##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





(Mark One)

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

For the quarterly period ended September 30, 2009

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  x    NO   ̈

Indicate by check mark whether the Registrant has submitted electronically and
posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).    Yes   ̈    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   |  | x  (Do not check if a smaller reporting company) |  | 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  x

As of October 30, 2009, 43,588,822 shares of the Registrants common stock were outstanding.









---

##### Table of Contents

VERAZ NETWORKS, INC AND SUBSIDIARIES

FORM 10-Q

For the Quarterly Period Ended September 30, 2009

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 |  | 20
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                             |  | 29
|ITEM 4T. CONTROLS AND PROCEDURES                                                              |  | 30
|                                                                                             
|PART II. OTHER INFORMATION                                                                   
|                                                                                              | 
|ITEM 1. LEGAL PROCEEDINGS                                                                     |  | 31
|ITEM 1A. RISK FACTORS                                                                         |  | 31
|ITEM 6. EXHIBITS                                                                              |  | 46
|SIGNATURE                                                                                     |  | 47



---

##### Table of Contents

VERAZ NETWORKS, INC AND SUBSIDIARIES

PART I. FINANCIAL INFORMATION

ITEM 
1. FINANCIAL STATEMENTS

Unaudited Condensed Consolidated Balance Sheets

(in thousands)



|                                           |  |                   |         |   |                  |   |         |  
|------------------------------------------ |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                           |  | September 30,2009 |         |   | December 31,2008 |  
|ASSETS                                     |  |                   |         |   |                  |   |         |  
|Current assets:                            |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                  |  | $                 | 15,937  |   |                  | $ | 35,388  |  
|Restricted cash                            |  |                   | 610     |   |                  |   | 604     |  
|Short-term investments                     |  |                   | 12,944  |   |                  |   | 2,650   |  
|Accounts receivable, net                   |  |                   | 30,679  |   |                  |   | 31,666  |  
|Inventories                                |  |                   | 8,317   |   |                  |   | 12,284  |  
|Prepaid expenses                           |  |                   | 1,953   |   |                  |   | 2,097   |  
|Deferred tax assets                        |  |                   |        |   |                  |   | 945     |  
|Other current assets                       |  |                   | 2,766   |   |                  |   | 3,674   |  
|Due from related parties                   |  |                   | 660     |   |                  |   | 912     |  
|                                           |  |                   |         |   |                  |   |         |  
|Total current assets                       |  |                   | 73,866  |   |                  |   | 90,220  |  
|Long-term investments                      |  |                   | 2,811   |   |                  |   |        |  
|Property and equipment, net                |  |                   | 3,532   |   |                  |   | 4,635   |  
|Other assets                               |  |                   | 128     |   |                  |   | 345     |  
|                                           |  |                   |         |   |                  |   |         |  
|Total assets                               |  | $                 | 80,337  |   |                  | $ | 95,200  |  
|                                           |  |                   |         |   |                  |   |         |  
|                                           |  |                  
|LIABILITIES AND STOCKHOLDERS EQUITY       |  |                   |         |   |                  |   |         |  
|Current liabilities:                       |  |                   |         |   |                  |   |         |  
|Accounts payable                           |  | $                 | 4,694   |   |                  | $ | 5,671   |  
|Accrued expenses                           |  |                   | 10,694  |   |                  |   | 13,204  |  
|Income tax payable                         |  |                   | 519     |   |                  |   | 354     |  
|Deferred revenue                           |  |                   | 13,853  |   |                  |   | 17,177  |  
|Due to related parties                     |  |                   | 1,255   |   |                  |   | 6,670   |  
|                                           |  |                   |         |   |                  |   |         |  
|Total current liabilities                  |  |                   | 31,015  |   |                  |   | 43,076  |  
|                                           |  |                   |         |   |                  |   |         |  
|Stockholders equity:                      |  |                   |         |   |                  |   |         |  
|Common stock                               |  |                   | 43      |   |                  |   | 43      |  
|Additional paid-in capital                 |  |                   | 132,061 |   |                  |   | 129,035 |  
|Deferred stock-based compensation          |  |                   |        |   |                  |   | (32     | )
|Accumulated other comprehensive income     |  |                   | 1,971   |   |                  |   | 268     |  
|Accumulated deficit                        |  |                   | (84,753 | ) |                  |   | (77,190 | )
|                                           |  |                   |         |   |                  |   |         |  
|Total stockholders equity                 |  |                   | 49,322  |   |                  |   | 52,124  |  
|                                           |  |                   |         |   |                  |   |         |  
|Total liabilities and stockholders equity |  | $                 | 80,337  |   |                  | $ | 95,200  |  
|                                           |  |                   |         |   |                  |   |         |  

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.



