sold through indirect channels, revenue
is recognized either on a sell-in basis or when the channel partner sells the product to the end user, depending on the Companys experience with the individual channel partner.

Revenue from sales of standalone training courses is recognized when the services are completed.

(iii) The fee is fixed or determinable



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The Company does not offer a right of return to its customers. Arrangement fees are
generally due within one year or less from the later of the date of delivery or acceptance. Some arrangements may have payment terms extending beyond these customary payment terms and therefore the arrangement fees are considered not to be fixed or
determinable. For multiple element arrangements with payment terms that are considered not to be fixed or determinable, revenue is recognized equal to the cumulative amount due and payable after allocating a portion of the cumulative amount due and
payable to any undelivered elements (generally PCS) based on VSOE, after delivery and acceptance of the software, hardware and services, and assuming all other revenue recognition criteria are satisfied. The Company defers the cost of inventory when
products have been shipped, but have not yet been installed or accepted, and expenses those costs in full in the same period that the deferred revenue is recognized as revenue (generally upon customer acceptance). In arrangements for which IP
revenue recognition is limited to amounts due and payable, all related inventory costs are expensed at the date of acceptance; this will initially result in lower or negative product margins and cause higher margins in subsequent periods, as
compared to similar arrangements with customary payment terms.

(iv) Collectibility is probable

Collectibility is assessed on a customer-by-customer basis. The Company evaluates the financial position, payment history, and ability to
pay of new customers, and of existing customers that substantially expand their commitments. If it is determined prior to revenue recognition that collectibility is not probable, recognition of the revenue is deferred and recognized upon receipt of
cash, assuming all other revenue recognition criteria are satisfied. In arrangements for which IP revenue recognition is limited to amounts of cash received, all related inventory costs are expensed at the date of acceptance; this will initially
result in lower or negative product margins and cause higher margins in subsequent periods, as compared to similar arrangements with customary payment terms.

Revenues include amounts billed to customers in sales transactions for shipping and handling. Shipping and handling fees represent less than 1% of revenues in each of the three and nine months ended September 30,
2008 and 2007, respectively. Shipping and handling costs are included in cost of revenues.

For purposes of classification in the condensed
consolidated statements of operations, revenue from sales of static trunking solutions, VoIP solutions, and Secure Communications solutions is allocated between DCME Products, IP Products and Services, as applicable, based on VSOE for any elements
for which VSOE exists or based on the relative stated invoice amount for elements for which VSOE does not exist.

(d) Investments

All debt and marketable equity securities are classified as available-for-sale. Available-for-sale securities are carried at fair
value with the unrealized gains and losses, net of tax, reported in stockholders equity as a component of accumulated other comprehensive income (loss). Unrealized losses considered to be other than temporary are recognized in earnings
currently. Realized gains and losses on sales of available-for-sale securities are computed based upon initial cost adjusted for any other-than-temporary declines in fair value. Gains or losses on securities sold are based on the specific
identification method.

(e) Government-Sponsored Research and Development

The Company records grants received from the Office of the Chief Scientist of the Israel Ministry of Industry and Trade (OCS) as a reduction of research
and development expenses on a monthly basis, based on the estimated reimbursable cost incurred. Royalties payable to the OCS are classified as cost of revenues. Royalty expenses relating to OCS grants included in cost of IP product revenues for the
three months ended September 30, 2008 and 2007, amounted to $0.4 million and $0.5 million, respectively. Royalty expenses relating to OCS grants included in cost of IP product revenues for the nine months ended September 30, 2008 and 2007,
amounted to $1.1 million and $1.4 million, respectively. As of September 30, 2008 and December 31, 2007, the royalty payable amounted to $1.2 million and $1.3 million, respectively. The maximum amount of the contingent liability related to
royalties payable to the Israeli Government was approximately $15.6 million as of September 30, 2008.

(f) Comprehensive Income
(Loss)

SFAS No. 130, Reporting Comprehensive Income, establishes standards for reporting and displaying comprehensive
income (loss) and its components in a full set of general-purposes financial statements. During the three months ended September 30, 2008, net loss and comprehensive loss was $5.4 million and $5.5 million, respectively, primarily related to
cumulative translation adjustment.



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During the nine months ended September 30, 2008, net loss and comprehensive loss was $20.1 million and $20.2 million, respectively. There was not
significant difference between the Companys net loss and comprehensive loss for the three and nine months ended September 30, 2007.

(g) Recent Accounting Pronouncements

With the exception of those discussed below, there have been no recent
accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2008, as compared to the recent accounting pronouncements described in the Companys Annual Report on Form 10-K for the fiscal
year ended December 31, 2007, that are of significance, or potential significance, to the Company.

In March 2008, the FASB issued
SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. SFAS No. 161 requires companies with derivative instruments to disclose information that should enable financial statement users to understand how and
why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,and how derivative instruments and related
hedged items affect a companys financial position, financial performance and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is
currently evaluating the impact, if any, that SFAS No. 161 will have on its consolidated financial statements and notes.

NOTE 4  FINANCIAL
INSTRUMENTS

The Company adopted SFAS No. 157 on January 1, 2008. SFAS No. 157 defines fair value as the price that would
be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). SFAS No. 157 classifies the inputs used to measure fair value into the following hierarchy:



|         |  |                                                                                                                                                                                                                                                                            
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Level 1: |  | Unadjusted quoted prices in active markets for identical assets or liabilities                                                                                                                                                                                             
|         | 
|Level 2: |  | Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or
inputs other than quoted prices that are observable for the assets or liability
|         | 
|Level 3: |  | Unobservable inputs for the asset or liability                                                                                                                                                                                                                             

The Company measures its fixed income available-for-sale securities assets at fair value on a
recurring basis and has determined that these financial assets are level 2 in the fair value hierarchy. The following table sets forth the Companys financial assets that were accounted for at fair value as of September 30, 2008 (in
thousands):



|                                           |  |                                    |        |                                                              |   |                                              |  |                                         |        |  |   |  
|------------------------------------------ |  | ---------------------------------- | ------ | ------------------------------------------------------------ | - | -------------------------------------------- |  | --------------------------------------- | ------ |  | - | -
|                                           |  | Fair Value at Reporting Date Using
|                                           |  | Total                              |        | Quoted prices in activemarkets for identicalassets (Level 1) |   | Significant otherobservable inputs (Level 2) |  | Significantunobservableinputs (Level 3)
|Assets:                                    |  |                                    |        |                                                              |   |                                              |  |                                         |        |  |   |  
|Fixed income available-for-sale securities |  | $                                  | 13,359 |                                                              | $ |                                             |  | $                                       | 13,359 |  | $ | 
|Money market funds                         |  |                                    | 11,811 |                                                              |   | 11,811                                       |  |                                         |       |  |   | 
|                                           |  |                                    |        |                                                              |   |                                              |  |                                         |        |  |   |  
|                                           |  | $                                  | 25,170 |                                                              | $ | 11,811                                       |  | $                                       | 13,359 |  | $ | 
|                                           |  |                                    |        |                                                              |   |                                              |  |                                         |        |  |   |  

The fixed income available-for-sale securities are included in cash and cash equivalents and
short-term investments in the unaudited condensed consolidated balance sheet and consist of bonds, notes and other securities issued by the United States government and agencies, commercial paper and corporate bonds. Cash equivalents consist of
instruments with remaining maturities of three months or less at the date of purchase.



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Short-term investments held by the Company are debt securities classified as available-for-sale. The
Company invests in publicly traded, highly liquid securities of entities with credit ratings of A, or better. Unrealized gains and losses, net of related income taxes, for available-for-sale securities are included as a separate component of
stockholders equity. The following is a summary of short-term investments as of September 30, 2008 (in thousands):



|                                                                                      |  |                      |   |  |               |       |                       |   |           |  |   |      
|------------------------------------------------------------------------------------- |  | -------------------- | - |  | ------------- | ----- | --------------------- | - | --------- |  | - | -----
|                                                                                      |  | Percentageof holding |   |  | AmortizedCost |       | UnrealizedGain (Loss) |   | FairValue
|Bonds, notes and other securities issued by the United States government and agencies |  | 8                    | % |  | $             | 374   |                       | $ |          |  | $ | 374  
|Commercial paper                                                                      |  | 84                   |   |  |               | 3,843 |                       |   | 5         |  |   | 3,848
|Corporate bonds                                                                       |  | 8                    |   |  |               | 350   |                       |   |          |  |   | 350  
|                                                                                      |  |                      |   |  |               |       |                       |   |           |  |   |      
|                                                                                      |  | 100                  | % |  | $             | 4,567 |                       | $ | 5         |  | $ | 4,572
|                                                                                      |  |                      |   |  |               |       |                       |   |           |  |   |      

NOTE 5  RELATED PARTY TRANSACTIONS

ECI:

As a result of the
acquisition of Veraz Networks Ltd. and Veraz Networks International in December 2002, at September 30, 2008 ECI held approximately 26% of the Companys outstanding common stock. Effective September 16, 2008, one of the Companys
board of directors representing ECI ceased his employment with ECI.

The Company is the exclusive worldwide distributor of a line of voice
compression telecommunications products, or Digital Circuit Multiplication Equipment (DCME), for ECI under the DCME Master Manufacturing and Distribution Agreement (DCME Agreement), which was executed in December 2002, and certain agreements
relating to third party intellectual property and quality assurance and quality control services. Under the DCME Agreement, ECI manufactures or subcontracts the manufacture of all DCME equipment sold by the Company and also provides certain supply,
service and warranty repairs. The DCME Agreement is automatically renewed for successive one-year periods unless earlier terminated and was renewed for the period ending December 31, 2008. The DCME Agreement may only be terminated by ECI in the
event the Company projects DCME revenues of less than $1.0 million in a calendar year, the Company breaches a material provision of the agreement and fails to cure such breach within 30 days, or the Company becomes insolvent.

The Company pays ECI a purchase price for the DCME product that is computed as a percentage of revenue. The purchase price remained unchanged in 2008 and
2007. From time to time, prior to fulfillment of the Companys order for a particular customer, ECI has requested that the Company obtain either a letter of credit or accounts receivable insurance to mitigate any collection risk. Amounts
recorded under this arrangement are included in DCME Products, costs of revenue in the consolidated statements of operations.

The Company
has historically also contracted with ECI for the use of certain of its Asian and European subsidiaries for selling and support activities, including for the use of office space and certain employee related expenses and other general administrative
expenses. The Company records revenue related to sales to the subsidiaries either on a sell-in basis or when a binding sales agreement with an end-user has been made, depending on the Companys experience with the individual integrator or
reseller. Revenues generated from sales under these arrangements are included in DCME Product, and IP Product, revenues, in the consolidated statements of operations, depending on the nature of the products sold. The Company also reimburses these
subsidiaries for certain operating expenses, such as local sales and marketing support. The Company has also contracted with ECI and certain of its Asian and European subsidiaries for local support, technology and administrative services. The
Company allocates such expenses between research and development, sales and marketing, and general and administrative, in the consolidated statements of operations. Additionally, from time to time the Company purchases products for resale from ECI,
some of which costs are included in IP Products, cost of revenues in the consolidated statements of operations. The terms of these resale purchases are agreed on a case-by-case basis.

The Company has appointed ECI as an agent for selling IP and DCME products and services in Russia and other countries from the former Soviet Union. The
Company compensates ECI for agent services in Russia by paying a commission based on sales. Further, the Company has appointed ECI 2005, an affiliate of ECI, as a partner to provide services directly to customers in Russia. The Companys
Russian customers may purchase installation, training and maintenance services from ECI 2005. To the extent ECI 2005 needs assistance in providing installation, training and maintenance services to its customers in Russia, ECI 2005 may purchase
these services from the Company. The Company also reimburses ECI 2005 for the costs associated with the services activity. In November 2007, the Company entered into a sublease agreement with ECI 2005 for office space located in Moscow. The sublease
term is for an eleven month period, and the monthly rent is equal to approximately $15,000. ECI 2005 rent is included in services, cost of revenues, in the consolidated statements of operations. One employee of ECI serves on the Companys
Russian advisory committee.



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In 2004, the Company entered into a sublease agreement with ECI for office space of 4,279 square feet
located in Florida, which was amended in 2006 and further amended in January 2008. The amended sublease agreement with ECI that commenced on May 1, 2008 for office space of 5,950 square feet was at a different location in Florida. The Company
has the right to terminate this sublease on the date immediately preceding the fourth, sixth or eighth anniversary of the commencement date and the twelfth anniversary if this sublease is extended pursuant to its terms. The monthly rent for this
sublease is approximately $13,000. For the three and nine months ended September 30, 2008, ECI rent is included in general and administrative expense, in the condensed consolidated statements of operations.

Persistent Systems Pvt Ltd:

On October 1, 2003, the Company entered into a Contractor Agreement with Persistent Systems Pvt. Ltd. (Persistent). Under the Contractor Agreement, Persistent provided independent contract research and development employees located at
Persistents facility in Pune, India. At the end of the initial two-year period of the Contractor Agreement, the Company exercised its option under the contract to convert some of the Persistent employees performing services under the
Contractor Agreement into full-time Veraz employees. In May of 2006, the Company entered into an addendum to the Contractor Agreement formalizing the transfer arrangements of certain employees of Persistent during the period ending in December 2006.
In November of 2005, Promod Haque, the Companys Chairman, joined the board of directors of Persistent when Norwest Venture Partners, with whom Mr. Haque is affiliated, made an equity investment in Persistent that resulted in Norwest
Venture Partners owning greater than 10% of Persistents outstanding capital stock. As part of the restructuring during the quarter ended September 30, 2008, the Company cancelled most of the contracted services with Persistent, but will
retain some services for a limited transition period. During the three months ended September 30, 2008 and 2007, the Company incurred related party research and development expenses to Persistent under the Contractor Agreement of $0.1 million
and $0.5 million, respectively. During the nine months ended September 30, 2008 and 2007, the Company incurred related party research and development expenses to Persistent under the Contractor Agreement of $0.8 million and $1.5 million,
respectively. As of September 30, 2008 and December 31, 2007, the Company had related party payables to Persistent in the amount of approximately $0.2 million and $0.5 million, respectively.

NOTE 6  INVENTORIES

The following tables
provide details of inventories as of September 30, 2008 and December 31, 2007 (in thousands):



|                                        |  |                   |        |                  |   |      
|--------------------------------------- |  | ----------------- | ------ | ---------------- | - | -----
|                                        |  | September 30,2008 |        | December 31,2007
|Finished products                       |  | $                 | 3,776  |                  | $ | 2,760
|Work in process at customers locations |  |                   | 4,826  |                  |   | 3,084
|Raw material and components             |  |                   | 3,778  |                  |   | 3,661
|                                        |  |                   |        |                  |   |      
|                                        |  | $                 | 12,380 |                  | $ | 9,505
|                                        |  |                   |        |                  |   |      

Inventories are stated at the lower of cost or market on a first-in, first-out basis. The Company
periodically reviews its inventories and reduces the carrying value to the estimated market value, if lower, based upon assumptions about future demand and market conditions.

When the Companys products have been shipped, but not yet installed or accepted, the revenue associated with the product has been deferred as a
result of not meeting the revenue recognition criteria for delivery (see Note 3(c)). During the period between product shipment and acceptance, the Company recognizes all labor-related expenses as incurred but defers the cost of the related
equipment in accordance with AICPA Accounting Research Bulletin (ARB) No. 43, Restatement and Revision of Accounting Research Bulletins, Chapter 4: Inventory Pricing, and classifies the deferred costs as Work in process at
customers locations within the inventories line item. These deferred costs are then expensed in the same period that the deferred revenue is recognized as revenue (generally upon customer acceptance). In arrangements for which revenue
recognition is limited to amounts due and payable, or of cash received, all related inventory costs are expensed at the date of customer acceptance.

NOTE 7LOAN

On December 7, 2006, the Company secured a loan with a financial institution in the face amount of
$5.0 million. The loan bears stated interest of 9.78% and is granted for a period of two years with the principal due in seventeen monthly installments commencing



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on July 1, 2007. During the period December 2006 through September 2007, the Company made monthly interest payments on the loan. The loan is secured by
certain assets, principally equipment, of the Company. The loan agreement required the Company to pay the financial institution a loan commitment fee of $0.3 million and prepay interest of $0.1 million for the period from the funding date through
January 31, 2007. In addition, in connection with this transaction the Company sold a warrant to purchase 50,000 shares of Series C convertible preferred stock to the financial institution for $0.2 million. At the date of issuance the fair
value of the warrant was estimated to be $0.4 million. The warrant was exercised in December 2006. The Company computed interest on the loan using the interest method. Based on the allocation of the net proceeds, between the loan and the warrant,
the loan has an effective interest rate of approximately 19%. The loan does not contain financial covenants.

As of September 30,
2008, the future principal payments due in 2008 under the loan arrangement amounted to approximately $0.6 million.

The Company accounts
for the imputed discount on the loan using the interest method in accordance with APB Opinion No. 21, Interest on Receivables and Payableswith the difference between the present value and the face value treated as a discount and
amortized as interest expense over the term of the loan.

As of September 30, 2008, the fair value of the loan amounted to
approximately $0.6 million and the unamortized discount amounted to $8,000.

NOTE 8  FACTORING

The Company did not sell any trade receivables during the three and nine months ended September 30, 2008. During the three and nine months ended
September 30, 2007, the Company sold trade receivables to financial institutions in a total amount of $3.9 million and $11.1 million, respectively. Control and risk of those trade receivables were fully transferred and accounted for as a sale
in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

The agreements, pursuant to which the Company sells its trade receivables, are structured such that the Company (i) transfers the proprietary rights in the receivable from the Company to the financial institution; (ii) legally
isolates the receivable from the Companys other assets, and presumptively puts the receivable beyond the lawful reach of the Company and its creditors, even in bankruptcy or other receivership; (iii) confers on the financial institution
the right to pledge or exchange the receivable; and (vi) eliminates the Companys effective control over the receivable, in the sense that the Company is not entitled and shall not be obligated to repurchase the receivable other than in
case of failure by the Company to fulfill its commercial obligation.

NOTE 9  RESTRUCTURING CHARGES

On July 31, 2008, the Company announced that it planned to reduce its workforce by approximately 160 employees and contractors and consolidate
certain operations across all organizations, primarily in the areas of research and development and services. These activities consist of severance costs, equipment write-downs and facilities consolidation. Costs associated with restructuring
activities, other than those activities related to business combinations, are accounted for in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities(SFAS 146).