3



---

##### 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, |  
|                                                                                                                            |  | 2009                            |        |   | 2008                           |   |        | 2009 |  |   | 2008   |  
|Revenues:                                                                                                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|IP Products                                                                                                                 |  | $                               | 10,630 |   |                                | $ | 15,080 |      |  | $ | 33,635 |   |  | $ | 45,520  |  
|DCME Products                                                                                                               |  |                                 | 520    |   |                                |   | 2,215  |      |  |   | 2,428  |   |  |   | 5,030   |  
|Services                                                                                                                    |  |                                 | 7,546  |   |                                |   | 5,660  |      |  |   | 20,404 |   |  |   | 16,556  |  
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Total revenues                                                                                                              |  |                                 | 18,696 |   |                                |   | 22,955 |      |  |   | 56,467 |   |  |   | 67,106  |  
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Cost of Revenues:                                                                                                           |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|IP Products                                                                                                                 |  |                                 | 3,614  |   |                                |   | 5,344  |      |  |   | 13,565 |   |  |   | 18,527  |  
|DCME Products                                                                                                               |  |                                 | 211    |   |                                |   | 878    |      |  |   | 943    |   |  |   | 1,958   |  
|Services                                                                                                                    |  |                                 | 2,920  |   |                                |   | 3,148  |      |  |   | 8,769  |   |  |   | 10,982  |  
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Total cost of revenues                                                                                                      |  |                                 | 6,745  |   |                                |   | 9,370  |      |  |   | 23,277 |   |  |   | 31,467  |  
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Gross profit                                                                                                                |  |                                 | 11,951 |   |                                |   | 13,585 |      |  |   | 33,190 |   |  |   | 35,639  |  
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Operating Expenses:                                                                                                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Research and development, net                                                                                               |  |                                 | 4,527  |   |                                |   | 5,612  |      |  |   | 14,078 |   |  |   | 20,747  |  
|Sales and marketing                                                                                                         |  |                                 | 5,290  |   |                                |   | 8,158  |      |  |   | 17,457 |   |  |   | 22,957  |  
|General and administrative                                                                                                  |  |                                 | 2,088  |   |                                |   | 3,528  |      |  |   | 7,863  |   |  |   | 12,155  |  
|Restructuring charges                                                                                                       |  |                                 |       |   |                                |   | 794    |      |  |   |       |   |  |   | 794     |  
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Total operating expenses                                                                                                    |  |                                 | 11,905 |   |                                |   | 18,092 |      |  |   | 39,398 |   |  |   | 56,653  |  
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Income (loss) from operations                                                                                               |  |                                 | 46     |   |                                |   | (4,507 | )    |  |   | (6,208 | ) |  |   | (21,014 | )
|Other income (expense), net                                                                                                 |  |                                 | (123   | ) |                                |   | (1,061 | )    |  |   | 24     |   |  |   | 226     |  
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Loss before income taxes                                                                                                    |  |                                 | (77    | ) |                                |   | (5,568 | )    |  |   | (6,184 | ) |  |   | (20,788 | )
|Provision (benefit) for income taxes                                                                                        |  |                                 | 1,553  |   |                                |   | (155   | )    |  |   | 1,379  |   |  |   | (689    | )
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Net loss                                                                                                                    |  | $                               | (1,630 | ) |                                | $ | (5,413 | )    |  | $ | (7,563 | ) |  | $ | (20,099 | )
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Net loss per share  basic and diluted                                                                                      |  | $                               | (0.04  | ) |                                | $ | (0.13  | )    |  | $ | (0.17  | ) |  | $ | (0.48   | )
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Weighted average shares outstanding used in computing net loss per share  basic and diluted                                |  |                                 | 43,505 |   |                                |   | 42,233 |      |  |   | 43,354 |   |  |   | 41,877  |  
|                                                                                                                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|                                                                                                                            |  |                                 |        |  
|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, |  
|                                                                                                                            |  | 2009                            |        |   | 2008                           |   |        | 2009 |  |   | 2008   |  
|Revenues:                                                                                                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|IP Products, related party sales                                                                                            |  | $                               |       |   |                                | $ | 7      |      |  | $ | 40     |   |  | $ | 66      |  
|Cost of Revenues:                                                                                                           |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|IP Products, costs arising from related party purchases                                                                     |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   | 184     |  
|DCME Products, costs arising from related party purchases                                                                   |  |                                 | 187    |   |                                |   | 800    |      |  |   | 845    |   |  |   | 1,782   |  
|Services, costs arising from related party purchases                                                                        |  |                                 |       |   |                                |   | 45     |      |  |   | 22     |   |  |   | 135     |  
|Operating Expenses:                                                                                                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Research and development                                                                                                    |  |                                 | 20     |   |                                |   | 135    |      |  |   | 109    |   |  |   | 858     |  
|Sales and marketing                                                                                                         |  |                                 | 155    |   |                                |   | 1,679  |      |  |   | 854    |   |  |   | 3,234   |  
|General and administrative                                                                                                  |  |                                 | 57     |   |                                |   | 61     |      |  |   | 189    |   |  |   | 193     |  

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.



4



---

##### Table of Contents

VERAZ NETWORKS, INC AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)