Restructuring activity for the three months ended September 30, 2008 was as follows (in thousands):



|                                 |  |                                                |      |   |                                   |   |     |                                                       |  |   |       |   |  |   |      |  
|-------------------------------- |  | ---------------------------------------------- | ---- | - | --------------------------------- | - | --- | ----------------------------------------------------- |  | - | ----- | - |  | - | ---- | -
|                                 |  | EmployeeTermination/Severance andRelated Costs |      |   | FacilityShutdown andConsolidation |   |     | Impairment ofFixed Assets orLoss on disposalof Assets |  |   | Total |  
|Balance at June 30, 2008         |  | $                                              |     |   |                                   | $ |    |                                                       |  | $ |      |   |  | $ |     |  
|Charges to operations            |  |                                                | 509  |   |                                   |   | 248 |                                                       |  |   | 37    |   |  |   | 794  |  
|Payments made during the quarter |  |                                                | (487 | ) |                                   |   | (10 | )                                                     |  |   |      |   |  |   | (497 | )
|Impairment of assets             |  |                                                |     |   |                                   |   |    |                                                       |  |   | (37   | ) |  |   | (37  | )
|                                 |  |                                                |      |   |                                   |   |     |                                                       |  |   |       |   |  |   |      |  
|Balance at September 30, 2008    |  | $                                              | 22   |   |                                   | $ | 238 |                                                       |  | $ |      |   |  | $ | 260  |  
|                                 |  |                                                |      |   |                                   |   |     |                                                       |  |   |       |   |  |   |      |  



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The $0.3 million restructuring accrual as of September 30, 2008, is included as a component of the
Companys current accrued expenses on its Unaudited Condensed Consolidated Balance Sheets and is expected to be settled by December 31, 2008.

NOTE 10  STOCK-BASED COMPENSATION

During the three months ended September 30, 2008 and 2007, the Company
amortized $78,000, and $79,000, respectively, of deferred stock-based compensation. During the nine months ended September 30, 2008 and 2007, the Company amortized $0.2 million, and $0.2 million, respectively, of deferred stock-based
compensation. During the three months ended September 30, 2008 and 2007, the Company reversed $3,000 and $1,000, respectively, of deferred stock-based compensation due to employee terminations. During the nine months ended September 30,
2008 and 2007, the Company reversed $5,000 and $22,000, respectively, of deferred stock-based compensation due to employee terminations. As of September 30, 2008, the total unamortized deferred stock-based compensation amounted to $0.1 million
and is expected to be amortized as follows: $77,000 during the remaining three months of 2008 and $34,000 in 2009.

During the three months
ended September 30, 2008, the Company granted 1,355,000 stock options and 40,000 restricted stock units (RSUs), with a weighted average grant date fair value per share of options is approximately $0.91 and grant date fair value of the RSUs is
$1.44, respectively. During the three months ended September 30, 2007, the Company granted zero stock options, and 435,320 RSUs with a weighted average fair value per share of approximately $6.02. During the nine months ended September 30,
2008, the Company granted 1,475,000 stock options and 1,099,105 RSUs with a weighted average fair value per share of approximately $0.93 and $4.71, respectively. During the nine months ended September 30, 2007, the Company granted zero stock
options, and 435,320 RSUs with a weighted average fair value per share of approximately $6.02. The amount of the RSUs expensed by the Company is based on the closing market price of the Companys common stock on the date of grant and are
amortized on a straight-line basis over the requisite service period.

The total stock-based compensation for options and RSUs granted for
the three months and nine months ended September 30, 2008, including the deferred compensation above, was $1.0 million and $3.3 million, respectively.

Stock Options:

The following weighted average assumptions were used to value options using the
Black-Scholes model for options granted during the three and nine months ended September 30, 2008 and 2007:



|                                                                 |  |                                 |      |                                |      |   |      |   |      |      |  |   |      |  
|---------------------------------------------------------------- |  | ------------------------------- | ---- | ------------------------------ | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                                                                 |  | Three Months EndedSeptember 30, |      | Nine Months EndedSeptember 30, |     
|                                                                 |  | 2008                            |      |                                | 2007 |   | 2008 |   |      | 2007 | 
|Expected term (in years)                                         |  |                                 | 6.06 |                                |      |  |      |   | 6.06 |      |  |   | 6.25 |  
|Risk-free interest rate                                          |  |                                 | 3.37 | %                              |      |  |      |   | 3.40 | %    |  |   | 4.72 | %
|Volatility                                                       |  |                                 | 67   | %                              |      |  |      |   | 67   | %    |  |   | 73   | %
|Dividend yield                                                   |  |                                 |     |                                |      |  |      |   |     |      |  |   |     |  
|Weighted-average fair value per share of underlying common stock |  | $                               | 0.91 |                                |      |  |      | $ | 0.93 |      |  | $ | 8.55 |  

Our computations of expected volatility for the three and nine months ended September 30,
2008 and 2007 were based on our historical and implied volatility. The interest rate for periods within the contractual life of the award was based on the U.S. Treasury yield curve in effect at the time of grant. The Company has not declared
dividends to date.

Restricted Stock Awards:

During the three months ended September 30, 2008 and 2007, the compensation expense on these stock based awards amounted to $0.6 million and $0.4 million, respectively. During the nine months ended
September 30, 2008 and 2007, the compensation expense on these stock based awards amounted to $2.0 million and $1.4 million, respectively.



14



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##### Table of Contents

Restricted stock activity as of September 30, 2008 was as follows:



|                                  |  |                 |  
|--------------------------------- |  | --------------- | -
|                                  |  | Number ofShares |  
|Outstanding at December 31, 2007  |  | 501,355         |  
|Granted                           |  | 1,099,105       |  
|Released                          |  | (128,879        | )
|Forfeited or expired              |  | (222,210        | )
|                                  |  |                 |  
|Outstanding at September 30, 2008 |  | 1,249,371       |  
|                                  |  |                 |  

In accordance with SFAS No. 123R, unamortized compensation expense on stock based awards
after January 1, 2006 is not included in deferred stock-based compensation. As of September 30, 2008, the balance of $9.1 million of total unrecognized compensation cost, related to non-vested stock-based awards granted under SFAS
No. 123R to employees and directors, is expected to be recognized over a weighted average period of approximately 2.6 years.

Stock
Award Activity:

A summary of the Companys stock award activity and related information for the nine months ended
September 30, 2008 is set forth in the following table:



|                                                          |  |                                   |   |  |                             |   |  |                              |      |                                          |      |                                       |   |      
|--------------------------------------------------------- |  | --------------------------------- | - |  | --------------------------- | - |  | ---------------------------- | ---- | ---------------------------------------- | ---- | ------------------------------------- | - | -----
|                                                          |  | Number ofSharesAvailablefor Grant |   |  | Number ofOptionsOutstanding |   |  | WeightedAverageExercisePrice |      | WeightedAverageContractualLife(in Years) |      | AggregateIntrinsicValue(in thousands)
|Balance at December 31, 2007                              |  | 82,815                            |   |  | 6,766,352                   |   |  | $                            | 1.39 |                                          |      |                                       |   |      
|Authorized                                                |  | 2,433,013                         |   |  |                             |   |  |                              |      |                                          |      |                                       |   |      
|Restricted stock units granted                            |  | (1,099,105                        | ) |  |                             |   |  |                              |      |                                          |      |                                       |   |      
|Restricted stock units cancelled and forfeited            |  | 222,210                           |   |  |                             |   |  |                              |      |                                          |      |                                       |   |      
|Options granted                                           |  | (1,475,000                        | ) |  | 1,475,000                   |   |  | $                            | 1.48 |                                          |      |                                       |   |      
|Options exercised                                         |  |                                  |   |  | (1,096,353                  | ) |  | $                            | 0.53 |                                          |      |                                       |   |      
|Options cancelled and forfeited                           |  | 367,458                           |   |  | (367,458                    | ) |  | $                            | 2.78 |                                          |      |                                       |   |      
|                                                          |  |                                   |   |  |                             |   |  |                              |      |                                          |      |                                       |   |      
|Balance at September 30, 2008                             |  | 531,391                           |   |  | 6,777,541                   |   |  | $                            | 1.48 |                                          | 6.30 |                                       | $ | 1,712
|Options vested and expected to vest at September 30, 2008 |  |                                   |   |  | 6,663,571                   |   |  | $                            | 1.46 |                                          | 6.25 |                                       | $ | 1,712
|Options exercisable at September 30, 2008                 |  |                                   |   |  | 4,623,920                   |   |  | $                            | 1.12 |                                          | 5.11 |                                       | $ | 1,700

NOTE 11  NET INCOME (LOSS) ALLOCABLE TO COMMON STOCKHOLDERS PER SHARE

Net loss allocable to common stockholders per share is computed in accordance with SFAS No. 128, Earnings per Share, by dividing the net loss
allocable to common stockholders by the weighted average number of shares of common stock outstanding. The Company has outstanding stock options and restricted stock units, which have not been included in the calculation of diluted net loss
allocable to common stockholders per share because to do so would be anti-dilutive. As such, the numerator and the denominator used in computing both basic and diluted net loss allocable to common stockholders per share for each period are the same.



15



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##### Table of Contents

Basic and diluted net income (loss) per share were calculated as follows (in thousands):



|                                                                              |  |                                 |   |                                |        |  |         |   |  |        |  
|----------------------------------------------------------------------------- |  | ------------------------------- | - | ------------------------------ | ------ |  | ------- | - |  | ------ | -
|                                                                              |  | Three Months EndedSeptember 30, |   | Nine Months EndedSeptember 30, |       
|                                                                              |  | 2008                            |   |                                | 2007   |  | 2008    |   |  | 2007   |  
|Numerator:                                                                    |  |                                 |   |                                |        |  |         |   |  |        |  
|Net income (loss)                                                             |  | (5,413                          | ) |                                | 332    |  | (20,099 | ) |  | (4,696 | )
|                                                                              |  |                                 |   |                                |        |  |         |   |  |        |  
|Denominator:                                                                  |  |                                 |   |                                |        |  |         |   |  |        |  
|Basic weighted-average shares:                                                |  |                                 |   |                                |        |  |         |   |  |        |  
|Weighted-average shares used in computing basic net income (loss) per share   |  | 42,233                          |   |                                | 40,684 |  | 41,877  |   |  | 31,545 |  
|                                                                              |  |                                 |   |                                |        |  |         |   |  |        |  
|Basic net income (loss) per common share                                      |  | (0.13                           | ) |                                | 0.01   |  | (0.48   | ) |  | (0.15  | )
|                                                                              |  |                                 |   |                                |        |  |         |   |  |        |  
|Diluted weighted-average shares:                                              |  |                                 |   |                                |        |  |         |   |  |        |  
|Basic shares (per above)                                                      |  | 42,233                          |   |                                | 40,684 |  | 41,877  |   |  | 31,545 |  
|Add: Effect of dilutive stock options                                         |  |                                |   |                                | 5,491  |  |        |   |  |       |  
|                                                                              |  |                                 |   |                                |        |  |         |   |  |        |  
|Weighted-average shares used in computing diluted net income (loss) per share |  | 42,233                          |   |                                | 46,175 |  | 41,877  |   |  | 31,545 |  
|                                                                              |  |                                 |   |                                |        |  |         |   |  |        |  
|Diluted net income (loss) per common share                                    |  | (0.13                           | ) |                                | 0.01   |  | (0.48   | ) |  | (0.15  | )
|                                                                              |  |                                 |   |                                |        |  |         |   |  |        |  
|Anti-dilutive shares excluded from net income (loss) per share calculation    |  | 2,114                           |   |                                |       |  | 3,189   |   |  | 5,783  |  
|                                                                              |  |                                 |   |                                |        |  |         |   |  |        |  

Certain common stock issuable under stock options, and RSUs were anti-dilutive for the three and
nine months ended September 30, 2008 and 2007 and were excluded from the diluted income (loss) per common share.

NOTE 12  SEC INQUIRY

On April 3, 2008, the Company received a letter from the SEC informing it that the SEC was conducting a confidential inquiry (SEC
Inquiry) and requesting that the Company voluntarily produce documents in connection with the SEC Inquiry. On April 5, 2008, the Companys Board of Directors appointed a special committee (Special Committee) consisting entirely of
independent directors to cooperate with the SEC in connection with the SEC Inquiry and to oversee an independent investigation into the matters raised by the SEC Inquiry. The Special Committee interviewed law firms to assist in the inquiry and on
April 10, 2008, retained Keker & Van Nest LLP (Independent Counsel), a law firm that had not previously represented the Company in any matters, to conduct an independent investigation. Between April 10, 2008 and July 17,
2008, Independent Counsel conducted an independent investigation into the matters raised by the SEC Inquiry. On July 17, 2008, Independent Counsel reported their findings to representatives of the SEC and on July 21, 2008 provided to the
SEC copies of certain documents collected by Independent Counsel during the course of its independent investigation. Other than providing additional documents as requested by the SEC, there has been no further activity concerning this matter. As a
result of the SEC Inquiry, the Company was not able to timely file its first quarter ended quarterly report on Form 10-Q and, on May 21, 2008, the Company received a notification letter from NASDAQ stating that its common stock may be subject
to delisting in accordance the NASDAQ rules. The Companys management attended a hearing on July 24, 2008 to request that NASDAQ grant the Companys request for an extension of time in which to comply with the NASDAQ listing
standards. On July 29, 2008, the Company filed its quarterly report on Form 10-Q for the quarter ended March 31, 2008 and now believes it is in compliance with all SEC filing requirements. Additionally, on August 6, 2008, the Company
received notification from NASDAQ informing the Company that the NASDAQ hearing panel had determined to continue listing the Companys common stock on the NASDAQ.

During the course of the inquiry, the Company became aware of allegations of misconduct relating to the Companys business practices in the Asia Pacific region that, if true, may constitute violations of the U.S.
Foreign Corrupt Practices Act (FCPA). These potential FCPA violations include alleged misconduct related to a Chinese customer and an Indonesian customer. In addition, the Special Committee was informed and made the Company aware of allegations of
possible fraud perpetrated against the Company and violations of the Companys Code of Conduct and Ethics (Policy). The allegations of possible fraud and violations of the Policy involve payments from a reseller to certain non-management
employees (whose employment has since been terminated) and other potentially inappropriate commercial relationships between non-management employees and a reseller. As of September 30, 2008, the Company had approximately $0.8 million in
accounts receivable that may be associated with such possible fraud and violations of the Policy. The Company has incurred expenses related to the SEC inquiry of approximately $0.2 million and $2.3 million for the three and nine months ended
September 30, 2008, respectively.



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##### Table of Contents

NOTE 13  INCOME TAXES

The Company recorded a provision (benefit) of income taxes of $(0.7) million and $0.8 million for the nine months ended September 30, 2008 and 2007, respectively. The tax benefit during the nine months ended
September 30, 2008 was primarily attributable to the Companys loss on operations in Israel. The Company believes that the related deferred tax asset will be realized. The tax provision during the nine months ended September 30, 2007,
was primarily attributable to the Companys profitable operations in Israel, for income generated on sales of products not covered under the Approved Enterprise status in Israel. In the first quarter of 2007, the Company eliminated its
valuation allowance attributable to its subsidiary in Israel, which resulted in a reduction of income tax expense of $0.2 million. In the second quarter of 2007, an Israeli court decision and related interpretations changed the application of net
loss carry forwards, which resulted in a reduction of income tax expense of $0.3 million, as the Company believes that it is more likely than not that this treatment will be accepted by the Israeli tax authorities.

The Companys tax provision for interim periods is calculated using the discrete period method. The difference between the U.S. federal statutory
tax rate of 35% and the Companys effective tax rate is primarily due to the benefit recorded for the Companys loss on operations in Israel offset by no benefit being recognized for net losses incurred in the U.S. as well as income earned
in lower tax rate jurisdictions, for which no U.S. income tax has been provided, as the Company intends to permanently reinvest these earnings outside of the U.S.

Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109(FIN
48). The adoption of FIN 48 did not have a material impact on the Companys financial position or results of operations. As of December 31, 2007, the Company had no unrecognized tax benefits.

The Company classifies interest and penalties related to tax contingencies as other expenses. As of December 31, 2007, the Company had not accrued
for any interest or penalties related to tax contingencies.

The Company files U.S. federal income tax returns as well as income tax
returns in various states and foreign jurisdictions. The Company may be subject to examination by the Internal Revenue Service (IRS) for calendar years from its inception in 2001 through 2007. Additionally, any net operating losses that were
generated in those years may also be subject to examination by the IRS, in the tax year the net operating loss is utilized. In addition, the Company may be subject to examination in the following foreign jurisdictions for the years specified: Brazil
for 2006 and 2007, France for 2006 and 2007, India for 2005 through 2007, Israel for 2003 through 2007, Singapore for 2005 through 2006, and the United Kingdom for 2005 through 2007.



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##### Table of Contents

NOTE 14  SEGMENT AND GEOGRAPHIC INFORMATION

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for reporting information about
operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance. The Companys chief operating decision maker is the Companys Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis,
accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. The Company has one business activity and there are no segment managers who are held accountable for operations,
operating results and plans for levels or components below the consolidated unit level. Accordingly, the Company is considered to be in a single reporting segment and operating unit structure. Revenue by geography is based on the billing address of
the customer. The following table sets forth revenue and long-lived assets by geographic area (in thousands):



|                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|------------------------------ |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                               |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                               |  | 2008                            |        | 2007                           |   | 2008   |  | 2007
|Revenues:                      |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Europe, Middle East and Africa |  | $                               | 14,996 |                                | $ | 13,309 |  | $    | 38,310 |  | $ | 43,862
|North America                  |  |                                 | 4,345  |                                |   | 10,889 |  |      | 12,300 |  |   | 24,707
|Asia Pacific and India         |  |                                 | 2,368  |                                |   | 5,755  |  |      | 9,521  |  |   | 14,314
|Caribbean and Latin America    |  |                                 | 1,246  |                                |   | 2,210  |  |      | 6,975  |  |   | 7,893 
|                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|                               |  | $                               | 22,955 |                                | $ | 32,163 |  | $    | 67,106 |  | $ | 90,776
|                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|                               |  |                                
|                               |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                               |  | 2008                            |        | 2007                           |   | 2008   |  | 2007
|Sales originating from:        |  |                                 |        |                                |   |        |  |      |        |  |   |       
|United States                  |  | $                               | 9,832  |                                | $ | 18,184 |  | $    | 30,968 |  | $ | 48,387
|Israel                         |  |                                 | 12,208 |                                |   | 10,859 |  |      | 31,780 |  |   | 35,318
|Other foreign countries        |  |                                 | 915    |                                |   | 3,120  |  |      | 4,358  |  |   | 7,071 
|                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|                               |  | $                               | 22,955 |                                | $ | 32,163 |  | $    | 67,106 |  | $ | 90,776
|                               |  |                                 |        |                                |   |        |  |      |        |  |   |       

Our subsidiary in Russia contributed to more than 10% of revenues in all the above periods.



|                        |  |                   |       |                  |   |      
|----------------------- |  | ----------------- | ----- | ---------------- | - | -----
|                        |  | September 30,2008 |       | December 31,2007
|Long-lived assets, net: |  |                   |       |                  |   |      
|United States           |  | $                 | 2,158 |                  | $ | 3,121
|Israel                  |  |                   | 2,832 |                  |   | 3,067
|Other foreign countries |  |                   | 499   |                  |   | 532  
|                        |  |                   |       |                  |   |      
|                        |  | $                 | 5,489 |                  | $ | 6,720
|                        |  |                   |       |                  |   |      



|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and Notes thereto for the year ended December 31, 2007, included in our Annual Report on Form
10-K, filed with the Securities and Exchange Commission on March 14, 2008. The discussion in this Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, such as statements of our future financial
operating results, plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed here. See Risk Factors in Item 1A of Part II for factors that could cause future results to differ
materially.