|                                                                            |  |                                 |         |   |      |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                            |  | Nine Months Ended September 30, |        
|                                                                            |  | 2009                            |         |   | 2008 |  
|Cash flows from operating activities:                                       |  |                                 |         |   |      |   |         |  
|Net loss                                                                    |  | $                               | (7,563  | ) |      | $ | (20,099 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                 |         |   |      |   |         |  
|Depreciation                                                                |  |                                 | 1,992   |   |      |   | 2,579   |  
|Stock-based compensation                                                    |  |                                 | 3,000   |   |      |   | 3,328   |  
|Loss on disposal of assets                                                  |  |                                 |        |   |      |   | 37      |  
|Provision (release) for doubtful accounts                                   |  |                                 | (428    | ) |      |   | 1,282   |  
|Amortization of debt issuance cost                                          |  |                                 |        |   |      |   | 162     |  
|Deferred income taxes                                                       |  |                                 | 1,237   |   |      |   | (944    | )
|Non-cash restructuring charges                                              |  |                                 | (39     | ) |      |   | 37      |  
|Functional currency exchange gains                                          |  |                                 | (394    | ) |      |   |        |  
|Net changes in operating assets and liabilities:                            |  |                                 |         |   |      |   |         |  
|Accounts receivable                                                         |  |                                 | 3,723   |   |      |   | 5,887   |  
|Inventories                                                                 |  |                                 | 4,307   |   |      |   | (2,875  | )
|Prepaid expenses and other current assets                                   |  |                                 | 1,262   |   |      |   | 1,288   |  
|Due from related parties                                                    |  |                                 | 252     |   |      |   | (24     | )
|Accounts payable                                                            |  |                                 | (1,186  | ) |      |   | (6,913  | )
|Accrued expenses                                                            |  |                                 | (2,756  | ) |      |   | (4,828  | )
|Income tax payable                                                          |  |                                 | 132     |   |      |   | (51     | )
|Deferred revenue                                                            |  |                                 | (4,045  | ) |      |   | 2,865   |  
|Due to related parties                                                      |  |                                 | (5,415  | ) |      |   | (1,441  | )
|                                                                            |  |                                 |         |   |      |   |         |  
|Net cash used in operating activities                                       |  |                                 | (5,921  | ) |      |   | (19,710 | )
|                                                                            |  |                                 |         |   |      |   |         |  
|                                                                            |  |                                
|Cash flows from investing activities:                                       |  |                                 |         |   |      |   |         |  
|Restricted cash                                                             |  |                                 | (6      | ) |      |   |        |  
|Maturities and sales of short-term investments                              |  |                                 | 13,941  |   |      |   | 9,573   |  
|Purchases of short-term investments                                         |  |                                 | (24,232 | ) |      |   | (8,781  | )
|Purchases of long-term investments, net                                     |  |                                 | (2,811  | ) |      |   |        |  
|Purchases of property and equipment                                         |  |                                 | (805    | ) |      |   | (1,553  | )
|Other assets                                                                |  |                                 | (74     | ) |      |   | 8       |  
|                                                                            |  |                                 |         |   |      |   |         |  
|Net cash used in investing activities                                       |  |                                 | (13,987 | ) |      |   | (753    | )
|                                                                            |  |                                 |         |   |      |   |         |  
|                                                                            |  |                                
|Cash flows from financing activities:                                       |  |                                 |         |   |      |   |         |  
|Proceeds from the exercise of stock options                                 |  |                                 | 58      |   |      |   | 613     |  
|Repayment of loan                                                           |  |                                 |        |   |      |   | (2,696  | )
|                                                                            |  |                                 |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                         |  |                                 | 58      |   |      |   | (2,083  | )
|                                                                            |  |                                 |         |   |      |   |         |  
|Effect of exchange rate changes                                             |  |                                 | 399     |   |      |   | 109     |  
|                                                                            |  |                                 |         |   |      |   |         |  
|Net decrease in cash and cash equivalents                                   |  |                                 | (19,451 | ) |      |   | (22,437 | )
|Cash and cash equivalents at beginning of period                            |  |                                 | 35,388  |   |      |   | 52,232  |  
|                                                                            |  |                                 |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                  |  | $                               | 15,937  |   |      | $ | 29,795  |  
|                                                                            |  |                                 |         |   |      |   |         |  

See accompanying Notes to Unaudited Condensed Consolidated Financial
Statements.



5



---

##### Table of Contents

VERAZ NETWORKS, INC AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

NOTE 1  THE COMPANY

Veraz Networks, Inc., or 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 Companys
products to transport, convert and manage voice traffic over both legacy Time-Division Multiplexing, or TDM, and Internet Protocol, or 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 the Company 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, 2009 and for the three and nine months ended
September 30, 2009 and 2008 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, 2008.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, pursuant to the rules
and regulations of the Securities and Exchange Commission, or 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, 2008, and include adjustments
(consisting of normal recurring adjustments) necessary for the fair presentation of the Companys financial position as of September 30, 2009, results of operations for the three and nine months ended September 30, 2009 and 2008, and
cash flows for the nine months ended September 30, 2009 and 2008. In the three and nine month periods ended September 30, 2009, other income (expense) included an additional expense of $0.4 million resulting from the correction of prior
period error. The Company determined that the amount was immaterial to the full fiscal year results.

The Company has
evaluated subsequent events through the date that the financial statements were issued on November 16, 2009 and determined that no subsequent events have occurred which would require disclosure or adjustment to the condensed consolidated
financial statements.

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 in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions about
future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. Such estimates include the
valuation of accounts receivable, inventories, and deferred tax assets, among others. These estimates and assumptions are based on managements best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis
using historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. The Company adjusts such estimates and assumptions when facts and circumstances dictate.
Illiquid credit markets, volatile equity, foreign currency, and energy markets, and declines in consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be
determined with precision, actual results could differ significantly from these estimates. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.

(b) Concentrations

Cash and cash equivalents are maintained with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be
redeemed upon demand and therefore bear minimal risk.