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##### Table of Contents

Overview

We are a leading global provider of voice infrastructure solutions for established and emerging wireline and wireless service providers. Service providers use our products to transport, convert and manage data and voice traffic both over
legacy TDM networks and IP networks, while enabling VoIP and other multimedia services. Our products include our IP products which consist of our ControlSwitch family of softswitch modules, our I-Gate 4000 family of media gateways and our Secure
Communications Software enhancement to our DCME products and our DTX family of DCME products. We also offer services consisting of hardware and software maintenance and support, installation, training and other professional services.

We outsource the manufacturing of our hardware products. Our I-Gate 4000 media gateways are manufactured for us by Flextronics. We buy our DCME products
from ECI which subcontracts the manufacturing to Flextronics. This enables us to focus mainly on the design, development, sales and marketing of our products and lowers our capital requirements. However, our ability to bring new products to market,
fulfill customer orders and achieve long-term growth depends on our ability to maintain sufficient technical personnel and obtain necessary external subcontractor capacity.

We sell our products primarily through a direct sales force and also through indirect sales channels.

SEC Inquiry

On April 3, 2008, the Company
received a letter from the SEC informing it that the SEC was conducting a confidential inquiry (SEC Inquiry) and requesting that the Company voluntarily produce documents in connection with the SEC Inquiry. On April 5, 2008, the Companys
Board of Directors appointed a special committee (Special Committee) consisting entirely of independent directors to cooperate with the SEC in connection with the SEC Inquiry and to oversee an independent investigation into the matters raised by the
SEC Inquiry. The Special Committee interviewed law firms to assist in the inquiry and on April 10, 2008, retained Keker & Van Nest LLP (Independent Counsel), a law firm that had not previously represented the Company in any matters, to
conduct an independent investigation. Between April 10, 2008 and July 17, 2008, Independent Counsel conducted an independent investigation into the matters raised by the SEC Inquiry. On July 17, 2008, Independent Counsel reported
their findings to representatives of the SEC and on July 21, 2008 provided to the SEC copies of certain documents collected by Independent Counsel during the course of its independent investigation. Other than providing additional documents as
requested by the SEC, there has been no further activity concerning this matter. As a result of the SEC Inquiry, the Company was not able to timely file its first quarter ended quarterly report on Form 10-Q and, on May 21, 2008, the Company
received a notification letter from NASDAQ stating that its common stock may be subject to delisting in accordance the NASDAQ rules. The Companys management attended a hearing on July 24, 2008 to request that NASDAQ grant the
Companys request for an extension of time in which to comply with the NASDAQ listing standards. On July 29, 2008, the Company filed its quarterly report on Form 10-Q for the quarter ended March 31, 2008 and now believes it is in
compliance with all SEC filing requirements. Additionally, on August 6, 2008, the Company received notification from NASDAQ informing the Company that the NASDAQ hearing panel had determined to continue listing the Companys common stock
on the NASDAQ.

During the course of the inquiry, the Company became aware of allegations of misconduct relating to the Companys
business practices in the Asia Pacific region that, if true, may constitute violations of the U.S. Foreign Corrupt Practices Act (FCPA). These potential FCPA violations include alleged misconduct related to a Chinese customer and an Indonesian
customer. In addition, the Special Committee was informed and made the Company aware of allegations of possible fraud perpetrated against the Company and violations of the Companys Code of Conduct and Ethics (Policy). The allegations of
possible fraud and violations of the Policy involve payments from a reseller to certain non-management employees (whose employment has since been terminated) and other potentially inappropriate commercial relationships between non-management
employees and a reseller. As of September 30, 2008, the Company had approximately $0.8 million in accounts receivable that may be associated with such possible fraud and violations of the Policy. We have incurred expenses related to the SEC
inquiry of approximately $0.2 million and $2.3 million for the three and nine months ended September 30, 2008, respectively.

Critical Accounting
Policies and Estimates

There have been no significant changes to our critical accounting policies and estimates during the nine months
ended September 30, 2008, as compared to the previous disclosures in managements discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K, filed with the Securities and Exchange
Commission on March 14, 2008.



19



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##### Table of Contents

Results of Operations

Comparison of Three Months Ended September 30, 2008 and 2007

Revenues (amount in thousands).



|                               |  |                                  |        |                           |      |        |        |   |                           |  |     |                         |  |   |        |   |  |     |   
|------------------------------ |  | -------------------------------- | ------ | ------------------------- | ---- | ------ | ------ | - | ------------------------- |  | --- | ----------------------- |  | - | ------ | - |  | --- | --
|                               |  | Three Months Ended September 30, |        |                           |      |        |        |   |                          
|                               |  | 2008                             |        |                           | 2007 |        |        |   |                          
|                               |  | Amount                           |        | Percentageof TotalRevenue |      |        | Amount |   | Percentageof TotalRevenue |  |     | Period-to-Period Change | 
|                               |  |                                  |        |                           |     
|                               |  |                                  |        |                           |      | Amount |        |   | Percentage                | 
|Revenue:                       |  |                                  |        |                           |      |        |        |   |                           |  |     |                         |  |   |        |   |  |     |   
|IP Products                    |  | $                                | 15,080 |                           | 66   | %      |        | $ | 19,409                    |  | 60  | %                       |  | $ | (4,329 | ) |  | (22 | )%
|DCME Products                  |  |                                  | 2,215  |                           | 10   |        |        |   | 6,485                     |  | 20  |                         |  |   | (4,270 | ) |  | (66 | ) 
|Services                       |  |                                  | 5,660  |                           | 24   |        |        |   | 6,269                     |  | 20  |                         |  |   | (609   | ) |  | (10 | ) 
|                               |  |                                  |        |                           |      |        |        |   |                           |  |     |                         |  |   |        |   |  |     |   
|Total revenues                 |  | $                                | 22,955 |                           | 100  | %      |        | $ | 32,163                    |  | 100 | %                       |  | $ | (9,208 | ) |  | (29 | )%
|                               |  |                                  |        |                           |      |        |        |   |                           |  |     |                         |  |   |        |   |  |     |   
|Revenue by Geography:          |  |                                  |        |                           |      |        |        |   |                           |  |     |                         |  |   |        |   |  |     |   
|Europe, Middle East and Africa |  | $                                | 14,996 |                           | 66   | %      |        | $ | 13,309                    |  | 41  | %                       |  | $ | 1,687  |   |  | 13  | % 
|North America                  |  |                                  | 4,345  |                           | 19   |        |        |   | 10,889                    |  | 34  |                         |  |   | (6,544 | ) |  | (60 | ) 
|Asia Pacific and India         |  |                                  | 2,368  |                           | 10   |        |        |   | 5,755                     |  | 18  |                         |  |   | (3,387 | ) |  | (59 | ) 
|Caribbean and Latin America    |  |                                  | 1,246  |                           | 5    |        |        |   | 2,210                     |  | 7   |                         |  |   | (964   | ) |  | (44 | ) 
|                               |  |                                  |        |                           |      |        |        |   |                           |  |     |                         |  |   |        |   |  |     |   
|Total revenues                 |  | $                                | 22,955 |                           | 100  | %      |        | $ | 32,163                    |  | 100 | %                       |  | $ | (9,208 | ) |  | (29 | )%
|                               |  |                                  |        |                           |      |        |        |   |                           |  |     |                         |  |   |        |   |  |     |   

The decrease in revenues resulted from a decrease in IP product revenues of $4.3 million and a
decrease in DCME product revenues of $4.3 million.

The decrease in IP product revenues was the result of lower bookings earlier in 2008
and fewer projects being completed and accepted in the third quarter of 2008 than in the same period of 2007. While our third quarter bookings increased compared to previous quarters in 2008 and revenue increased 22% compared to our second quarter
of 2008, the bookings did not always result in revenues in the current quarter. Revenue was unfavorably impacted in the current quarter of 2008 by the timing and amount of bookings in prior quarters. The timing and amount of bookings is affected by
a number of factors, including a delay in the number of deals in the Asia Pacific region due to headcount turnover related to the SEC Inquiry, the increased slowdown in capital spending in some regions that have placed orders in the past and
increased competition in some regions, particularly in the Asia Pacific region. We expect that IP product revenues as a percentage of total revenues will continue to increase in future periods and the DCME product revenues will continue to decline,
as the telecommunications industry recovers from its economic decline.

The decrease in DCME product revenues was the result of the
expected decline in the size of the overall DCME market and we expect the decline to continue over the foreseeable future as customers migrate from traditional voice networks including DCME products to IP products. At this late stage of the product
life cycle of this legacy product, the rate of decline of DCME product revenues will vary from quarter to quarter. We still expect our DCME product sales to continue to decline over time, while there will be some periods where the DCME sales could
be higher or lower than our expectations.

Services revenues decreased 10% year over year. Our IP services revenues increased to $4.8
million in the three months ended September 30, 2008 from $4.7 million in the three months ended September 30, 2007 due to recognition of previously deferred revenue for deployments, for both professional services and support and
maintenance. This increase in IP services revenue was offset by a decrease in DCME services revenues to $0.9 million from $1.6 million in the three months ended September 30, 2008 and 2007, respectively. Over time we expect DCME services
revenues to decrease as new DCME implementations continue to decrease and customers migrate to next generation networks.

Revenue by
Geography

The decrease in revenues of $9.2 million resulted from a decrease in sales to the North America, Asia Pacific and India and
Caribbean and Latin America regions, offset by an increase of $1.7 million in revenues resulting from an increase in sales to the Europe, Middle East and Africa region. We had significant turnover of our sales employees in the Asia Pacific region in
the third quarter of 2008 that resulted in lower revenues in the region. Revenue recognized in the North America region for the third quarter of 2007 included more revenue arrangements recognized for initial ControlSwitch implementations compared to
the third quarter of 2008. During the three months ended September 30, 2008, revenues were 19% from North America and 81% international as compared to 34% from North America and 66% international during the three months ended September 30,
2007. The geographic mix of revenues will vary significantly on a quarterly basis, primarily depending on the timing of the completion of projects.



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##### Table of Contents

Cost of Revenues and Gross Profit (amount in thousands).



|                       |  |                                  |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|---------------------- |  | -------------------------------- | ------ | ------------------------- | ---- | ------ | ------ | - | ------------------------- |  | -- | ----------------------- |  | - | ------ | - |  | --- | --
|                       |  | Three Months Ended September 30, |        |                           |      |        |        |   |                          
|                       |  | 2008                             |        |                           | 2007 |        |        |   |                           |  |    |                        
|                       |  | Amount                           |        | Percentageof TotalRevenue |      |        | Amount |   | Percentageof TotalRevenue |  |    | Period-to-Period Change | 
|                       |  |                                  |        |                           |      | Amount |        |   | Percentage                | 
|Cost of Revenues:      |  |                                  |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|IP Products            |  | $                                | 5,344  |                           | 35   | %      |        | $ | 9,792                     |  | 50 | %                       |  | $ | (4,448 | ) |  | (45 | )%
|DCME Products          |  |                                  | 878    |                           | 40   | %      |        |   | 2,355                     |  | 36 | %                       |  |   | (1,477 | ) |  | (63 | )%
|Services               |  |                                  | 3,148  |                           | 56   | %      |        |   | 3,067                     |  | 49 | %                       |  |   | 81     |   |  | 3   | % 
|                       |  |                                  |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|Total cost of revenues |  | $                                | 9,370  |                           | 41   | %      |        |   | 15,214                    |  | 47 | %                       |  | $ | (5,844 | ) |  | (38 | )%
|                       |  |                                  |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|Gross Profit:          |  |                                  |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|IP Products            |  | $                                | 9,736  |                           | 65   | %      |        | $ | 9,617                     |  | 50 | %                       |  | $ | 119    |   |  | 1   | % 
|DCME Products          |  |                                  | 1,337  |                           | 60   | %      |        |   | 4,130                     |  | 64 | %                       |  |   | (2,793 | ) |  | (68 | )%
|Services               |  |                                  | 2,512  |                           | 44   | %      |        |   | 3,202                     |  | 51 | %                       |  |   | (690   | ) |  | (22 | )%
|                       |  |                                  |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|Total gross profit     |  | $                                | 13,585 |                           | 59   | %      |        | $ | 16,949                    |  | 53 | %                       |  | $ | (3,364 | ) |  | (20 | )%
|                       |  |                                  |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   

Cost of Revenues.The decrease in sales of IP and DCME products resulted in a commensurate
decrease in related cost of revenues. Although overall cost of revenues decreased as a result of the decrease in revenues, we continued to incur the same fixed overhead costs.

Cost of IP product revenues decreased by 45% resulting from a 22% decrease in IP product revenues. Cost of DCME product revenues decreased by 63%, which
corresponds to a 66% decrease in DCME product revenues.

The cost of services revenues was relatively flat with the same period of 2007.
The cost of services revenues decreased on a sequential quarter basis from the second quarter of 2008 due to the restructuring activities in the third quarter. We expect cost of service revenues to decrease during the fourth quarter of 2008, on an
absolute basis, as well as decrease as a percentage of total revenues, as we realize the full quarter worth of cost savings due to restructuring.

Gross Profit.Gross profit decreased by $3.4 million, to $13.6 million during the third quarter of 2008. Despite a decrease in IP product revenues of $4.3 million, IP product gross profit was flat from $9.7 million for the three
months ended September 30, 2008 from $9.6 million in the three months ended September 30, 2007, resulting in an increase of $0.1 million or 1%. DCME product gross profit decreased to $1.3 million for the three months ended
September 30, 2008 from $4.1 million in the three months ended September 30, 2007, a decrease of $2.8 million or 68%, which corresponds to a 66% decrease in DCME product revenues. Services gross profit decreased to $2.5 million for the
three months ended September 30, 2008 from $3.2 million in the three months ended September 30, 2007, a decrease of $0.7 million or 22%, which was due to lower service revenues and lower services margin.

Gross Margin.Gross margin, which is gross profit as a percentage of revenue, increased to 59% from 53% for the three months ended
September 30, 2008 and 2007, respectively. This increase is primarily attributable to the mix of revenues related to higher margin expansion projects with existing customers along with better contract pricing.

Overall IP product gross margin may fluctuate on a sequential quarter over quarter basis due to changes in the IP product mix and the timing of the
recognition of revenue and the associated costs. Typically, IP product revenues from expansion sales will have higher gross margins than revenues from initial VoIP solution deployments.

We expect that DCME product gross margins will increase from the current quarter and remain relatively consistent with the most recent year because we
anticipate continuing to pay a fixed percentage of sales for manufacturing costs.

The decrease in services gross margin in the third
quarter of 2008 compared to the same period of 2007, was attributable to the individual service engagement requirements and the timing of the services expenses which may not be in the same period as when the services revenues are recognized. We
expect our services margins to marginally improve during the fourth quarter of 2008 due to our restructuring initiated in the third quarter of 2008.



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##### Table of Contents

Operating Expenses (amount in thousands).



|                              |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|----------------------------- |  | ------------------------------- | ------ | ------------------------- | ---- | ------ | ------ | - | ------------------------- |  | -- | ----------------------- |  | - | ------ | - |  | --- | --
|                              |  | Three Months Ended September 30 |        |                           |      |        |        |   |                          
|                              |  | 2008                            |        |                           | 2007 |        |        |   |                           |  |    |                        
|                              |  | Amount                          |        | Percentageof TotalRevenue |      |        | Amount |   | Percentageof TotalRevenue |  |    | Period-to-Period Change | 
|                              |  |                                 |        |                           |      | Amount |        |   | Percentage                | 
|Research and development, net |  | $                               | 5,612  |                           | 24   | %      |        | $ | 7,571                     |  | 24 | %                       |  | $ | (1,959 | ) |  | (26 | )%
|Sales and marketing           |  |                                 | 8,158  |                           | 36   | %      |        |   | 7,017                     |  | 22 | %                       |  |   | 1,141  |   |  | 16  | % 
|General and administrative    |  |                                 | 3,528  |                           | 15   | %      |        |   | 2,361                     |  | 7  | %                       |  |   | 1,167  |   |  | 49  | % 
|Restructuring charges         |  |                                 | 794    |                           | 3    | %      |        |   |                          |  |   | %                       |  |   | 794    |   |  |    | % 
|                              |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|Total operating expenses      |  | $                               | 18,092 |                           | 79   | %      |        | $ | 16,949                    |  | 53 | %                       |  | $ | 1,143  |   |  | 7   | % 
|                              |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   

Research and development expenses, net.Research and development expenses consist primarily
of salaries and related compensation for our engineering personnel responsible for design, development, testing and certification of our products. Our research and development efforts have been partially financed through grants from the Office of
the Chief Scientist of the Israel Ministry of Industry and Trade (OCS). We record grants received from the OCS as a reduction of research and development expenses. Research and development expenses, net of grants received from the OCS, decreased to
$5.6 million for the three months ended September 30, 2008 from $7.6 million in the three months ended September 30, 2007. Grants received from the OCS were $0.6 million in the three months ended September 30, 2008 and $0.4 million in
the three months ended September 30, 2007. The decrease in research and development expenses was primarily due to a $1.1 million decrease in salary and related costs, a decrease in outside professional services of $0.5 million, decrease in
allocations of $0.1 million and travel and facilities costs of $0.1 million and an increase in grants received from the OCS of $0.2 million, offset by an increase in stock based compensation of $0.2 million. A large portion of the decrease in salary
and related costs can be attributed to the restructuring which occurred early in the third quarter of 2008.

Research and development
expenses, net, remained at 24% of total revenues in the three months ended September 30, 2008 and 2007, respectively. We expect research and development expenses to decrease during the fourth quarter of 2008, primarily due to our restructuring
initiative, as a result of decreased headcount.

Sales and marketing expenses.Sales and marketing expenses consist primarily of
salaries and related compensation for our personnel, as well as marketing expenses, including attendance at trade shows, participation in trade associations and promotional activities. Sales and marketing expenses increased to $8.2 million for the
three months ended September 30, 2008 from $7.0 million in the three months ended September 30, 2007. Within sales and marketing expenses, we saw an increase in salaries and related compensation of $0.9 million, including the expense of
$0.5 million for employment related taxes. The $0.5 million represents the amount of an error that was made in prior years that we are correcting in the current quarter as it is not considered material to the estimated full fiscal year results. In
addition, we had increased costs of consultants and other third party services of $0.3 million and stock based compensation of $0.1 million, offset by a $0.2 million decrease in agent commissions.

Sales and marketing expenses were 36% and 22% of total revenues in the three months ended September 30, 2008 and 2007, respectively. We expect sales
and marketing expenses to increase on an absolute basis due to increased sales commissions expense resulting from increased sales as well as higher commissions being paid to certain sales persons as we approach the end of the sales compensation plan
year. However, other sales and marketing expenses will be impacted by sales arrangements which may include agent commissions and related expenses that will depend on the individual contract.

General and administrative expenses.General and administrative expenses consist primarily of salaries and related compensation costs for our
executive management, finance personnel, legal and professional services, travel and related expenses, insurance and other overhead costs. General and administrative expenses increased to $3.5 million for the three months ended September 30,
2008 from $2.4 million in the three months ended September 30, 2007. The increase in general and administrative expenses was primarily related to an additional allowance for doubtful accounts of $0.6 million, increases in salaries and related
compensation, including stock based compensation of $0.4 million, and additional costs related to the SEC inquiry of approximately $0.2 million.

General and administrative expenses were 15% and 7% of total revenues in the three months ended September 30, 2008 and 2007, respectively. We expect expenses and costs associated with our general and administrative functions to
decrease on an absolute basis, and to decrease as a percentage of total revenues. We do expect to incur some additional costs related to the SEC inquiry in the near term, but not to the extent that we experienced in the third and second quarters of
2008.



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##### Table of Contents

Restructuring charges. On July 31, 2008, we announced that we planned to reduce our workforce
by approximately 160 employees and contractors and consolidate certain operations across all organizations, primarily in the areas of research and development and services. These activities consist of severance costs, equipment write-downs and
facilities consolidation. Costs associated with restructuring activities, other than those activities related to business combinations, are accounted for in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, (SFAS 146).

Restructuring activity for the three months ended September 30, 2008 was as follows (in thousands):



|                                 |  |                                                |      |   |                                   |   |     |                                                       |  |   |       |   |  |   |      |  
|-------------------------------- |  | ---------------------------------------------- | ---- | - | --------------------------------- | - | --- | ----------------------------------------------------- |  | - | ----- | - |  | - | ---- | -
|                                 |  | EmployeeTermination/Serverace andRelated Costs |      |   | FacilityShutdown andConsolidation |   |     | Impairment ofFixed Assets orLoss on disposalof Assets |  |   | Total |  
|Balance at June 30, 2008         |  | $                                              |     |   |                                   | $ |    |                                                       |  | $ |      |   |  | $ |     |  
|Charges to operations            |  |                                                | 509  |   |                                   |   | 248 |                                                       |  |   | 37    |   |  |   | 794  |  
|Payments made during the quarter |  |                                                | (487 | ) |                                   |   | (10 | )                                                     |  |   |      |   |  |   | (497 | )
|Impairment of assets             |  |                                                |     |   |                                   |   |    |                                                       |  |   | (37   | ) |  |   | (37  | )
|                                 |  |                                                |      |   |                                   |   |     |                                                       |  |   |       |   |  |   |      |  
|Balance at September 30, 2008    |  | $                                              | 22   |   |                                   | $ | 238 |                                                       |  | $ |      |   |  | $ | 260  |  
|                                 |  |                                                |      |   |                                   |   |     |                                                       |  |   |       |   |  |   |      |  

The $0.3 million restructuring accrual as of September 30, 2008, is included as a component
of our current accrued expenses on the Unaudited Condensed Consolidated Balance Sheets and is expected to be settled by December 31, 2008.

Other income (expense), net.Other income (expense), net consists primarily of interest income earned on cash and cash equivalents, foreign currency exchange gains (losses) and collection fees offset by interest expense and bank
charges. Other income (expense), net, was a net expense of $1.1 million in the three months ended September 30, 2008, as compared with a net income of $0.5 million in the three months ended September 30, 2007. The decrease was primarily
due to an increase in foreign currency exchange losses on certain balance sheet items that are denominated in foreign currency, as well as by a decrease in interest income, resulting from lower cash and cash equivalents balances due to significant
use of cash for normal operating activities.

Provision (benefit) for income taxes. Income taxes provided a benefit of $0.2 million
in the three months ended September 30, 2008 compared to a provision of $0.2 million in the three months ended September 30, 2007. The income tax benefit in the three months ended September 30, 2008, was primarily attributable to our
loss on operations in Israel. We believe that the related deferred tax asset will be realized. The income tax provision in the three months ended September 30, 2007 was attributable to our profitable foreign operations, primarily in Israel, for
income generated on sales of products not covered under the Approved Enterprise status in Israel.

Net income (loss).Net loss was
$5.4 million for the three months ended September 30, 2008 as compared to a net income of $0.3 million in the three months ended September 30, 2007. The increase in net loss was mainly attributable to the decrease in gross profit of $3.4
million as compared to the three months ended September 30, 2007 and an increase in operating expenses by $1.1 million partly related to restructuring charges.



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##### Table of Contents

Comparison of Nine Months Ended September 30, 2008 and 2007

Revenues (amount in thousands).



|                               |  |                                 |        |                           |      |        |        |   |                           |  |     |                         |  |   |         |   |  |     |   
|------------------------------ |  | ------------------------------- | ------ | ------------------------- | ---- | ------ | ------ | - | ------------------------- |  | --- | ----------------------- |  | - | ------- | - |  | --- | --
|                               |  | Nine Months Ended September 30, |        |                           |      |        |        |   |                          
|                               |  | 2008                            |        |                           | 2007 |        |        |   |                           |  |     |                        
|                               |  | Amount                          |        | Percentageof TotalRevenue |      |        | Amount |   | Percentageof TotalRevenue |  |     | Period-to-Period Change | 
|                               |  |                                 |        |                           |      | Amount |        |   | Percentage                | 
|Revenues:                      |  |                                 |        |                           |      |        |        |   |                           |  |     |                         |  |   |         |   |  |     |   
|IP Products                    |  | $                               | 45,520 |                           | 68   | %      |        | $ | 58,428                    |  | 64  | %                       |  | $ | (12,908 | ) |  | (22 | )%
|DCME Products                  |  |                                 | 5,030  |                           | 7    |        |        |   | 16,115                    |  | 18  |                         |  |   | (11,085 | ) |  | (69 | )%
|Services                       |  |                                 | 16,556 |                           | 25   |        |        |   | 16,223                    |  | 18  |                         |  |   | 333     |   |  | 2   | % 
|                               |  |                                 |        |                           |      |        |        |   |                           |  |     |                         |  |   |         |   |  |     |   
|Total revenues                 |  | $                               | 67,106 |                           | 100  | %      |        | $ | 90,766                    |  | 100 | %                       |  | $ | (23,660 | ) |  | (26 | )%
|                               |  |                                 |        |                           |      |        |        |   |                           |  |     |                         |  |   |         |   |  |     |   
|Revenue by Geography:          |  |                                 |        |                           |      |        |        |   |                           |  |     |                         |  |   |         |   |  |     |   
|Europe, Middle East and Africa |  | $                               | 38,310 |                           | 57   | %      |        | $ | 43,802                    |  | 48  | %                       |  | $ | (5,492  | ) |  | (13 | )%
|North America                  |  |                                 | 12,300 |                           | 18   |        |        |   | 24,707                    |  | 27  |                         |  |   | (12,407 | ) |  | (50 | )%
|Asia Pacific and India         |  |                                 | 9,521  |                           | 14   |        |        |   | 14,314                    |  | 16  |                         |  |   | (4,793  | ) |  | (33 | )%
|Caribbean and Latin America    |  |                                 | 6,975  |                           | 10   |        |        |   | 7,893                     |  | 9   |                         |  |   | (918    | ) |  | (12 | )%
|                               |  |                                 |        |                           |      |        |        |   |                           |  |     |                         |  |   |         |   |  |     |   
|Total revenues                 |  | $                               | 67,106 |                           | 100  | %      |        | $ | 90,716                    |  | 100 | %                       |  | $ | (23,610 | ) |  | (26 | )%
|                               |  |                                 |        |                           |      |        |        |   |                           |  |     |                         |  |   |         |   |  |     |   

The decrease in revenues resulted from a decrease in IP product revenues of $12.9 million and a
$11.1 million decline in DCME product revenues, offset by an increase in services revenues of $0.3 million.

The decrease in IP product
revenues was the result of the timing of bookings in 2008 and in prior quarters of 2007 as well as fewer projects being completed and accepted in the nine months, offset by recognition of revenues for new VoIP solution deployments and revenue
recognized from deals that had been booked in previous periods which had been reflected as deferred revenue on the consolidated balance sheet as of December 31, 2007. Revenue was unfavorably impacted by timing and amount of bookings in the
current quarter and in the prior quarters. The timing and amount of bookings is affected by a number of factors, including a delay in orders that we expected to close, the increased slowdown in capital spending in some regions that have placed
orders in the past and increased competition in some regions, particularly in the Asia Pacific region. We expect that IP product revenues as a percentage of total revenues will continue to increase in future periods as the DCME product revenues
continue to decline, and as the telecommunications industry recovers from its economic decline.

The decrease in DCME product revenues was
the result of the expected decline in the size of the overall DCME market and we expect the decline to continue over the foreseeable future as customers migrate from traditional voice networks including DCME products to IP products. At this late
stage of the product life cycle of this legacy product, the rate of decline of DCME product revenues will vary from quarter to quarter. We still expect our DCME product sales to continue to decline over time, while there will be some periods where
the DCME sales could be higher or lower than our expectations.

Services revenue increased by 2% year over year. The slight increase in
services revenues resulted from recognition of previously deferred revenue for VoIP solution deployment for both professional services and support and maintenance. IP services revenues increased to $13.2 million in the nine months ended
September 30, 2008 from $11.6 million in the nine months ended September 30, 2007. This increase in IP services revenue was primarily offset by DCME services revenues decreasing to $3.3 million from $4.6 million in the nine months ended
September 30, 2008 and 2007, respectively. Over time we expect DCME services revenues to decrease as new DCME implementations continue to decrease and customers migrate to next generation networks.

Revenue by Geography

The decrease in
revenues of $23.6 million resulted from a decrease in sales in all regions, primarily from the North America and the Asia Pacific and India regions, and remaining from Europe, Middle East and Africa and the Caribbean and Latin America regions. We
had significant turnover of our sales employees in the Asia Pacific region in 2008 in the nine months ended September 30, 2008 and this resulted in lower revenues in the region. Revenue recognized in the North America region for the nine months
ended September 30, 2007 included more revenue arrangements recognized for initial ControlSwitch implementations compared to the nine months ended September 30, 2008. During the nine months ended September 30, 2008, revenues were 18% from North
America and 82% international as compared to 27% from North America and 73% international during the nine months ended September 30, 2007. The geographic mix of revenues will vary significantly on a quarterly basis, primarily depending on the
timing of the completion of projects.



24



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##### Table of Contents

Cost of Revenues and Gross Profit (amount in thousands).



|                       |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |         |   |  |     |   
|---------------------- |  | ------------------------------- | ------ | ------------------------- | ---- | ------ | ------ | - | ------------------------- |  | -- | ----------------------- |  | - | ------- | - |  | --- | --
|                       |  | Nine Months Ended September 30, |        |                           |      |        |        |   |                          
|                       |  | 2008                            |        |                           | 2007 |        |        |   |                           |  |    |                        
|                       |  | Amount                          |        | Percentageof TotalRevenue |      |        | Amount |   | Percentageof TotalRevenue |  |    | Period-to-Period Change | 
|                       |  |                                 |        |                           |      | Amount |        |   | Percentage                | 
|Cost of Revenues:      |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |         |   |  |     |   
|IP Products            |  | $                               | 18,527 |                           | 41   | %      |        | $ | 24,625                    |  | 42 | %                       |  | $ | (6,098  | ) |  | (25 | )%
|DCME Products          |  |                                 | 1,958  |                           | 39   | %      |        |   | 5,642                     |  | 35 | %                       |  |   | (3,684  | ) |  | (65 | )%
|Services               |  |                                 | 10,982 |                           | 66   | %      |        |   | 8,820                     |  | 54 | %                       |  |   | 2,162   |   |  | 25  | % 
|                       |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |         |   |  |     |   
|Total cost of revenues |  | $                               | 31,467 |                           | 47   | %      |        | $ | 39,087                    |  | 43 | %                       |  | $ | (7,620  | ) |  | (19 | )%
|                       |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |         |   |  |     |   
|Gross Profit:          |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |         |   |  |     |   
|IP Products            |  | $                               | 26,994 |                           | 59   | %      |        | $ | 33,803                    |  | 58 | %                       |  | $ | (6,809  | ) |  | (20 | )%
|DCME Products          |  |                                 | 3,072  |                           | 61   | %      |        |   | 10,473                    |  | 65 | %                       |  |   | (7,401  | ) |  | (71 | )%
|Services               |  |                                 | 5,573  |                           | 34   | %      |        |   | 7,413                     |  | 46 | %                       |  |   | (1,840  | ) |  | (25 | )%
|                       |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |         |   |  |     |   
|Total gross profit     |  | $                               | 35,639 |                           | 53   | %      |        | $ | 51,689                    |  | 57 | %                       |  | $ | (16,050 | ) |  | (31 | )%
|                       |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |         |   |  |     |   

Cost of Revenues.The decrease in sales of IP and DCME products resulted in a decrease in
related cost of revenues. Although overall cost of revenues decreased as a result of the decrease in revenues, we continued to incur the same fixed overhead costs.

Cost of IP product revenues decreased by 19% resulting from a 25% decrease in IP product revenues. Cost of DCME product revenues decreased by 65%, which corresponds to a 69% decrease in DCME product revenues, offset
by increase in services revenue by 25%.

The increase in cost of services revenues is due to an increase in labor and related expenses,
including stock based compensation, of $1.0 million as a result of an increase in customer support headcount to support new product implementations for our growing customer base, as well as to provide more resources to sell other professional
services. In addition, costs of consultants and other third party services for assistance with product implementations increased by $0.6 million, travel and related expenses increased by $0.3 million, and royalty costs of $0.3 million. We expect
cost of service revenues to decrease during the third quarter of 2008 due to restructuring, and decrease in future periods on an absolute basis, as well as decrease as a percentage of total revenues.

Gross Profit.Gross profit decreased by $16.1 million. IP product gross profit decreased to $27.0 million for the nine months ended
September 30, 2008 from $33.8 million in the nine months ended September 30, 2007, a decrease of $6.8 million or 20%, which was caused by 22% decrease in IP product revenues. DCME product gross profit decreased to $3.1 million for the nine
months ended September 30, 2008 from $10.5 million in the nine months ended September 30, 2007, a decrease of $7.4 million or 71%, which corresponds to a 69% decrease in DCME product revenues. Services gross profit decreased to $5.6
million for the nine months ended September 30, 2008 from $7.4 million in the nine months ended September 30, 2007, a decrease of $1.9 million or 25%, which was due to lower service revenues and lower services margin.

Gross Margin.Gross margin, which is gross profit as a percentage of revenue, decreased to 53% from 57% for the nine months ended
September 30, 2008 and 2007, respectively. This decrease is primarily attributable to increased competition and to the allocation of the same fixed overhead costs to a smaller amount of revenues.

Overall IP product gross margin may fluctuate on a sequential quarter over quarter basis due to changes in the IP product mix and the timing of the
recognition of revenue and the associated costs. Typically, IP product revenues from expansion sales will have higher gross margins than revenues from initial VoIP solution deployments.

We expect that DCME product gross margins will remain relatively consistent with the most recent year because we anticipate continuing to pay a fixed
percentage of sales for manufacturing costs.



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The decrease in services gross margin for the nine months ended September 30, 2008 compared to the same
period of 2007 was attributable to increased competition and our continued investment in our service organization. Additionally, services gross margin will vary due to individual requirements of the services engagements and the timing of the
services expenses, which may not be in the same period as when the services revenues are recognized. We expect our services margins to improve during the fourth quarter of 2008 due to our restructuring initiated in the third quarter of 2008.

Operating Expenses (amount in thousands).



|                              |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|----------------------------- |  | ------------------------------- | ------ | ------------------------- | ---- | ------ | ------ | - | ------------------------- |  | -- | ----------------------- |  | - | ------ | - |  | --- | --
|                              |  | Nine Months Ended September 30, |        |                           |      |        |        |   |                          
|                              |  | 2008                            |        |                           | 2007 |        |        |   |                           |  |    |                        
|                              |  | Amount                          |        | Percentageof TotalRevenue |      |        | Amount |   | Percentageof TotalRevenue |  |    | Period-to-Period Change | 
|                              |  |                                 |        |                           |      | Amount |        |   | Percentage                | 
|Research and development, net |  | $                               | 20,747 |                           | 31   | %      |        | $ | 23,175                    |  | 26 | %                       |  | $ | (2,428 | ) |  | (10 | )%
|Sales and marketing           |  |                                 | 22,957 |                           | 34   | %      |        |   | 19,956                    |  | 22 | %                       |  |   | 3,001  |   |  | 15  | % 
|General and administrative    |  |                                 | 12,155 |                           | 18   | %      |        |   | 7,082                     |  | 8  | %                       |  |   | 5,073  |   |  | 72  | % 
|Restructuring charges         |  |                                 | 794    |                           | 1    | %      |        |   |                          |  |   | %                       |  |   | 794    |   |  |    | % 
|                              |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   
|Total operating expenses      |  | $                               | 56,653 |                           | 84   | %      |        | $ | 50,213                    |  | 55 | %                       |  | $ | 6,440  |   |  | 13  | % 
|                              |  |                                 |        |                           |      |        |        |   |                           |  |    |                         |  |   |        |   |  |     |   

Research and development expenses, net.Research and development expenses consist primarily
of salaries and related compensation for our engineering personnel responsible for design, development, testing and certification of our products. Our research and development efforts have been partially financed through grants from the OCS. We
record grants received from the OCS as a reduction of research and development expenses. Research and development expenses, net of grants received from the OCS, decreased to $20.7 million for the nine months ended September 30, 2008 from $23.2
million in the nine months ended September 30, 2007. Grants received from the OCS were $1.8 million in the nine months ended September 30, 2008 and $1.1 million in the nine months ended September 30, 2007. The decrease in research and
development expenses was primarily due to a decrease in outside professional services of $1.3 million, salaries and related expenses of $0.7 million primarily due to the restructuring in the third quarter of 2008 and decreased headcount throughout
2008 from normal attrition, a decrease in facilities allocations and depreciation of $0.3 million, an increase in grants received from the OCS of $0.7 million, offset by an increase in stock based compensation of $0.6 million.