6



---

##### Table of Contents

Declining business and consumer confidence have resulted in an economic slowdown and a
global recession. Continuing market upheavals, including specifically the lack of credit currently available in the market, may have an adverse effect on the Company due to its dependence on capital budgets and customer confidence and customer
dependence on obtaining credit to finance purchases of the products. The 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 the business. In an economic slowdown characterized by lower corporate earnings, lower business investment, fewer options to obtain credit, the demand for the Companys
products could be adversely affected. Adverse changes in the economy could affect earnings negatively and could have a material adverse effect on the business, results of operations and financial condition.

The Company performs credit evaluations of its customers and, with the exception of certain financing transactions, does not require
collateral from its customers. However, when the Company uses integrators or resellers affiliated with ECI Telecom, a related party, from time to time, prior to fulfillment of the Companys order for a particular customer, ECI Telecom has
requested that the Company obtain either a letter of credit or accounts receivable insurance to mitigate any collection risk (see Note 5).

Pursuant to a master manufacturing and master agreement with ECI Telecom, a related party, the Company derives a portion of its revenues from sales of its line of voice compression telecommunications
products, or Digital Circuit Multiplication Equipment, or DCME, products (3% and 4% of revenues during the three and nine months ended September 30, 2009, respectively and 10% and 7% of revenues during the three and nine months ended
September 30, 2008, respectively) and related services (4% of revenues during each of the three and nine months ended September 30, 2009 and 4% and 5% of revenues each during the three and nine months ended September 30, 2008,
respectively).

The Company receives certain of its components from other sole suppliers. Additionally, the Company relies on
a limited number of contract manufacturers to provide manufacturing services for its products. The inability of any contract manufacturer, supplier or ECI Telecom to fulfill supply requirements of the Company could materially impact the
Companys future operating results.

The substantial majority of the manufacturing of the Companys hardware
products occurs in Israel. In addition, a significant portion of the Companys operations are 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.

One customer,
Rostelecom, contributed to 13% of the Companys revenues in the three months ended September 30, 2009. Two customers, Vimpelcom and Sky2net Limited, contributed 14% and 12% of the Companys revenues in the three months ended
September 30, 2008, respectively. No customer contributed to 10% or more of the Companys revenues in the nine months ended September 30, 2009 or 2008. One customer, VIVO S/A, accounted for 10% or more of the Companys accounts
receivable as of September 30, 2009 and no customer accounted for 10% or more of accounts receivable as of December 31, 2008. To date, the Company has not experienced any material credit issues with Rostelecom or VIVO S/A.

(c) Revenue Recognition

DCME product revenues consist of revenues from the sale of the DCME hardware products. IP product revenues consists of revenues from the sale of the I-Gate 4000 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, or PCS, installation
training and other professional services.

Based on the revenue recognition guidelines, revenue should not be recognized until
it is realized or realizable and earned pursuant to the criteria discussed below. Generally, revenue from standalone sales of DCME products is recognized upon shipment of products and transfer of title. When sales of DCME are bundled with
installation services, the hardware and services are accounted as separate units of accounting as the deliverables meet the separation criteria.Revenue for each deliverable is recognized upon the shipment of products for hardware and
software and completion of services.

All of the Companys IP products may be sold in bundled arrangements that include
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.



7



---

##### Table of Contents

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

Delivery of hardware and software products generally occurs at the point of shipment when title and risk of loss have passed to the customer.
However, initial 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 on the initial VOIP solution arrangement or the Company has completed its contractual requirements.
Historically, the Company has successfully implemented all subsequent sales of VOIP solutions. Accordingly, as of the beginning of January 2009, revenue recognition on subsequent sales of VOIP solutions after the initial arrangement has been
accepted from the customer typically occurs at the time of shipment when title and risk of loss have passed to the customer since the additional equipment is merely an expansion of the customers already existing working network. The revenue
impact related to subsequent sales of VOIP solutions on the financial statements for the three and nine months ended September 30, 2009 were zero and $0.2 million, respectively.

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

(iii) The fee is fixed or determinable

The Company does not offer a right of return to its customers. Arrangement fees are generally due within one year or less from date of acceptance, or the date of delivery if no acceptance, if required.
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 vendor specific objective
evidence, or 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.

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.

(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.

For most arrangements, the
Company has established VSOE for the related PCS based on stated renewal rates and installation services based on the price charged when the same element is sold separately. Accordingly, the Company generally allocates revenue in multiple element
arrangements 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.



8



---

##### Table of Contents

Revenues include amounts billed to customers in sales transactions for shipping and
handling. Shipping and handling fees represented less than 1% of revenues in each of the nine months ended September 30, 2009 and 2008. 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

The Company invests in short-term and long-term investments. The short-term investments are debt and marketable equity securities and are
classified as available-for-sale. The Companys long-term investment consists of a certificate of deposit security which is classified as a 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 current earnings. 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, or 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, 2009 and 2008 amounted to $0.3 million and $0.4 million, respectively. Royalty expenses relating to OCS grants included in cost of IP product revenues for the nine months ended
September 30, 2009 and 2008 amounted to $1.1 million in each period. As of September 30, 2009 and December 31, 2008, the royalty payable amounted to $0.6 million and $1.2 million, respectively. The maximum amount of the contingent
liability related to royalties payable to the Israeli Government was approximately $16.2 million as of September 30, 2009.