Research and development expenses, net, were 31% and 26% of total revenues in the nine months ended September 30, 2008 and 2007, respectively. We
expect research and development expenses to decrease during the fourth quarter of 2008, primarily due to our restructuring initiative, which will result in decreased headcount.

Sales and marketing expenses.Sales and marketing expenses consist primarily of salaries and related compensation for our personnel, as well as
marketing expenses, including attendance at trade shows, participation in trade associations and promotional activities. Sales and marketing expenses increased to $23.0 million for the nine months ended September 30, 2008 from $20.0 million in
the nine months ended September 30, 2007. The increase in sales and marketing expenses was primarily due to an increase in salaries and related compensation of $2.1 million for salaries and commissions, including the expense of $0.5 million for
employment related taxes. The $0.5 million represents the amount of an error that was made in prior years that we are correcting in the current quarter as it is not considered material to the estimated full fiscal year results. In addition, we had
increases in travel and related expenses of $0.5 million, cost of consultants and other third party services of $0.8 million, facility and IT related allocations of $0.5 million, recruiting of $0.2 million, and stock based compensation of $0.3
million, offset by a $1.7 million decrease in agent commissions for sales in 2007.

Sales and marketing expenses were 34% and 22% of total
revenues in the nine months ended September 30, 2008 and 2007, respectively. We expect sales and marketing expenses to remain relatively constant on an absolute basis.

General and administrative expenses.General and administrative expenses consist primarily of salaries and related compensation costs for our
executive management, finance personnel, legal and professional services, travel and related expenses, insurance and other overhead costs. General and administrative expenses increased to $12.2 million for the nine months ended September 30,
2008 from $7.1 million in the nine months ended September 30, 2007. The increase in general and administrative expenses was primarily due to an increase in salaries and related compensation, including stock based compensation of $1.2 million,
outside professional services, including audit and tax related costs of $0.8 million, legal expenses of $1.7 million, an additional allowance for doubtful accounts of $1.5 million. Included in the above is the SEC inquiry of approximately $2.3
million, which included additional costs related to legal fees, costs for our independent auditors as well as other consultants.



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General and administrative expenses were 18% and 8% of total revenues in the nine months ended
September 30, 2008 and 2007, respectively. We expect expenses and costs associated with our general and administrative functions to decrease on an absolute basis, and to decrease as a percentage of total revenues. We do expect to incur some
additional costs related to the SEC inquiry, but not to the extent that we experienced in the third and prior quarters of 2008.

Restructuring charges. We recorded restructuring charges of $0.8 million for the nine months ended September 30, 2008. As of September 30, 2008, $0.3 million is recorded as a restructuring accrual in current accrued
expenses on our Unaudited Condensed Consolidated Balance Sheets and is expected to be settled by December 31, 2008.

Other income
(expense), net.Other income (expense), net consists primarily of interest income earned on cash and cash equivalents, foreign currency exchange gains (losses) and collection fees offset by interest expense and bank charges. Other income, net
was $0.2 million in the nine months ended September 30, 2008, as compared with $0.7 million in the nine months ended September 30, 2007. The decrease was primarily due to an increase in foreign currency exchange losses on certain balance
sheet items that are denominated in a foreign currency, as well as lower expenses on the Companys note as more principle has been paid off.

Provision (benefit) for income taxes. Income tax provided a benefit of $0.7 million in the nine months ended September 30, 2008 compared to a provision of $0.8 million in the nine months ended September 30, 2007. The income
tax benefit in the nine months ended September 30, 2008 was primarily attributable to our loss on operations in Israel. We believe that the related deferred tax asset will be realized. The income tax provision in the nine months ended
September 30, 2007 was attributable to our profitable foreign operations, primarily in Israel, for income generated on sales of products not covered under the Approved Enterprise status in Israel.

Net income (loss).Net loss was $20.1 million for the nine months ended September 30, 2008 as compared to a net income of $1.3 million in the
nine months ended September 30, 2007. The increase in net loss was mainly attributable to the decrease in gross profit of $16.1 million as compared to the nine months ended September 30, 2007 and an increase in operating expenses by $6.4
million partially related to the SEC inquiry.

Deemed dividend on Series D convertible preferred stock.Upon the closing of the
initial public offering of our common stock, all shares of convertible preferred stock outstanding automatically converted into shares of common stock. The beneficial conversion feature of the Series D convertible preferred stock resulted in a
deemed dividend in the aggregate amount of approximately $6.0 million. The amount of deemed dividend decreased the net income attributable to common stockholders in the quarter ended September 30, 2007.

Liquidity and Capital Resources

At
September 30, 2008, we had unrestricted cash and cash equivalents and short-term investments of $34.4 million, a decrease from $57.6 million from December 31, 2007. The decrease in cash was primarily due to cash used to fund operations as
a result of the decreased bookings during 2008. Additionally, we had a restructuring initiative in our third quarter of 2008 involving the elimination of approximately 160 of our positions through layoffs from all departments throughout our
organization. Our objective with the restructuring is to reduce our overall cash burn rate, gradually move toward generation of cash from operating activities in 2009 and streamline our operations while maintaining core research and development
capability. We believe that our existing cash, cash equivalents and short-term investments will meet our normal operating and capital expenditure needs for at least the next twelve months. We do not currently maintain any auction rate securities or
mortgage derivative securities.

Operating Activities

Net cash used in our operating activities was $19.7 million and $8.8 million during the nine months ended September 30, 2008 and 2007, respectively.

Net cash used in our operating activities in the nine months ended September 30, 2008 was primarily attributable to our net loss of $20.1 million.
We also had an increase in inventories of $2.9 million, related party transactions of $1.4 million, and decreases in accounts payable, accrued payroll and expenses in the aggregate amount of $11.7 million. The amount of cash used was offset by a
decrease in accounts receivable of $5.9 million, prepaid expenses and other current assets of $1.3 million, and an increase in deferred revenue of $2.9 million. The net cash used in our operating activities were related to our decrease in revenues
and the increase in operating expenses. Further, we incurred non-cash expenses of $2.6 million and $3.3 million of depreciation and stock-based compensation, respectively. Our working capital decreased to $45.9 million as of September 30, 2008,
from $60.7 million as of December 31, 2007.



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Net cash used in our operating activities in the nine months ended September 30, 2007 was primarily
attributable to a decrease in deferred revenue in the amount of $13.4 million and an increase in accounts receivable of $5.1 million, net of receivables sold during the period in the total amount of $11.1 million. We also had an increase in prepaid
expenses and other current assets, and decreases in accrued expenses and in the net amount due to related parties in the aggregate amount of $4.3 million. The amount of cash used was offset by a decrease in inventories and an increase in accounts
payable in the aggregate amount of $8.0 million. These were all related to sales growth and expanded operations. In addition, we incurred $2.8 million and $1.6 million of depreciation and stock-based compensation, respectively, which are non-cash
expenses. Our working capital increased to $58.0 million as of September 30, 2007, from $7.6 million as of December 31, 2006.

Investing
Activities

Net cash used in our investing activities was $0.8 million during the nine months ended September 30, 2008. Net
cash used in our investing activities was $8.7 million during the nine months ended September 30, 2007.

Investing activities in the
nine months ended September 30, 2008 consisted primarily of net purchases of short-term investments of $8.8 million as well as purchases of property and equipment of $1.6 million, offset by sales and maturities of short-term investments of $9.6
million.

Investing activities in the nine months ended September 30, 2007 consisted primarily of net purchases of short-term
investments of $6.2 million and of property and equipment of $2.5 million.

Financing Activities

Net cash used in our financing activities was $2.1 million for the nine months ended September 30, 2008. Net cash provided by our financing
activities was $51.1 million during the nine months ended September 30, 2007.

Net cash used in our financing activities in the nine
months ended September 30, 2008 was due to repayments of a loan in the amount of $2.7 million offset by proceeds received from the exercise of stock options in the amount of $0.6 million.

Net cash provided by our financing activities in the nine months ended September 30, 2007 primarily consisted of proceeds from the initial public
offering of our common stock in the amount of $54.0 million, offset by cash paid related to offering costs in the amount of $5.8 million, and to a lesser extent of net proceeds from the second closing of our Series D convertible preferred stock
financing in the amount of $3.4 million and of proceeds received from the exercise of stock options in the amount of $0.4 million. In addition, during the period we repaid our loan payable in the amount of $0.8 million.

Off-Balance Sheet Arrangements

At September 30,
2008, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited purposes.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

Foreign Currency Risk

Nearly all of our revenue, costs and expenses, including subcontractor manufacturing expenses,
are denominated in U.S. dollars. However, we do maintain sales and business operations in foreign countries, and part of our revenue is derived from customers in foreign countries. As such, we have exposure to adverse changes in exchange rates
associated with operating expenses, including personnel, facilities and other expenses, of our foreign operations and sales to our customers. If the exchange rate between the U.S. dollar and the New Israeli Shekel would fluctuate by 10% our
operating expenses would have increased or decreased by approximately $1.5 million in 2007. During the nine months ended September 30, 2008, we estimate that our operating expenses increased by $1.7 million due to unfavorable foreign exchange
movements related to U.S. dollar versus New Israeli Shekel. Additionally, we are impacted by assets or liabilities that are denominated in a currency other a subsidiarys functional currency. Our intercompany short-term loan with our Brazilian
subsidiary is denominated in U.S. dollars, while the Brazilian subsidiarys functional currency is the Brazilian Real. The impact of the change in the foreign exchange rate between the US dollar and the Brazilian Real resulted in the increase
in the value of the intercompany loan in US dollars as compared to December 31, 2007 of approximately $0.4 million at September 30, 2008. The change is recorded in other income (expenses) in the Unaudited Consolidated Statements of
Operations.



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Interest Rate Sensitivity

We had cash, cash equivalents, restricted cash, and short-term investments totaling $34.4 million at September 30, 2008. These amounts were invested primarily in commercial paper and money market funds. The
unrestricted cash and cash equivalents are held for working capital purposes. We do not enter into investments for trading or speculative purposes. Due to the short-term nature of these investments, we do not believe that a 10% change in interest
rates would have a material impact on our financial position and results of operations. However, declines in interest rates and cash balances will reduce future investment income.

As of September 30, 2008, we had $0.6 million of debt outstanding, which will be fully paid as of the end of fourth quarter of 2008. Our loan
agreement provides for a stated fixed interest rate of 9.78%.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

Limitations of Disclosure Controls and
Procedures and Internal Control Over Financial Reporting

Our management, including our Chief Executive Officer and Chief Financial
Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

Disclosure Controls and Procedures

We maintain
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, or the Exchange Act) that are designed to provide reasonable assurance that the information required to be disclosed in the
reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated
to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Our management evaluated (with the participation of our Chief Executive Officer and Chief Financial Officer) our disclosure controls and procedures, and concluded that our disclosure controls and procedures were
effective as of September 30, 2008, to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2008 that have materially
affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION



|ITEM 1A. | RISK FACTORS
|-------- | ------------

The risk factors set forth below
include any material changes to, and supersede the description of, the risk factors disclosed in Item 1A of our Annual Report on Form 10-K.



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We commenced a restructuring initiative during the third quarter of 2008 to streamline our operations and to reduce
our overall cash burn rate. The restructuring may impact our ability to execute our business plan and may not achieve the sought after cash reductions.

During the nine months ended September 30, 2008, we used $19.7 million to fund our operating activities and we have never generated sufficient cash to fund our operations. Accordingly, during the third quarter of 2008
we commenced a significant restructuring initiative involving the elimination of approximately 160 positions through layoffs from all departments throughout our organization, but primarily in the research and development and services organizations
and in our India operations. The objective of the restructuring is to reduce our overall cash burn rate and streamline our operations while maintaining core research and development capability. There can be no assurance that we will be able to
reduce spending as planned or that unanticipated costs will not occur. Our restructuring efforts to focus on key products may not prove successful due to a variety of factors, including, without limitation, risks that a smaller workforce may have
difficulty successfully completing research and development efforts and adequately monitoring our development and commercialization efforts. In addition, we may, in the future, decide to restructure operations and reduce expenses further by taking
such measures as additional reductions in our workforce and reductions in other spending. Any restructuring places a substantial strain on remaining management and employees and on operational resources and there is a risk that our business will be
adversely affected by the diversion of management time to the restructuring efforts. There can be no assurance that following this restructuring, we will have sufficient cash resources to allow us to fund our operations as planned.

We received a letter regarding a confidential informal inquiry by the SEC, or SEC Inquiry, and cooperation with such governmental inquiry has and will continue to
cost significant amounts of money and management resources and may result in charges filed against us and in fines or penalties.

On
April 3, 2008, we received a letter from the SEC informing us that the SEC is conducting an a confidential informal inquiry into the Company. In response to the inquiry, our Board of Directors appointed a special investigation committee
composed of independent directors to cooperate with the SEC in connection with such inquiry and to perform our own investigation of the matters surrounding the inquiry. The special investigation committee, in turn, retained independent legal counsel
to perform an internal investigation. We have incurred, and continue to incur, significant costs related to the governmental inquiry, which had a material adverse effect on our financial condition and results of operations in the second quarter and
may, in future quarters, also have a material adverse effect on our financial condition and results of operations. Further, the governmental inquiry has caused and may continue to cause, a diversion of our managements time and attention which
could also have a material adverse effect on our financial condition and results of operations.

As a result of the SEC inquiry, criminal
or civil charges could be filed against us and we could be required to pay significant fines or penalties in connection with the governmental inquiry or other governmental investigations. Any criminal or civil charges by the SEC or other
governmental agency or any fines or penalties imposed by the SEC could materially harm our business, results of operations, financial position and cash flows.

We have not been in compliance with SEC reporting requirements and may continue to face compliance issues with such regulatory bodies. If we are unable to remain in compliance with SEC reporting requirements and NASDAQ listing
requirements our business will be harmed.

Due to the SEC Inquiry, we were unable to file our periodic report on Form 10-Q for the
period ending March 31, 2008 with the SEC on a timely basis. As a result of our failure to file our periodic report on a timely basis, we will not be eligible to use a registration statement on Form S-3 to register offers and sales of our
securities until all periodic reports have been timely filed for at least 12 months.

If we fail to continue to comply with the listing requirements
of NASDAQ, the price of our common stock and our ability to access the capital markets could be negatively impacted.

Our common
stock is currently listed on the NASDAQ. Our stock has traded below $1.00 per share over the last six months. The listing standards of the NASDAQ provide,among other things, that a company may be delisted if the bid price of its stock
drops below $1.00 for a period of 30 consecutive business days. Although the NASDAQ has temporarily suspended the bid price rules until January 16, 2009, our stock may continue to trade below $1.00 per share following the suspension.
Announcements by us of potential or pending NASDAQ delisting actions could further depress our stock price and market value and our stock price will need to trade above $1.00 on a sustained basis to remain listed. If our stock price trades below
$1.00 for a sustained period, we may seek to implement a reverse stock split. Reverse stock splits frequently result in a loss in stockholder value as the actual post-split price is often lower than the pre-split price, adjusted for the split. If we
fail to comply with the listing standards, our common stock may be delisted and traded on the over-the-counter bulletin board network. Moving our listing off the NASDAQ could adversely affect the liquidity of our common stock and the delisting of
our common stock would significantly affect the ability of investors to trade our securities and could significantly negatively affect the value and liquidity of our common stock. In addition, the delisting of our common stock could adversely affect
our ability to raise capital on terms acceptable to us or at all. Delisting from NASDAQ could



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also have other negative results, including the potential loss of confidence by suppliers and employees, the loss of institutional investor interest and
fewer business development opportunities. In addition, we would be subject to a number of restrictions regarding the registration and qualification of our common stock under federal and state securities laws.

Difficult conditions in the domestic and international economies generally may materially adversely affect our business and results of operations and we do not
expect these conditions to improve in the near future.

Declining business and consumer confidence and increased unemployment have
resulted in a economic slowdown and fears of a recession. Continuing market upheavals may have an adverse affect on us because we are dependent on capital budgets and confidence of our customers. Our revenues are likely to decline in such
circumstances. Factors such as business investment, the volatility and strength of the capital markets all affect the business and economic environment and, ultimately, the amount and profitability of our business. In an economic slowdown
characterized by higher unemployment, lower family income, lower corporate earnings, lower business investment and lower consumer spending, the demand for our products could be adversely affected. Adverse changes in the economy could affect earnings
negatively and could have a material adverse effect on our business, results of operations and financial condition.

The demand for our solutions
depends in large part on continued capital spending in the telecommunications equipment industry. A decline in demand, or a decrease or delay in capital spending by service providers, could have a material adverse effect on our results of
operations. Recent turmoil in the worlds credit markets may have an adverse impact on the capital spending in the markets we serve and, as a result, could have a material adverse effect on our business and our results of operations.

We are exposed to the risks associated with the volatility of the United States and global economies. In October 2008, the global financial
markets experienced significant losses due to failures of many financial institutions. The governments of the United States and several foreign countries instituted a bailout plan to assist many financial institutions through the economic crisis.
This crisis results in decreased visibility regarding whether or when there will be sustained growth periods for sales of our products and uncertainty regarding the amount of sales, since our customers may rely on lending arrangements and/or have
limited resources to finance capital technology expenditures. In addition, it is expected that this crisis and economic uncertainty will result in decreased consumer spending, which will likely reduce the need for our products from customers. Slow
or negative growth in the global economy may continue to materially and adversely affect our business, financial condition and results of operations for the foreseeable future. Our results of operations would be further adversely affected if we were
to experience lower-than-anticipated order levels, cancellations of orders in backlog, extended customer delivery requirements or pricing pressure as a result of the slowdown.

In addition to the potential decline in capital spending resulting from the volatility in the capital markets, capital spending in the telecommunications
equipment industry has in the past, and may in the future, fluctuate significantly based on numerous factors, including:



| |  |  | capital spending levels of service providers;
| | - |  | ---------------------------------------------



| |  |  | competition among service providers;
| | - |  | ------------------------------------



| |  |  | pricing pressures in the telecommunications equipment market;
| | - |  | -------------------------------------------------------------



| |  |  | end user demand for new services;
| | - |  | ---------------------------------



| |  |  | service providers emphasis on generating revenues from traditional infrastructure instead of migrating to emerging networks and technologies;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | lack of or evolving industry standards;
| | - |  | ---------------------------------------



| |  |  | consolidation in the telecommunications industry; and
| | - |  | -----------------------------------------------------



| |  |  | changes in the regulation of communications services.
| | - |  | -----------------------------------------------------

We cannot make assurances of the rate, or extent to which, the telecommunications equipment industry will grow, if at all. Demand for our solutions and our IP products in particular will depend on the magnitude and
timing of capital spending by service providers as they extend and migrate their networks. Furthermore, industry growth rates may not be as forecast, resulting in spending on product development well ahead of market requirements. The
telecommunications equipment industry from time to time has experienced and appears to be currently experiencing a downturn. In response to the current downturn, service providers have slowed



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their capital expenditures, and may also cancel or delay new developments, reduce their workforces and inventories and take a cautious approach to acquiring
new equipment and technologies, which could have a negative impact on our business. A continued downturn in the telecommunications industry may cause our operating results to fluctuate from period to period, which also may increase the volatility of
the price of our common stock and harm our business.

Our success depends in large part on continued migration to an IP network architecture for
interactive communications. If the migration to IP networks does not occur or if it occurs more slowly than we expect, our operating results would be harmed.

Our IP products are used by service providers to deliver premium interactive communications over IP networks. Our success depends on the continued migration of service providers networks to a single IP network
architecture, which depends on a number of factors outside of our control. Among other things, existing networks include switches and other equipment that may have remaining useful lives of twenty or more years and therefore may continue to operate
reliably for a lengthy period of time. Other factors that may delay or speed the migration to IP networks include service providers concerns regarding initial capital outlay requirements, available capacity on legacy networks, competitive and
regulatory issues, and the implementation of an enhanced services business model. As a result, service providers may defer investing in products, such as ours, that are designed to migrate interactive communications to IP networks. If the migration
to IP networks does not occur for these or other reasons, or if it occurs more slowly than we expect, our operating results will be harmed.

We have
not had sustained profits and our losses could continue.

We have experienced significant losses in the past and have not had
sustained profits. For the fiscal years ended December 31, 2005 and 2006, we recorded net losses of approximately $14.3 million and $13.7 million, respectively. For the year ended December 31, 2007, we achieved net income of approximately
$3.4 million. As of December 31, 2007, our accumulated deficit was $56.2 million, and for the nine months ended September 30, 2008, we incurred a net loss of $20.1 million. We have never generated sufficient cash to fund our operations and
can give no assurance that we will generate net income.

We face intense competition from the leading telecommunications networking companies in the
world as well as from emerging companies. If we are unable to compete effectively, we might not be able to achieve sufficient market penetration, revenue growth or profitability.

Competition in the market for our products and especially our IP products is intense. This market has historically been dominated by established telephony
equipment providers, such as Alcatel-Lucent, Ericsson LM Telephone Co., Nortel Networks Corp. and Nokia-Siemens Networks, all of which are our direct competitors. We also face competition from other telecommunications and networking companies,
including Cisco Systems, Inc., Sonus Networks, Inc., and Huawei, some of which have entered our market by acquiring companies that design competing products. Because the market for our products is rapidly evolving, additional competitors with
significant financial resources may enter these markets and further intensify competition.

Many of our current and potential competitors
have significantly greater selling and marketing, technical, manufacturing, financial, governmental and other resources available to them, allowing them to offer a more diversified bundle of products and services. In some cases, our competitors have
undercut the pricing of our products or provided more favorable financing terms, which has made us uncompetitive or forced us to reduce our average selling prices, negatively impacting our margins. Further, some of our competitors sell significant
amounts of other products to our current and prospective customers. In addition, some potential customers when selecting equipment vendors to provide fundamental infrastructure products prefer to purchase from larger, established vendors. Our
competitors broad product portfolios, coupled with already existing relationships, may cause our customers or potential customers to buy our competitors products or harm our ability to attract new customers.

To compete effectively, we must deliver innovative products that:



| |  |  | provide extremely high reliability, compression rates and voice quality;
| | - |  | ------------------------------------------------------------------------



| |  |  | scale and deploy easily and efficiently;
| | - |  | ----------------------------------------



| |  |  | interoperate with existing network designs and other vendors equipment;
| | - |  | ------------------------------------------------------------------------



| |  |  | support existing and emerging industry, national and international standards;
| | - |  | -----------------------------------------------------------------------------



| |  |  | provide effective network management;
| | - |  | -------------------------------------



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| |  |  | are accompanied by comprehensive customer support and professional services;
| | - |  | ----------------------------------------------------------------------------



| |  |  | provide a cost-effective and space efficient solution for service providers; and
| | - |  | --------------------------------------------------------------------------------



| |  |  | offer a broad array of services.
| | - |  | --------------------------------

If we are unable to compete successfully against our current and future competitors, we could experience reduced gross profit margins, price reductions, order cancellations, and loss of customers and revenues, each of which would adversely
impact our business.

We currently conduct a significant amount of business with ECI Telecom Ltd., or ECI. If our relationship with ECI is adversely
affected for any reason our business could be harmed and our results of operations would likely be negatively affected.

Our
agreements with ECI were entered into in the context of affiliated parties and were negotiated in the overall context of the 2002 share acquisition. As a result, the terms of our agreements with ECI may be more or less favorable to us than if they
had been negotiated with unaffiliated third parties. Conflicts of interest may arise between ECI and us with respect to any number of matters, including indemnification obligations we have to each other, labor, tax, employee benefit and other
matters arising from the 2002 share acquisition transaction, intellectual property matters and business opportunities that are attractive to ECI and us. Either we or ECI may make strategic choices that are not in the best interest of the other
party. For example, other than restrictions with respect to ECIs exploitation of DCME products, nothing prohibits ECI from competing with us in other matters or offering VoIP products which compete with ours. We may not be able to resolve any
potential conflicts that may arise between ECI and us, and even if we are able to do so, the resolution may be less favorable than if we were dealing with an unrelated third party.

ECI also owns the technology underlying our DCME product lines. Pursuant to the DCME Master Manufacturing and Distribution Agreement, or the DCME
Agreement, we have secured the right to act as exclusive worldwide distributor of ECIs DCME line of products. Under the DCME Agreement, ECI provides certain supply, service and warranty obligations and manufactures or subcontracts the
manufacture of all DCME equipment sold by us. The DCME Agreement may only be terminated by ECI in the event we project DCME revenues of less than one million dollars in a calendar year, we breach a material provision of the DCME Agreement and fail
to cure such breach within 30 days or we become insolvent. Upon the occurrence of one of these events and the election by ECI to terminate the DCME Agreement, ECI would be under no obligation to continue to contract with us. If the value of the
shares held by ECI declines, either by disposition of the shares or a decline in our stock price, ECI may be less likely to enter into agreements on reasonable terms or at all. Accordingly, in the event of the occurrence of one of these termination
events, we cannot assure you that the DCME Agreement will be extended or renewed at all or on reasonable commercial terms.

In addition,
our relationship with ECI could be adversely affected by divestment of its shares of our common stock or by declines in our stock price.

We do not currently have an independent ability to produce DCME products and have not entered into arrangements with any third party that would enable us to obtain DCME or similar products in the event that ECI ceases to provide us with
DCME products. Should ECI, or a successor entity to ECI, particularly as a result of the pending acquisition of ECI, become unable or unwilling to fulfill its obligations under the DCME Agreement for any reason or if the DCME Agreement is
terminated, we will need to take remedial measures to manufacture DCME or similar products, which could be expensive, and if such efforts fail, our business would be materially harmed.

ECI beneficially owns a significant percentage of our common stock, which will allow ECI to significantly influence us and matters requiring stockholder approval and could discourage potential acquisitions of
our company.

ECI owns approximately 26% of our outstanding common stock. As a result of its ownership in us, ECI is able to exert
significant influence over actions requiring the approval of our stockholders, including change of control transactions and any amendments to our certificate of incorporation. Because of the nature of our business relationship with ECI and the size
and nature of ECIs ownership position in us, the interests of ECI may be different than those of our other stockholders. In addition, the significant ownership percentage of ECI could have the effect of delaying or preventing a change in
control of our company or otherwise discouraging a potential acquirer from obtaining control of our company. In 2007, ECI was acquired by affiliates of the Swarth Group and certain funds that have appointed Ashmore Investment Management Limited as
their investment manager who maintains dispositive and/or voting power and is no longer traded on NASDAQ. As a result of the change in ownership, the investment objectives of ECI may have changed as compared to the investment objectives when ECI was
a publicly-traded company. The possible change in investment objectives may affect whether, or for how long, ECI will continue to hold our shares.



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Our revenue and operating results may be adversely impacted if sales of our IP products and other products are
unstable and if revenue from our DCME products continues to fluctuate and if the mix between new sales and expansion sales changes substantially.

Our DCME products incorporate mature technologies that we expect to be in less demand by our customers in the future. While we are actively pursuing new customers for our DCME products and seeking to increase sales of
our additional product offerings to these customers, including our IP products, we believe that there are fewer opportunities for new DCME sales, and we expect DCME sales to continue to decrease over the foreseeable future. If the decrease in DCME
revenues occurs more rapidly than we anticipate and/or the sales of our other products, including our IP products, do not make up for the decline in revenues, our business and results of operations will be harmed. Additionally, we believe that the
mix between new IP product sales and expansion sales in any given quarter may fluctuate and our gross margins could be adversely impacted.

Our
accountants identified and reported to us material weaknesses for the years ended December 31, 2003, 2004 and 2005, relating to our internal controls over financial reporting and significant deficiencies for the year ended December 31,
2006. If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our operating results, our ability to operate our business and our stock price.

In connection with the audit of our consolidated financial statements for the years ended December 31, 2003, 2004 and 2005,
our independent registered public accounting firm identified material weaknesses in our internal controls over financial reporting related to closing processes, adequate maintenance of books and records and our revenue recognition processes. Our
audit for 2005 and 2006 resulted in the discovery of significant deficiencies. For 2005, we had significant deficiencies with respect to insufficient control over cash disbursements and deficiencies in internal control over financial reporting
related to accounting for derivative financial instruments resulting in errors in accounting for changes in the estimated fair value of certain derivative financial instruments. For 2006, we had significant deficiencies with respect to inconsistency
in the effectiveness of managements review of the deferred costs and inconsistency in effectiveness of managements review over revenue arrangements.

Our independent registered public accounting firm was not, however, engaged to audit, nor has it audited, the effectiveness of our internal control over financial reporting. Accordingly, our independent registered
public accounting firm has not rendered an opinion on our internal control over financial reporting. Similarly, we have not performed an evaluation of internal controls over financial reporting, as we are not currently required to comply with
Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. Additional material weaknesses, significant deficiencies and other control deficiencies may have existed or may in the future be identified when such additional
evaluations are performed.

We have already taken the following measures to remediate the material weaknesses and significant deficiencies
in the prior years as noted above including: (a) hiring of additional, experienced personnel, (b) improving training, and (c) implementing additional internal control processes. Further, we may need to take additional measures in the
future to remediate any material weaknesses or significant deficiencies in our financial reporting.

Due to these measures that have
already been taken, and measures that will be taken in the future to remediate the material weaknesses and significant deficiencies, our finance and administrative costs increased from $5.8 million in 2005 to $9.6 million in 2007, an increase of
$3.8 million. While it is difficult to differentiate the increase in costs that are attributable to remediation, as compared to an ordinary increase in costs resulting from the growth in the overall business, we believe that the majority of the
increase is directly or indirectly attributable to measures taken to remediate the material weaknesses and significant deficiencies.

Further, we believe such costs may materially increase in the future. As a result, we expect to incur significant additional expenses which are expected to negatively impact our financial performance. This remediation process also will
result in a diversion of managements time and attention. We cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations and may not be able to ensure that the
process is effective or that the internal controls are or will be effective in a timely manner. Ensuring that we have adequate internal financial and accounting controls and procedures in place to help ensure that we can produce accurate financial
statements on a timely basis is a costly and time-consuming effort that needs to be evaluated frequently.

Although we have taken measures
to remediate the material weaknesses as well as the other significant deficiencies and control deficiencies, we cannot assure you that we have identified all, or that we will not in the future have additional, material weaknesses, significant
deficiencies and control deficiencies. Our independent registered public accounting firm has not evaluated any of the



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measures we have taken, or that we propose to take, to address the material weakness and the significant deficiencies and control deficiencies discussed
above. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in implementation, could cause us to fail to meet our periodic reporting obligations or result in material misstatements in our financial
statements. Any such failure could also adversely affect managements assessment of our disclosure controls and procedures, required with the filing of our quarterly and annual reports after our initial public offering, and the results of
periodic management evaluations and annual auditor attestation reports regarding the effectiveness of our internal controls over financial reporting that will be required when the SECs rules under Section 404 of the Sarbanes-Oxley Act is
expected to be applicable to us beginning with our Annual Report on Form 10-K for the year ending December 31, 2009, to be filed in early 2010. The existence of a material weakness could result in errors in our financial statements that could
result in a restatement of financial statements, cause us to fail to meet our reporting obligations and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.

The largest customers in the telecommunications industry have substantial negotiating leverage, which may require that we agree to terms and conditions that are
less advantageous to us than the terms and conditions of our existing customer relationships or risk limiting our ability to sell our products to these large service providers, thereby harming our operating results.

Large telecommunications service providers have substantial purchasing power and leverage negotiating contractual terms and conditions relating to the
sale of our products to them. As we seek to sell more products to these large telecommunications providers, we may be required to agree to such terms and conditions in order to complete such sales, which may result in lower margins, affect the
timing of the recognition of the revenue derived from these sales and the amount of deferred revenues, each of which may have an adverse effect on our business and financial condition.

In addition, our future success depends in part on our ability to sell our products to large service providers operating complex networks that serve
large numbers of subscribers and transport high volumes of traffic. The communications industry historically has been dominated by a relatively small number of service providers. While deregulation and other market forces have led to an increasing
number of service providers in recent years, large service providers continue to constitute a significant portion of the market for communications equipment. If we fail to sell additional IP products to our large customers or to expand our customer
base to include additional customers that deploy our products in large-scale networks serving significant numbers of subscribers, our revenue growth will be limited.

Consolidation or downturns in the telecommunications industry may affect demand for our products and the pricing of our products which could limit our growth and may harm our business.

The telecommunications industry, which includes all of our customers, has experienced increased consolidation in recent years, and we expect this trend to
continue. Consolidation among our customers and prospective customers may cause delays or reductions in capital expenditure plans and/or increased competitive pricing pressures as the number of available customers declines and their relative
purchasing power increases in relation to suppliers. The occurrence of any of these factors, separately or in combination, may lead to decreased sales or slower than expected growth in revenues and could harm our business and operations.

The communications industry is cyclical and reactive to general economic conditions. In the recent past, worldwide economic downturns, pricing
pressures and deregulation have led to consolidations and reorganizations. These downturns, pricing pressures and restructurings have been causing delays and reductions in capital and operating expenditures by many service providers. These delays
and reductions, in turn, have been reducing demand for communications products like ours. A continuation or subsequent recurrence of these industry patterns, as well as general domestic and foreign economic conditions and other factors that reduce
spending by companies in the communications industry, could harm our operating results in the future.

If we fail to anticipate and meet specific
customer requirements or if our products fail to interoperate with our customers existing networks or with existing and emerging industry, national and international standards, we may not be able to retain our current customers or attract new
customers.

We must effectively anticipate, and adapt our business, products and services in a timely manner to meet customer
requirements. We must also meet existing and emerging industry, national and international standards in order to meet changing customer demands. Prospective customers may require product features and capabilities that are not included in our current
product offerings. The introduction of new or enhanced products also requires that we carefully manage the transition from our older products in order to minimize disruption in customer ordering patterns and ensure that adequate supplies of our new
products can be delivered to meet anticipated customer demand. If we fail to develop products and offer services that satisfy customer requirements, or if we fail to effectively manage the transition from our older products to our new or enhanced
products, our ability to create or increase demand for our products would be seriously harmed and we may lose current and prospective customers, thereby harming our business.



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Many of our customers will require that our products be designed to interface with their existing
networks or with existing or emerging industry, national and international standards, each of which may have different and unique specifications. Issues caused by a failure to achieve homologation to certain standards or an unanticipated lack of
interoperability between our products and these existing networks may result in significant warranty, support and repair costs, divert the attention of our engineering personnel from our hardware and software development efforts and cause
significant customer relations problems. If our products do not interoperate with our customers respective networks or applicable standards, installations could be delayed or orders for our products could be cancelled, which would seriously
harm our gross margins and result in the loss of revenues and/or customers.

We expect that a majority of the revenues generated from our products,
especially our IP products, including our ControlSwitch, will be generated from a limited number of customers. If we lose customers or are unable to grow and diversify our customer base, our revenues may fluctuate and our growth likely would be
limited.

To date, we have sold our IP products to approximately 110 customers. We expect that for the foreseeable future, the
majority of the revenues from our IP products will be generated from a limited number of customers in sales transactions that are unpredictable in many key respects, including, but not limited to, the timing of when these transactions close relative
to when the related revenue will be recognized, when cash will be received, the mix of hardware and software, the gross margins related to these transactions and the total amount of payments to be received. We do not expect to have regular,
recurring sales to a limited number of customers. Due to the limited number of our customers and the irregular sales cycle in the industry, if we lose customers and/or fail to grow and diversify our customer base, or if they do not purchase our IP
products at levels or at the times we anticipate, our ability to maintain and grow our revenues will be adversely affected. The growth of our customer base could also be adversely affected by:



| |  |  | consolidation in the telecommunications industry affecting our customers;
| | - |  | -------------------------------------------------------------------------



| |  |  | unwillingness of customers to implement our new products or renew contracts as they expire;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | potential customer concerns about our status as an emerging telecommunications equipment vendor;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | delays or difficulties that we may experience in the development, introduction and/or delivery of products or product enhancements;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | deterioration in the general financial condition (including bankruptcy filings) of our customers and the potential unavailability to our customers of credit
or financing for additional purchases;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | new product introductions by our competitors;
| | - |  | ---------------------------------------------



| |  |  | geopolitical risks and uncertainties in countries where our customers or our own facilities are located; or
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | failure of our products to perform as expected.
| | - |  | -----------------------------------------------

Our quarterly operating results have fluctuated significantly in the past and may continue to fluctuate in the future, which could lead to volatility in the price of our common stock.