(f) Comprehensive Loss

The components of comprehensive loss for the three and nine months ended
September 30, 2009 and 2008 were as follows (in thousands):



|                                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|---------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                         |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                         |  | 2009                            |        |   | 2008                           |   |        | 2009 |  |   | 2008   |  
|Net loss                                 |  | $                               | (1,630 | ) |                                | $ | (5,413 | )    |  | $ | (7,563 | ) |  | $ | (20,099 | )
|Foreign currency translation adjustments |  |                                 | 584    |   |                                |   | (109   | )    |  |   | 1,702  |   |  |   | (109    | )
|                                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Total Comprehensive loss                 |  | $                               | (1,046 | ) |                                | $ | (5,522 | )    |  | $ | (5,861 | ) |  | $ | (20,208 | )
|                                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  

(g) Stock-Based Compensation

Stock-based compensation cost is estimated at the grant date based on the awards fair-value as calculated by the Black-Scholes
option-pricing model and is recognized as expense on a straight-line basis over the requisite service period. This model requires various judgment-based assumptions including expected volatility, forfeiture rates, and expected option life.
Significant changes in any of these assumptions could materially affect the fair value of stock-based awards granted in the future; specifically, any changes in assumptions for expected volatility and expected life significantly affect the grant
date fair value. Changes in the expected dividend rate and expected risk-free rate of return do not significantly impact the calculation of fair value, and determining these inputs is not highly subjective. The expected term represents the period
that stock-based awards are expected to be outstanding, giving consideration to the contractual terms of the stock-based awards, vesting schedules, and expectations of future employee behavior as influenced by changes to the terms of our stock-based
awards. The Company determined the expected term in accordance with the simplified method. Under this approach, the expected term would be presumed to be the mid-point between the vesting date and the end of the contractual term. The use
of this approach, with appropriate disclosure, was permitted for a plain vanilla employee stock option for which the value was estimated using a Black-Scholes formula. The computation of expected volatility is based on the historical and
implied volatility of comparable companies from a representative peer group based on industry and market capitalization data.



9



---

##### Table of Contents

(h) Foreign Currency Translation

For foreign subsidiaries using the U.S. dollar as their functional currency, transactions and monetary balances denominated in
non-dollar currencies are remeasured into dollars using current exchange rates. Transaction gains or losses are recorded in other income (expense), net. For foreign subsidiaries using the local currency as their functional currency, assets and
liabilities are translated at exchange rates in effect at the balance sheet date and income and expenses are translated at average exchange rates. The effect of these translation adjustments are reported as a separate component of stockholders
equity (See Comprehensive Loss note 3(f) above).

(i) Foreign Currency Forward Contracts

The Company enters into forward foreign exchange contracts in which the counterparty is generally a bank. The Company purchases forward
foreign exchange contracts to mitigate the risk of changes in foreign exchange rates on certain expenses denominated in New Israeli Shekels. Although the Company believes that these contracts are effective as hedges from an economic perspective,
they do not qualify for hedge accounting. Any derivative that is either not designated as a hedge, or is so designated but is ineffective, is recorded at fair value and changes in fair value are recognized in other income (expense), as they are
incurred. As of September 30, 2009, the Company had $2.9 million in outstanding forward contracts for the purchase of new Israeli shekels. The outstanding forward contracts generally have maturities of approximately one to nine months from the
date into which they were entered and expire at or near the end of the month. As of September 30, 2009, the outstanding contracts expire at various dates between October 2009 and December 2009. During the three and nine months ended
September 30, 2009, the benefit of the forward contracts recorded in other income, net was a total of $0.2 million and $0.4 million, respectively. During the three and nine months ended September 30, 2008, the Company did not purchase any
forward contracts.

(j) Recent Accounting Pronouncements

FASB Accounting Standards Codification

In June 2009, the Financial Accounting Standards Board, or FASB, issued the FASB Accounting Standards Codification, or the Codification, which provides authoritative guidance for GAAP. The Codification,
which changes the referencing of financial standards, became effective for interim and annual periods ending on or after September 15, 2009. The Codification is now the single official source of authoritative U.S. GAAP (other than guidance
issued by the SEC), superseding existing FASB, American Institute of Certified Public Accountants, Emerging Issues Task Force, or EITF, and related literature. Only one level of authoritative U.S. GAAP now exists. All other literature is considered
non-authoritative. The Codification does not change U.S. GAAP. The Company adopted the Codification during the third quarter of 2009. The adoption of the Codification did not have any substantive impact on our condensed consolidated financial
statements or related footnotes.

Fair Value Measurements and Disclosures

In August 2009, the FASB issued Accounting Standards Codification, or ASC No. 2009-05Fair Value Measurements and Disclosures
(Topic 820): Measuring Liabilities at Fair Value. This update provides clarifications for the fair value measurement of liabilities in circumstances in which a quoted price in an active market for the identical liability is not available.
The new guidance is effective for interim and annual periods beginning after August 27, 2009, and applies to all fair-value measurements of liabilities required by GAAP. No new fair-value measurements are required by the standard. The Company
does not have long-term liabilities. The adoption of this statement did not have any material impact on the Companys financial condition or operating results for the quarter ended September 30, 2009.

In April 2009, the FASB issued authoritative guidance included in ASC 820, Fair Value Measurements and Disclosures (previously FSP
FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That are not Orderly), for estimating fair value when the market activity for an
asset or liability has declined significantly. The Company adopted the guidance in the second quarter of 2009. The adoption of the guidance did not have a significant impact on the condensed consolidated financial statements or related footnotes.

In April 2009, the FASB issued authoritative fair value disclosure guidance included in ASC 825, Financial Instruments
(previously FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments), for financial instruments. The guidance requires disclosures for interim reporting periods of publicly traded companies as well as in
annual financial statements. The guidance also requires those disclosures in summarized financial information at interim reporting periods. The Company adopted the guidance in the second quarter of 2009. The adoption of the guidance did not have a
significant impact on the condensed consolidated financial statements or related footnotes.



10



---

##### Table of Contents

In September 2006, the FASB issued authoritative guidance included in ASC 820 Fair Value
Measurements and Disclosures (previously SFAS 157 Fair Value Measurements and FSP FAS 157-2 Effective Date of FASB Statement No. 157) for fair value measurements, which defines fair value, establishes a framework and gives
guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurement. The Company adopted the guidance in the first quarter of 2009. The adoption of the guidance did not have a significant impact on the
condensed consolidated financial statements or related footnotes.

Measurement of Other-Than-Temporary Impairments

Authoritative guidance included in ASC 320 Investments Debt and Equity Securities (previously FSP FAS 115-2 and FAS 124-2
Recognition and Presentation of Other-Than-Temporary Impairments) is intended to bring consistency to the timing of impairment recognition, and provide improved disclosures about the credit and noncredit components of impaired debt securities that
are not expected to be sold. The guidance also requires interim disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. The Company adopted the guidance in the second quarter of 2009. As of
September 30, 2009, the unrealized losses were zero. The adoption of the statements did not have an impact on the Companys financial condition or operating results.

Subsequent Events

In May 2009, the FASB issued authoritative guidance included in ASC 855, Subsequent Events (previously SFAS 165 Subsequent Events), to incorporate accounting and disclosure requirements related to subsequent events into GAAP,
making management responsible for subsequent-events accounting and disclosure. The Company adopted the guidance in the second quarter of 2009. The adoption of this statement did not have any material impact on its financial condition or operating
results for the quarter ended September 30, 2009.

Derivative Instruments and Hedging Activities

In March 2008, the FASB issued the FASB ASC 815 Derivative and Hedging (previously SFAS 161 Disclosures about Derivative
Instruments and Hedging Activities). The guidance 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 the literature 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. The Company adopted the literature in the first quarter of 2009 and it requires enhanced disclosures, without a change to existing standards relative to measurement and recognition. The Companys adoption of the
literature did not have any effect on its earnings or financial position.

Business Combination

In December 2007, the FASB issued FASB ASC 805, Business Combinations (previously SFAS No. 141 (revised 2007), Business
Combinations), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree in a
business combination. Under this guidance, an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. The guidance further
requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred; that restructuring costs generally be expensed in periods subsequent to the acquisition date; and that changes in accounting for deferred
tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. In addition, acquired in-process research and development is capitalized as an intangible asset
and amortized over its estimated useful life. The Company adopted the guidance in the first quarter of 2009,

Revenue
Recognition

In October 2009, the FASB issued FASB Accounting Standards Update, or FASB ASU 2009-13Revenue
Recognition (Topic 605): Multiple-Deliverable Revenue Arrangementsa consensus of the FASB Emerging Issues Task Force,or ASU 2009-13. ASU 2009-13 addresses how to measure and allocate arrangement consideration to one or more units of
accounting within a multiple-deliverable arrangement. The new guidance states that if vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, companies will be required to develop a best
estimate of the selling price to separate deliverables and allocate arrangement consideration using the relative selling price method. The accounting guidance will be applied prospectively and will become effective during the first quarter of 2011.
Early adoption is allowed. The company is currently evaluating the impact of this accounting guidance on its consolidated financial statements.



11



---

##### Table of Contents

In October 2009, the FASB issued ASU No. 2009-14Software (Topic 985): Certain
Revenue Arrangements That Include Software Elementsa consensus of the FASB Emerging Issues Task Force, orASU 2009-14. Previously, companies that sold tangible products with more than incidental software were required to apply
software revenue recognition guidance. This guidance often delayed revenue recognition for the delivery of the tangible product. Under the new guidance, tangible products that have software components that are essential to the
functionality of the tangible product will be excluded from the software revenue recognition guidance. The new guidance will include factors to help companies determine what is essential to the functionality. Software-enabled
products will now be subject to other revenue guidance and will likely follow the guidance for multiple deliverable arrangements issued by the FASB in September 2009. The new guidance is to be applied on a prospective basis for revenue arrangements
entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. If a vendor elects earlier application and the first reporting period of adoption is not the first reporting period in
the vendors fiscal year, the guidance must be applied through retrospective application from the beginning of the vendors fiscal year and the vendor must disclose the effect of the change to those previously reported periods. The company
is currently evaluating the impact of this accounting guidance on its consolidated financial statements.