Our quarterly revenues and operating results have fluctuated significantly in the past and they may continue to fluctuate in the future, due to a number
of factors, many of which are outside of our control and any of which may cause our stock price to fluctuate. From our experience, customer purchases of telecommunications equipment have been unpredictable and irregular batch sales as customers
build out their networks, rather than regular, recurring sales. The primary factors that may affect our quarterly revenues and results include the following:



| |  |  | fluctuation in demand for our products and the timing and size of customer orders;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | the length and variability of the sales cycle for our products;
| | - |  | ---------------------------------------------------------------



| |  |  | new product introductions and enhancements by our competitors and us;
| | - |  | ---------------------------------------------------------------------



| |  |  | our ability to develop, introduce and ship new products and product enhancements that meet customer requirements in a timely manner;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | the mix of product configurations sold and the mix of sales to new customers and expansion sales to existing customers;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to obtain sufficient supplies of sole or limited source components;
| | - |  | -------------------------------------------------------------------------------



| |  |  | our ability to attain and maintain production volumes and quality levels for our products;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | costs related to acquisitions of complementary products, technologies or businesses;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | changes in our pricing policies, the pricing policies of our competitors and the prices of the components of our products;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing of revenue recognition, amount of deferred revenues and receivables collections;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | difficulties or delays in deployment of customer IP networks that would delay anticipated customer purchases of additional products and services;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | general economic conditions, as well as those specific to the telecommunications, networking and related industries;
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | consolidation within the telecommunications industry, including acquisitions of or by our customers; and
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | the failure of certain of our customers to successfully and timely reorganize their operations, including emerging from bankruptcy.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------

In addition, as a result of our accounting policies, we may be unable to recognize all of the revenue associated with
certain customer contracts in the same period as the costs associated with those contracts are expensed, which could cause our quarterly gross margins, particularly of IP gross margins, to fluctuate significantly. Further, our accounting policies
may require that revenue related to certain customer contracts be delayed for periods of a year or more. This delay may cause spikes in our revenue in quarters when it is recognized and may result in deferred revenue to revenue conversion taking
longer than anticipated.

A significant portion of our operating expenses are fixed in the short-term. If revenues for a particular quarter
are below expectations, we may not be able to reduce operating expenses proportionally for the quarter. Therefore, any such revenue shortfall would likely have a direct negative effect on our operating results for that quarter.

We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance.

We believe it likely that in some future quarters, our operating results may be below the expectations of public market analysts and investors, which may
adversely affect our stock price. A decline in the market price of our common stock could cause our stockholders to lose some or all of their investment and may adversely impact our ability to attract and retain employees and raise capital. In
addition, stockholders may initiate securities class action lawsuits. Whether or not meritorious, litigation brought against us could result in substantial costs and could divert the time and attention of our management. Our insurance to cover
claims of this sort, if brought, may not be adequate.

If we do not respond rapidly to technological changes or to changes in industry standards, our
products could become obsolete.

The market for IP infrastructure products and services is characterized by rapid technological
change, frequent new product introductions and evolving standards. We may be unable to respond quickly or effectively to these developments. We may experience difficulties with software development, hardware design, manufacturing, marketing or
certification that could delay or prevent our development, introduction or marketing of new products and enhancements. The introduction of new products by our competitors, the market acceptance of products based on new or alternative technologies or
the emergence of new industry standards could render our existing or future products obsolete. If the standards adopted are different from those that we have chosen to support, market acceptance of our products may be significantly reduced or
delayed. If our products become technologically obsolete, we may be unable to sell our products in the marketplace and generate revenues, and our business could be adversely affected.



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Because our products are sophisticated and designed to be deployed in complex environments and in multiple
locations, they may have errors or defects that we find only after full deployment. If these errors lead to customer dissatisfaction or we are unable to establish and maintain a support infrastructure and required support levels to service these
complex environments, our business may be seriously harmed.

Our products are sophisticated and are designed to be deployed in large
and complex networks. Because of the nature of our products, they can only be fully tested when substantially deployed in very large networks with high volumes of traffic. Some of our customers have only recently begun to commercially deploy our
products or deploy our products in larger configurations and they may discover errors or defects in the software or hardware, or the products may not operate as expected or our products may not be able to function in the larger configurations
required by certain customers. If we are unable to fix errors or other performance problems that may be identified after full deployment of our products, we could experience:



| |  |  | cancellation of orders or other losses of, or delays in, revenues;
| | - |  | ------------------------------------------------------------------



| |  |  | loss of customers and market share;
| | - |  | -----------------------------------



| |  |  | harm to our reputation;
| | - |  | -----------------------



| |  |  | a failure to attract new customers or achieve market acceptance for our products;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | increased service, support and warranty costs and a diversion of development resources;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | increased insurance costs and losses to our business and service provider customers; and
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | costly and time-consuming legal actions by our customers.
| | - |  | ---------------------------------------------------------

If we experience warranty failure that indicates either manufacturing or design deficiencies, we may be required to recall units in the field and/or stop producing and shipping such products until the deficiency is
identified and corrected. In the event of such warranty failures, our business could be adversely affected resulting in reduced revenue, increased costs and decreased customer satisfaction. Because customers often delay deployment of a full system
until they have tested the products and any defects have been corrected, we expect these revisions may cause delays in orders by our customers for our systems. Because our strategy is to introduce more complex products in the future, this risk will
intensify over time. Service provider customers have discovered errors in our products. If the costs of remediating problems experienced by our customers exceed our expected expenses, which historically have not been significant, these costs may
adversely affect our operating results.

In addition, because our products are deployed in large and complex networks around the world. Our
customers expect us to establish a support infrastructure and maintain demanding support standards to ensure that their networks maintain high levels of availability and performance. To support the continued growth of our business, our support
organization will need to provide service and support at a high level throughout the world. This will include hiring and training customer support engineers both at our primary corporate locations as well as our smaller offices in new geographies
such as Central and South America and Russia. If we are unable to provide the expected level of support and service to our customers, we could experience:



| |  |  | loss of customers and market share;
| | - |  | -----------------------------------



| |  |  | a failure to attract new customers in new geographies;
| | - |  | ------------------------------------------------------



| |  |  | increased service, support and warranty costs and a diversion of development resources; and
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | network performance penalties.
| | - |  | ------------------------------

The
long and variable sales and deployment cycles for our products may cause our operating results to vary materially, which could result in a significant unexpected revenue shortfall in any given quarter.

Our products have lengthy sales cycles, which typically extend from three to twelve months and may take up to two years. A customers decision to
purchase our products often involves a significant commitment of the customers resources and a product evaluation and qualification process that can vary significantly in length. The length of our sales cycles also varies depending on the type
of customer to which we are selling, the product being sold and the type of network in which our product will be utilized. We may incur substantial sales and marketing expenses and expend significant management effort during this time, regardless of
whether we make a sale.

Even after making the decision to purchase our products, our customers may deploy our products slowly. Timing of
deployment can vary widely among customers. The length of a customers deployment period will impact our ability to recognize revenue related



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to such customers purchase and may also directly affect the timing of any subsequent purchase of additional products by that customer. As a result of
these lengthy and uncertain sales and deployment cycles for our products, it is difficult for us to predict the quarter in which our customers may purchase additional products or features from us, and our operating results may vary significantly
from quarter to quarter, which may negatively affect our operating results for any given quarter.

We rely on channel partners for a significant
portion of our revenue. Our failure to effectively develop and manage these third party distributors, systems integrators and resellers specifically and our indirect sales channel generally, and disruptions to the processes and procedures that
support our indirect sales channels could adversely affect our ability to generate revenues from the sale of our products.

We rely
on third party distributors, systems integrators and resellers for a significant portion of our revenue. Our revenues depend in large part on the performance of these indirect channel partners. Although many aspects of our partner relationships are
contractual in nature, our arrangements with our indirect channel partners are not exclusive. Accordingly, important aspects of these relationships depend on the continued cooperation between the parties.

In particular, we have appointed ECI as an agent for selling our IP and DCME products in Russia and an affiliate of ECI provides services for us in
Russia. During the fiscal years ended December 31, 2007 and 2006, $23.9 million and $28.7 million, respectively, of our revenues were derived from sales in Russia, which required, in some cases, payment of an agent fee to ECI or an affiliate of
ECI. The agreement governing this arrangement may be terminated by either party with three months written notice. In the event ECI, a successor entity to ECI or an affiliate entity of ECI, is unable to continue to sell our products for any reason,
elects not to sell our products or elects to terminate this agreement, then our business and results of operations would likely be materially harmed.

Many factors out of our control could interfere with our ability to market, license, implement or support our products with any of our partners, which in turn could harm our business. These factors include, but are
not limited to, a change in the business strategy of one of our partners, the introduction of competitive product offerings by other companies that are sold through one of our partners, potential contract defaults by one of our partners, or changes
in ownership or management of one of our distribution partners. Some of our competitors may have stronger relationships with our distribution partners than we do, and we have limited control, if any, as to whether those partners implement our
products rather than our competitors products or whether they devote resources to market and support our competitors products rather than our offerings. In addition, we recognize a portion of our revenue based on a sell-through model
using information provided by our partners. If those partners provide us with inaccurate or untimely information, then the amount or timing of our revenues could be adversely impacted and our operating results may be harmed.

Moreover, if we are unable to leverage our sales and support resources through our distribution partner relationships, we may need to hire and train
additional qualified sales and engineering personnel. We cannot assure you, however, that we will be able to hire additional qualified sales and engineering personnel in these circumstances, and our failure to do so may restrict our ability to
generate revenue or implement our products on a timely basis. Even if we are successful in hiring additional qualified sales and engineering personnel, we will incur additional costs and our operating results, including our gross margin, may be
adversely affected. The loss of or reduction in sales by these resellers could reduce our revenues. If we fail to maintain relationships with these third party resellers, fail to develop new relationships with third party resellers in new markets,
fail to manage, train, or provide incentives to, existing third party resellers effectively or if these third party resellers are not successful in their sales efforts, sales of our products may decrease and our operating results would suffer.

We may face risks associated with our international sales that could impair our ability to grow our revenues.

For the fiscal years ended December 31, 2007, 2006, and 2005, revenues from outside North America were approximately, $93.1 million, $81.8 million,
and $63.0 million, respectively. We intend to continue selling into our existing international markets and expand into additional international markets where we currently do not do business. If we are unable to continue to sell products effectively
in these existing international markets and expand into additional new international markets, our ability to grow our business will be adversely affected. Some factors that may impact our ability to maintain our international operations and sales
and/or cause our results from operations in these international markets to differ from expectations include:



| |  |  | difficulty enforcing contracts and collecting accounts receivable in foreign jurisdictions, leading to longer collection periods;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | certification and qualification requirements relating to our products;
| | - |  | ----------------------------------------------------------------------



| |  |  | the impact of recessions in economies outside the United States;
| | - |  | ----------------------------------------------------------------



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| |  |  | unexpected changes in foreign regulatory requirements, including import and export regulations, and currency exchange rates;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | certification and qualification requirements for doing business in foreign jurisdictions;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | inadequate protection for intellectual property rights in certain countries;
| | - |  | ----------------------------------------------------------------------------



| |  |  | less stringent adherence to ethical and legal standards by prospective customers in certain foreign countries, including compliance with the Foreign Corrupt
Practices Act;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | potentially adverse tax consequences;
| | - |  | -------------------------------------



| |  |  | unfavorable foreign exchange movements, particularly the continued devaluation of the US dollar, which could result in decreased revenues and/or increased
expenses; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | political and economic instability.
| | - |  | -----------------------------------

Maintaining and improving our financial controls and the requirements of being a public company may strain our resources, divert managements attention and affect our ability to attract and retain qualified board members.

As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, and the NASDAQ Stock
Market Rules, or Nasdaq rules. The requirements of these rules and regulations will increase our legal and financial compliance costs, make some activities more difficult, time-consuming or costly and may also place undue strain on our personnel,
systems and resources. The Exchange Act will require, among other things, that we file annual, quarterly and current reports with respect to our business and financial condition.

The Sarbanes-Oxley Act will require, among other things, that we maintain effective disclosure controls and procedures and internal control over
financial reporting. As a public company, our systems of internal controls over financial reporting will be required to be periodically assessed and reported on by management and will be subject to annual audits by our independent auditors. We are
presently evaluating our internal controls for compliance and will be required to comply with the Sarbanes-Oxley guidelines beginning with our Annual Report on Form 10-K for the year ending December 31, 2009, to be filed in early 2010. During
the course of our evaluation, we may identify areas requiring improvement and may be required to design enhanced processes and controls to address issues identified through this review. This could result in significant delays and cost to us and
require us to divert substantial resources, including management time, from other activities. We have commenced a review of our existing internal control structure. Although our review is not complete, we have taken steps to improve our internal
control structure by hiring or transferring dedicated, internal Sarbanes-Oxley Act compliance personnel to analyze and improve our internal controls, to be supplemented periodically with outside consultants as needed. However, we cannot be certain
regarding when we will be able to successfully complete the procedures, certification and attestation requirements of Section 404 of the Sarbanes-Oxley Act. If we fail to achieve and maintain the adequacy of our internal controls, we may not be
able to conclude that we have effective internal controls over financial reporting in accordance with the Sarbanes-Oxley Act. Moreover, effective internal controls are necessary for us to produce reliable financial reports and are important to help
prevent fraud. As a result, our failure to satisfy the requirements of Section 404 on a timely basis could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm the market value of
our common stock. Any failure to maintain effective internal controls also could impair our ability to manage our business and harm our financial results.

Under the Sarbanes-Oxley Act and Nasdaq rules, we are required to maintain an independent board. We also expect these rules and regulations will make it more difficult and more expensive for us to maintain
directors and officers liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to maintain coverage. If we are unable to maintain adequate directors and officers insurance,
our ability to recruit and retain qualified directors, especially those directors who may be deemed independent for purposes of Nasdaq rules, and officers will be significantly curtailed.

If we lose the services of one or more members of our current executive management team or other key employees, or if we are unable to attract additional
executives or key employees, we may not be able to execute on our business strategy.

Our future success depends in large part upon
the continued service of our executive management team and other key employees. In particular, Doug Sabella, our president and chief executive officer, is critical to the overall management of our company as well as to the development of our culture
and our strategic direction.



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In order to be successful, we must also hire, retain and motivate key employees, including those in
managerial, technical, marketing and sales positions. In particular, our product generation efforts depend on hiring and retaining qualified engineers. Experienced management and technical, sales, marketing and support personnel in the
telecommunications and networking industries are in high demand and competition for their talents is intense. This is particularly the case in Silicon Valley, where our headquarters and significant operations are located.

The loss of services of any of our executives or of one or more other members of our executive management or sales team or other key employees, none of
which is bound by an employment agreement for any specific term, could seriously harm our business.

We have no internal hardware manufacturing
capabilities and we depend exclusively upon contract manufacturers to manufacture our hardware products. Our failure to successfully manage our relationships with Flextronics, ECI or other replacement contract manufacturers would impair our ability
to deliver our products in a manner consistent with required volumes or delivery schedules, which would likely cause us to fail to meet the demands of our customers and damage our customer relationships.

We outsource the manufacturing of all of our hardware products. Our I-Gate 4000 media gateways are exclusively manufactured for us by Flextronics. We buy
our DCME products from ECI who subcontracts the manufacturing to Flextronics. These contract manufacturers provide comprehensive manufacturing services, including assembly of our products and procurement of materials and components. Each of our
contract manufacturers also builds products for other companies and may not always have sufficient quantities of inventory available or may not allocate their internal resources to fill these orders on a timely basis.

We do not have long-term supply contracts with these contract manufacturers and they are not required to manufacture products for any specified period at
any specified price. We do not have internal manufacturing capabilities to meet our customers demands and we cannot assure you that we will be able to develop or contract for additional manufacturing capacity on acceptable terms on a timely
basis if it is needed. An inability to manufacture our products at a cost comparable to our historical costs could impact our gross margins or force us to raise prices, affecting customer relationships and our competitive position.

Qualifying a new contract manufacturer and commencing commercial scale production is expensive and time consuming and could result in a significant
interruption in the supply of our products. If our contract manufacturers are not able to maintain our high standards of quality, increase capacity as needed, or are forced to shut down a factory, our ability to deliver quality products to our
customers on a timely basis may decline, which would damage our relationships with customers, decrease our revenues and negatively impact our growth.

We and our contract manufacturers rely on single or limited sources for the supply of some components of our products and if we fail to adequately predict our manufacturing requirements or if our supply of any of these components is
disrupted, we will be unable to ship our products on a timely basis, which would likely cause us to fail to meet the demands of our customers and damage our customer relationships.

We and our contract manufacturers currently purchase several key components of our products, including commercial digital signal processors, from single
or limited sources. We purchase these components on a purchase order basis. If we overestimate our component requirements, we could have excess inventory, which would increase our costs and result in write-downs harming our operating results. If we
underestimate our requirements, we may not have an adequate supply, which could interrupt manufacturing of our products and result in delays in shipments and revenues.

We currently do not have long-term supply contracts with our component suppliers and they are not required to supply us with products for any specified periods, in any specified quantities or at any set price, except
as may be specified in a particular purchase order. Because the key components and assemblies of our products are complex, difficult to manufacture and require long lead times, in the event of a disruption or delay in supply, or inability to obtain
products, we may not be able to develop an alternate source in a timely manner, at favorable prices, or at all. In addition, during periods of capacity constraint, we are disadvantaged compared to better capitalized companies, as suppliers may in
the future choose not to do business with us or may require higher prices or less advantageous terms. A failure to find acceptable alternative sources could hurt our ability to deliver high-quality products to our customers and negatively affect our
operating margins. In addition, reliance on our suppliers exposes us to potential supplier production difficulties or quality variations. Our customers rely upon our ability to meet committed delivery dates, and any disruption in the supply of key
components would seriously adversely affect our ability to meet these dates and could result in legal action by our customers, loss of customers or harm our ability to attract new customers, any of which could decrease our revenues and negatively
impact our growth.



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Failure to manage expenses and inventory risks associated with meeting the demands of our customers may adversely
affect our business or results of operations.

To ensure that we are able to meet customer demand for our products, we place orders
with our contract manufacturers and suppliers based on our estimates of future sales. If actual sales differ materially from these estimates because of inaccurate forecasting or as a result of unforeseen events or otherwise, our inventory levels and
expenses may be adversely affected and our business and results of operations could suffer. In addition, in order to remain competitive, we must continue to introduce new products and processes into our manufacturing environment. There cannot be any
assurance, however, that the introduction of new products will not create obsolete inventories related to older products.