NOTE 4  FINANCIAL
INSTRUMENTS

Assets are measured and recorded at fair value on a recurring basis for cash, cash equivalents, and short-term
and long-term available-for-sale securities, excluding accrued interest components, as presented on the Companys consolidated condensed balance sheets as of September 30, 2009 and December 31, 2008. A summary of cash, cash
equivalents, and short-term and long-term available-for-sale securities as of September 30, 2009 and December 31, 2008 were as follows (in thousands):



|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|------------------------------- |  | --------------------- | - |  | ------------- | ------ | ------------------------ | - | ---------------- |  | - | ------
|Security Description            |  | Percentage ofholdings |   |  | AmortizedCost |        | UnrealizedGains (Losses) |   | Fair MarketValue
|September 30, 2009              |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Cash and Cash equivalents:      |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Money market funds              |  | 100                   | % |  | $             | 8,380  |                          | $ |                 |  | $ | 8,380 
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Total cash and cash equivalents |  | 100                   | % |  | $             | 8,380  |                          | $ |                 |  | $ | 8,380 
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|                                |  |                       |   | 
|Short-term investments:         |  |                       |   |  |               |        |                          |   |                  |  |   |       
|U.S. Treasury bills             |  | 100                   | % |  | $             | 12,937 |                          | $ | 7                |  | $ | 12,944
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Total short-term investments    |  | 100                   | % |  | $             | 12,937 |                          | $ | 7                |  | $ | 12,944
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|                                |  |                       |   | 
|Long-term investments:          |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Certificate of deposit          |  | 100                   | % |  | $             | 2,811  |                          | $ |                 |  | $ | 2,811 
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Total long-term investments     |  | 100                   | % |  | $             | 2,811  |                          | $ |                 |  | $ | 2,811 
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|                                |  |                       |   | 
|December 31, 2008               |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Cash and Cash equivalents:      |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Money market funds              |  | 92                    | % |  | $             | 20,918 |                          | $ |                 |  | $ | 20,918
|U.S. Treasury bills             |  | 8                     | % |  |               | 1,700  |                          |   |                 |  |   | 1,700 
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Total cash and cash equivalents |  | 100                   | % |  | $             | 22,618 |                          | $ |                 |  | $ | 22,618
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|                                |  |                       |   | 
|Short-term investments:         |  |                       |   |  |               |        |                          |   |                  |  |   |       
|U.S. Treasury bills             |  | 100                   | % |  | $             | 2,650  |                          | $ |                 |  | $ | 2,650 
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       
|Total short-term investments    |  | 100                   | % |  | $             | 2,650  |                          | $ |                 |  | $ | 2,650 
|                                |  |                       |   |  |               |        |                          |   |                  |  |   |       

Cash equivalents consist of instruments with remaining maturities of three months or
less at the date of purchase.

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, on available-for-sale securities are included as a
separate component of stockholders equity. Contractual maturities of available-for-sale short-term securities at September 30, 2009 are due within 12 months.

The long-term investment held by the Company was classified as available-for-sale. The Company invested in a highly liquid certificate of
deposit security denominated in Brazilian Real that will mature in 2011. Interest is paid monthly and the Company can withdraw the deposit with a penalty of the current months interest. The interest earned during the period is included in the
Other Income of Condensed Consolidated Statements of Operations. The Contractual maturity of the available-for-sale long-term security at September 30, 2009 is greater than 12 months.



12



---

##### Table of Contents

For other-than-temporary impairments, the Company discloses the gross unrealized losses and
fair value for those investments that were in an unrealized loss position and have been in a continuous loss position. As of September 30, 2009 and December 31, 2008, the gross unrealized losses were zero.

The before-tax net unrealized holding gains (losses) on available-for-sale investments that have been included in accumulated other
comprehensive income (loss) and the before-tax net gains (losses) reclassified from accumulated other comprehensive income (loss) into earnings were immaterial for all periods presented.

Fair Value Measurements of Financial Instruments

The Companys portfolio manager utilizes a third party pricing services, Interactive Data Corporation, to determine the fair value of the Companys short-term securities. The Company measures
its fixed income and long-term investments available-for-sale securities assets at fair value on a recurring basis and has determined that these financial assets were level 1 and 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, 2009 (in thousands):



|                                           |  |       |        |                                                             |   |                                            |  |                                        |        |  |   |  
|------------------------------------------ |  | ----- | ------ | ----------------------------------------------------------- | - | ------------------------------------------ |  | -------------------------------------- | ------ |  | - | -
|                                           |  |       |        | Fair Value at Reporting Date Using                         
|                                           |  | Total |        | Quoted prices inactive markets foridentical assets(Level 1) |   | Significant otherobservableinputs(Level 2) |  | Significantunobservableinputs(Level 3)
|Assets:                                    |  |       |        |                                                             |   |                                            |  |                                        |        |  |   |  
|Fixed income available-for-sale securities |  | $     | 12,944 |                                                             | $ |                                           |  | $                                      | 12,944 |  | $ | 
|Money market funds                         |  |       | 8,380  |                                                             |   | 8,380                                      |  |                                        |       |  |   | 
|Long-term investment                       |  |       | 2,811  |                                                             |   | 2,811                                      |  |                                        |       |  |   | 
|                                           |  |       |        |                                                             |   |                                            |  |                                        |        |  |   |  
|                                           |  | $     | 24,135 |                                                             | $ | 11,191                                     |  | $                                      | 12,944 |  | $ | 
|                                           |  |       |        |                                                             |   |                                            |  |                                        |        |  |   |  

NOTE 5  RELATED PARTY TRANSACTIONS

ECI Telecom:

As a result of the acquisition of Veraz Networks Ltd. and Veraz Networks International in December 2002, at September 30, 2009 ECI Telecom held approximately 25% of the Companys outstanding common stock. The Company is the
exclusive worldwide distributor of the DCME line of products, or DCME, for ECI Telecom under the DCME Master Manufacturing and Distribution Agreement, or the 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 Telecom 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, 2009. The DCME Agreement may only be terminated by ECI
Telecom 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. As
result of the DCME agreement with ECI Telecom, the Company does not currently have an independent ability to produce DCME products and has not entered into arrangements with any third party that would enable the Company to obtain DCME or similar
products in the event that ECI Telecom ceases to provide DCME products to the Company. Should ECI Telecom become unable or unwilling to fulfill its obligations under the DCME Agreement for any reason or if the DCME Agreement is terminated, the
Company will need to take remedial measures to manufacture DCME or similar products, which could be expensive, and if such efforts fail, the Companys business would be materially harmed.