If we are not able to
obtain necessary licenses of third-party technology at acceptable prices, or at all, our products could become obsolete.

We have
incorporated third-party licensed technology into our current products. From time to time, we may be required to license additional technology from third parties to develop new products or product enhancements. Third-party licenses may not be
available or continue to be available to us on commercially reasonable terms or at all. The inability to maintain or re-license any third-party licenses required in our current products or to obtain any new third-party licenses to develop new
products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost, and delay or prevent us from making these products or enhancements, any of which could seriously harm
the competitiveness of our products.

Failures by our strategic partners or by us in integrating our products with those provided by our strategic
partners could seriously harm our business.

Our solutions include the integration of products supplied by strategic partners, who
offer complementary products and services and we expect to further integrate our IP Products with such partner products and services in the future. We rely on these strategic partners in the timely and successful deployment of our solutions to our
customers. If the products provided by these partners have defects or do not operate as expected, or if we do not effectively integrate and support products supplied by these strategic partners, or if these strategic partners fail to be able to
support products, we may have difficulty with the deployment of our solutions, which may result in:



| |  |  | a loss of, or delay in, recognizing revenues;
| | - |  | ---------------------------------------------



| |  |  | increased service, support and warranty costs and a diversion of development resources; and
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | network performance penalties.
| | - |  | ------------------------------

In addition to cooperating with our strategic partners on specific customer projects, we also may compete in some areas with these same partners. If these strategic partners fail to perform or choose not to cooperate with us on certain
projects, in addition to the effects described above, we could experience:



| |  |  | a loss of customers and market share; and
| | - |  | -----------------------------------------



| |  |  | a failure to attract new customers or achieve market acceptance for our products.
| | - |  | ---------------------------------------------------------------------------------

Our ability to compete and our business could be jeopardized if we are unable to protect our intellectual property.

We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights.
However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. Our patent applications may not issue as patents at all or they may not issue as patents in a
form that will be advantageous to us. Our issued patents and those that may issue in the future may be challenged, invalidated or circumvented, which could limit our ability to stop competitors from marketing related products. Although we have taken
steps to protect our intellectual property and proprietary technology, there is no assurance that third parties will not be able to invalidate or design around our patents. Furthermore, although we have entered into confidentiality agreements and
intellectual property assignment agreements with our employees, consultants and advisors, such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of
unauthorized use or disclosure or other breaches of the agreements.



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Additionally, despite our efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult and we cannot be certain that the steps we have taken to do so will prevent unauthorized use of our technology, particularly in
foreign countries where the laws may not protect our proprietary rights as comprehensively as in the United States. If competitors are able to use our technology or develop unpatented proprietary technology similar to ours or competing technologies,
our ability to compete effectively could be harmed.

Possible third-party claims of infringement of proprietary rights against us could have a
material adverse effect on our business, results of operation or financial condition.

The telecommunications industry generally and
the market for IP telephony products in particular are characterized by a relatively high level of litigation based on allegations of infringement of proprietary rights. We have in the past received and may in the future receive inquiries from other
patent holders and may become subject to claims that we infringe their intellectual property rights. We cannot assure you that we are not in infringement of third party patents. Any parties claiming that our products infringe upon their proprietary
rights, regardless of its merits, could force us to license their patents for substantial royalty payments or to defend ourselves and possibly our customers or contract manufacturers in litigation. We may also be required to indemnify our customers
and contract manufacturers for damages they suffer as a result of such infringement. These claims and any resulting licensing arrangement or lawsuit, if successful, could subject us to significant royalty payments or liability for damages and
invalidation of our proprietary rights. Any potential intellectual property litigation also could force us to do one or more of the following:



| |  |  | stop selling, incorporating or using our products that use the challenged intellectual property;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on
reasonable terms, or at all; or
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | redesign those products that use any allegedly infringing technology.
| | - |  | ---------------------------------------------------------------------

Any lawsuits regarding intellectual property rights, regardless of their success, would be time-consuming, expensive to resolve and would divert our
managements time and attention.

Regulation of the telecommunications industry could harm our operating results and future prospects.

The telecommunications industry is highly regulated and our business and financial condition could be adversely affected by the changes in
the regulations relating to the telecommunications industry. Currently, there are few laws or regulations that apply directly to access to, or delivery of, voice services on IP networks. We could be adversely affected by regulation of IP networks
and commerce in any country, including the United States, where we operate. Such regulations could include matters such as voice over the Internet or using Internet protocol, encryption technology, and access charges for service providers. The
adoption of such regulations could decrease demand for our products, and at the same time increase the cost of selling our products, which could have a material adverse effect on our business, operating result and financial condition.

Compliance with regulations and standards applicable to our products may be time consuming, difficult and costly, and if we fail to comply, our product sales will
decrease.

In order to achieve and maintain market acceptance, our products must continue to meet a significant number of
regulations and standards. In the United States, our products must comply with various regulations defined by the Federal Communications Commission and Underwriters Laboratories, including particular standards relating to our DCME products and our
enhanced access switching solution, also known as our Class 5 solution.

As these regulations and standards evolve, and if new regulations
or standards are implemented, we will be required to modify our products or develop and support new versions of our products, and this will increase our costs. The failure of our products to comply, or delays in compliance, with the various existing
and evolving industry regulations and standards could prevent or delay introduction of our products, which could harm our business. User uncertainty regarding future policies may also affect demand for communications products, including our
products. Moreover, distribution partners or customers may require us, or we may otherwise deem it necessary or advisable, to alter our products to address actual or anticipated changes in the regulatory environment. Our inability to alter our
products to address these requirements and any regulatory changes could have a material adverse effect on our business, financial condition and operating results.

Failure of our hardware products to comply with evolving industry standards and complex government regulations may prevent our hardware products from gaining wide acceptance, which may prevent us from growing our sales.

The market for network equipment products is characterized by the need to support industry standards as different standards emerge,
evolve and achieve acceptance. We will not be competitive unless we continually introduce new products and product



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enhancements that meet these emerging standards. Our products must comply with various domestic regulations and standards defined by agencies such as the
Federal Communications Commission, in addition to standards established by governmental authorities in various foreign countries and the recommendations of the International Telecommunication Union. If we do not comply with existing or evolving
industry standards or if we fail to obtain timely domestic or foreign regulatory approvals or certificates we will not be able to sell our products where these standards or regulations apply, which may harm our business.

Production and marketing of products in certain states and countries may subject us to environmental and other regulations including, in some instances,
the requirement to provide customers the ability to return product at the end of its useful life and make us responsible for disposing or recycling products in an environmentally safe manner. Additionally, certain states and countries may pass
regulations requiring our products to meet certain requirements to use environmentally friendly components. Such laws and regulations have recently been passed in several jurisdictions in which we operate, including the European Union which issued
Directive 2002/96/EC Waste Electrical and Electronic Equipment, or WEEE, to mandate funding, collection, treatment, recycling and recovery of WEEE by producers of electrical or electronic equipment into Europe. China is in the final approval stage
of compliance programs which will harmonize with the European Union WEEE and RoHS directives. In the future, Japan and other countries are expected to adopt environmental compliance programs. If we fail to comply with these regulations, we may not
be able to sell our products in jurisdictions where these regulations apply, which would have a material adverse affect on our results of operations.

We have invested substantially in our enhanced access switching solution and we may be unable to achieve and maintain substantial sales.

We have spent considerable effort and time developing our Class 5 solution, and have had limited sales of this product line to date. Although we have scaled back our development efforts with respect to new features
and functionalities for our Class 5 solution, we continue to spend effort and time on our solution. We anticipate sales of our access solution as part of our operational plan and we may not achieve the success rate we currently anticipate or we may
not achieve any success at all. The market for our access solution is new and it is unclear whether there will be broad adoption of this solution by our existing and future potential customers.

Future interpretations of existing accounting standards could adversely affect our operating results.

Generally accepted accounting principles in the United States are subject to interpretation by the FASB, the American Institute of Certified Public
Accountants, or AICPA, the SEC and various other bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results, and
could affect the reporting of transactions completed before the announcement of a change.

For example, we recognize our product software
license revenue in accordance with AICPA Statement of Position, or SOP, 97-2, Software Revenue Recognition, as amended by SOP 98-9, Software Revenue Recognition with Respect to Certain Transactions, and related interpretations. The
AICPA or other accounting standards setters may continue to issue interpretations and guidance for applying the relevant accounting standards to a wide range of sales contract terms and business arrangements that are prevalent in software licensing
arrangements. Future interpretations of existing accounting standards, including SOP 97-2 and SOP 98-9, or changes in our business practices could result in future changes in our revenue recognition accounting policies that have a material adverse
effect on our results of operations. We may be required to delay revenue recognition into future periods, which could adversely affect our operating results. We have in the past had to, and in the future may have to, defer recognition for license
fees due to several factors, including whether a transaction involves:



| |  |  | software arrangements that include undelivered elements for which we do not have vendor specific objective evidence, or VSOE, of fair value;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | requirements that we deliver services for significant enhancements and modifications to customize our software for a particular customer;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | material acceptance criteria or other identified product-related issues; or
| | - |  | ---------------------------------------------------------------------------



| |  |  | payment terms extending beyond our customary terms.
| | - |  | ---------------------------------------------------

Because of these factors and other specific requirements under accounting principles generally accepted in the United States for software revenue recognition, we must have very precise terms in our software
arrangements in order to recognize revenue when we initially deliver software or perform services. Negotiation of mutually acceptable terms and conditions can extend our sales cycle, and we sometimes accept terms and conditions that do not permit
revenue recognition at the time of delivery.



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Increased political, economic and social instability in the Middle East, may adversely affect our business and
operating results.

The continued threat of terrorist activity and other acts of war or hostility, including the war in Iraq and
threats against Israel, have created uncertainty throughout the Middle East and have significantly increased the political, economic and social instability in Israel where substantially all of our products are manufactured. Acts of terrorism, either
domestically or abroad and particularly in Israel, or a resumption of the confrontation along the northern border of Israel, would likely create further uncertainties and instability. To the extent terrorism, or the political, economic or social
instability results in a disruption of our operations or delays in our manufacturing or shipment of our products, then our business, operating results and financial condition could be adversely affected.

Our I-Gate 4000 media gateways and our DCME products are exclusively manufactured for us by Flextronics, with the DCME products being manufactured by
Flextronics through our relationship with ECI. The Flextronics manufacturing facility is located in Migdal-Haemek, Israel, which is located in northern Israel. While Flextronics has other locations across the world at which our manufacturing
requirements may be fulfilled and we are in the process of diversifying our manufacturing capabilities to locations outside of the Middle East, any disruption to its Israeli manufacturing capabilities in Migdal-Haemek would likely cause a material
delay in our manufacturing process. If we are forced or if we decide to switch the manufacture of our products to a different Flextronics facility, the time and expense of such switch along with the increased costs, if any, of operating in another
location, would adversely affect our operations. In addition, while we expect that Flextronics will have the capacity to manufacture our products at facilities outside of Israel, there can be no assurance that such capacity will be available when we
require it or upon terms favorable or acceptable to us. To the extent terrorism, or political, economic or social instability results in a disruption of Flextronics manufacturing facilities in Israel or ECI operations in Israel as they relate
to our business, then our business, operating results and financial condition could be adversely affected.

In addition, any hostilities
involving Israel or the interruption or curtailment of trade between Israel and its present trading partners, or a significant downturn in the economic or financial condition of Israel, could adversely affect our operations and product development,
cause our revenues to decrease and adversely affect the price of our shares. Furthermore, several countries, principally in the Middle East, still restrict doing business with Israel, Israeli companies or companies with operations in Israel. Should
additional countries impose restrictions on doing business with Israel, our business, operating results and financial condition could be adversely affected.

Our operations may be disrupted by the obligations of our personnel to perform military service.

Many of our 150
employees in Israel, including certain key employees, are obligated to perform up to one month (in some cases more) of annual military reserve duty until they reach age 45 and, in emergency circumstances, could be called to active duty. Recently,
there have been call-ups of military reservists, including several of our employees, and it is possible that there will be additional call-ups in the future. Our operations could be disrupted by the absence of a significant number of our employees
due to military service or the absence for extended periods of one or more of our key employees for military service. Such disruption could adversely affect our business and results of operations.

The grants we have received from the Israeli government for certain research and development expenditures restrict our ability to manufacture products and transfer
technologies outside of Israel and require us to satisfy specified conditions. If we fail to satisfy these conditions, we may be required to refund grants previously received together with interest and penalties.

Our research and development efforts have been financed, in part, through grants that we have received from the OCS. We, therefore, must comply with the
requirements of the Israeli Law for the Encouragement of Industrial Research and Development, 1984 and related regulations, or the Research Law.

Under the Research Law, the discretionary approval of an OCS committee is required for any transfer of technology or manufacturing of products developed with OCS funding. OCS approval is not required for the export of any products resulting
from the research or development. There is no assurance that we would receive the required approvals for any proposed transfer. Such approvals, if granted, may be subject to the following additional restrictions:



| |  |  | we could be required to pay the OCS a portion of the consideration we receive upon any transfer of such technology or upon an acquisition of our Israeli
subsidiary by an entity that is not Israeli. Among the factors that may be taken into account by the OCS in calculating the payment amount are the scope of the support received, the royalties that were paid by us, the amount of time that elapsed
between the date on which the know-how was transferred and the date on which the grants were received, as well as the sale price; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | the transfer of manufacturing rights could be conditioned upon an increase in the royalty rate and payment of increased aggregate royalties and payment of
interest on the grant amount.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

These restrictions may impair our ability to sell our company, technology assets or to
outsource manufacturing outside of Israel. The restrictions will continue to apply even after we have repaid the full amount of royalties payable for the grants.



|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

Use
of Proceeds from Public Offering of Common Stock

In April 2007, we completed an IPO of common stock in which we sold and issued
6,750,000 shares of our common stock at an issue price of $8.00 per share. The effective date of the Securities Act registration statement for the IPO was April 4, 2007 and the Commission file number assigned to the registration statement is
333-138121. We raised a total of $54.0 million in gross proceeds from the IPO, or $46.6 million in net proceeds after deducting underwriting discounts and commissions of $3.8 million and other offering costs of $3.6 million. We applied $8.3 million
of our net proceeds from the IPO against our normal operational expenditures during the quarter ended September 30, 2008. The remaining net proceeds have been invested in cash, cash equivalents and short-term investments, in accordance with our
investment policy, in money-market mutual funds. None of the remaining net proceeds were paid, directly or indirectly, to directors, officers, persons owning ten percent or more of our equity securities, or any of our other affiliates. ECI sold
2,250,000 shares of our common stock at an issue price of $8.00 per share, raising a total of $18.0 million in gross proceeds from the IPO. Lehman Brothers Inc. and Credit Suisse Securities (USA) LLC were managing underwriters.



|ITEM 6. | EXHIBITS
|------- | --------

The following is an index of the exhibits included in
this report:



|        |  |                                                                                                                                                                                  
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description of document                                                                                                                                                          
|        | 
|3.1     |  | Amended and Restated Certificate of Incorporation of the Registrant (1)                                                                                                          
|        | 
|3.2     |  | Amended and Restated Bylaws of the Registrant (1)                                                                                                                                
|        | 
|4.1     |  | Reference is made to Exhibits 3.1 and 3.2                                                                                                                                        
|        | 
|4.2     |  | Specimen stock certificate (1)                                                                                                                                                   
|        | 
|10.1    |  | Offer Letter, dated August 1, 2007, by and between William R. Rohrbach and the Registrant                                                                                        
|        | 
|10.2    |  | Amendment to Employment Letter, dated September 8, 2008, by and between Albert Wood and the Registrant (2)                                                                       
|        | 
|10.3    |  | Transition and Separate Agreement, dated October 1, 2008, by and between Amit Chawla and the Registrant (3)                                                                      
|        | 
|31.1    |  | Certification of Chief Executive Officer, pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|        | 
|31.2    |  | Certification of Chief Financial Officer, pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|        | 
|32.1    |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002    



|(1) | Filed as an exhibit to Veraz Networks, Inc. Registration Statement on Form S-1 (No. 333-138121) and incorporated herein by reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------



|(2) | Filed as an exhibit to Veraz Networks, Inc. Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 11, 2008 and incorporated herein by
reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Filed as an exhibit to Veraz Networks, Inc. Current Report on Form 8-K, filed with the Securities and Exchange Commission on October 3, 2008 and incorporated herein by
reference.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                        |  |  |  |                      |  |             |  |                                                   
|----------------------- |  |  |  | -------------------- |  | ----------- |  | --------------------------------------------------
|                        |  |  |  | Veraz Networks, Inc.
|                        |  |  | 
|Date: November 14, 2008 |  |  |  | By:                  |  | /s/ Al Wood
|                        |  |  |  |                      |  |             |  | Al Wood, Chief Financial Officer                  
|                        |  |  |  |                      |  |             |  | (Principal Financial and Chief Accounting Officer)



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EXHIBIT INDEX



|        |  |                                                                                                                                                                                  
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description of document                                                                                                                                                          
|        | 
|3.1     |  | Amended and Restated Certificate of Incorporation of the Registrant (1)                                                                                                          
|        | 
|3.2     |  | Amended and Restated Bylaws of the Registrant (1)                                                                                                                                
|        | 
|4.1     |  | Reference is made to Exhibits 3.1 and 3.2                                                                                                                                        
|        | 
|4.2     |  | Specimen stock certificate (1)                                                                                                                                                   
|        | 
|10.1    |  | Offer Letter, dated August 1, 2007, by and between William R. Rohrbach and the Registrant                                                                                        
|        | 
|10.2    |  | Amendment to Employment Letter, dated September 8, 2008, by and between Albert Wood and the Registrant (2)                                                                       
|        | 
|10.3    |  | Transition and Separate Agreement, dated October 1, 2008, by and between Amit Chawla and the Registrant (3)                                                                      
|        | 
|31.1    |  | Certification of Chief Executive Officer, pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|        | 
|31.2    |  | Certification of Chief Financial Officer, pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|        | 
|32.1    |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002    



|(1) | Filed as an exhibit to Veraz Networks, Inc. Registration Statement on Form S-1 (No. 333-138121) and incorporated herein by reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------



|(2) | Filed as an exhibit to Veraz Networks, Inc. Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 11, 2008 and incorporated herein by
reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Filed as an exhibit to Veraz Networks, Inc. Current Report on Form 8-K, filed with the Securities and Exchange Commission on October 3, 2008 and incorporated herein by
reference.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------