The Company pays ECI Telecom a purchase price for the DCME product that is computed as a percentage of revenue. The percentage of revenue
that the Company pays has remained unchanged during the nine months ended September 30, 2009 and year ended December 31, 2008. From time to time, prior to fulfillment of the Companys order for a particular customer, ECI Telecom 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 condensed consolidated
statements of operations.



13



---

##### Table of Contents

The Company historically also contracted with ECI Telecom for the use of certain of its
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 recorded 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 revenues, in the condensed consolidated statements of operations, depending on the nature of the products sold. The Company also reimbursed these subsidiaries for certain operating expenses, such as local sales and marketing support. The
Company also historically contracted with ECI Telecom and certain of its 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 condensed consolidated statements of operations. All such relationships (other than in Israel), however, have been terminated.

The Company had appointed ECI Telecom as an agent for selling IP and DCME products and services in Russia and other countries from the former Soviet Union. The Company compensated ECI Telecom for agent
services in Russia by paying a commission based on sales. Further, the Company had appointed ECI 2005, an affiliate of ECI Telecom, as a partner to provide services directly to customers in Russia. Effective as of April 30, 2009, ECI Telecom
and the Company mutually agreed to terminate the appointment of ECI Telecom as a selling agent and the appointment of ECI 2005 as partner to provide services. Following termination of the appointment of ECI Telecom as selling agent, the Company is
still obligated to pay ECI Telecom agent fees related to certain specified accounts for any sales completed by October 31, 2009. At certain times, the Companys Russian customers purchased installation, training and maintenance services
from ECI 2005. To the extent ECI 2005 needed assistance in providing installation, training and maintenance services to its customers in Russia, these services were available from the Company. The Company also reimbursed 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 was for an eleven month period, and the monthly rent was equal to
approximately $15,000. The sublease was extended and eventually terminated as of March 31, 2009. ECI 2005 rent was included in services and cost of revenues in the condensed consolidated statements of operations for the nine months ended
September 30, 2009.

In January 2008, the Company entered into a sublease agreement with ECI Telecom
that commenced on May 1, 2008 for office space of 5,950 square feet in Florida. The Company has the right to terminate this sublease on the date immediately preceding the fourth, sixth or eighth annual anniversary of the commencement date and
the 12thanniversary 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, 2009, ECI Telecom rent is included in general and administrative expense in the condensed consolidated statements of
operations. Additionally, the Company entered into a consulting agreement with ECI Telecom for ECI personnel to provide certain logistical support services at the Florida facility but terminated that agreement effective as of June 30, 2009.

Effective June 30, 2009, the Company and ECI Telecom entered into a Settlement Agreement and General Release (Settlement
Agreement) relating to a variety of outstanding commercial issues between the parties. The Settlement Agreement effected a mutual release of certain outstanding commercial issues and other claims as of the date of the Settlement Agreement. The
Settlement Agreement did not materially impact the Companys financial statements. Some payments under the Settlement Agreement were made in July 2009.

Persistent Systems Pvt Ltd:

On October 1, 2003, the Company
entered into a Contractor Agreement with Persistent Systems Pvt. Ltd., or 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. In 2008, as part of the restructuring activity, the Company cancelled most of the contracted services with Persistent, but has retained some services for a limited transition period. During the three
months ended September 30, 2009 and 2008, the Company incurred related party research and development expenses owed to Persistent under the Contractor Agreement of zero and $0.1 million, respectively. During the nine months ended
September 30, 2009 and 2008, the Company incurred related party research and development expenses owed to Persistent under the Contractor Agreement of $43,000 and $0.8 million, respectively. As of September 30, 2009 and December 31,
2008, the Company had related party payables to Persistent in the amount of approximately $29,000 and $37,000, respectively.



14



---

##### Table of Contents

NOTE 6  INVENTORIES

The following tables provide details of inventories as of September 30, 2009 and December 31, 2008 (in thousands):



|                                        |  |                   |       |                  |   |       
|--------------------------------------- |  | ----------------- | ----- | ---------------- | - | ------
|                                        |  | September 30,2009 |       | December 31,2008
|Finished products                       |  | $                 | 2,835 |                  | $ | 4,217 
|Work in process at customers locations |  |                   | 2,207 |                  |   | 5,060 
|Raw material and components             |  |                   | 3,275 |                  |   | 3,007 
|                                        |  |                   |       |                  |   |       
|                                        |  | $                 | 8,317 |                  | $ | 12,284
|                                        |  |                   |       |                  |   |       

Inventories are stated at the lower of cost or market value 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 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  STOCK-BASED COMPENSATION

The following table summarizes the effects of stock-based compensation (in thousands):



|                                       |  |                                 |     |                                |   |       |  |      |       |  |   |      
|-------------------------------------- |  | ------------------------------- | --- | ------------------------------ | - | ----- |  | ---- | ----- |  | - | -----
|                                       |  | Three Months EndedSeptember 30, |     | Nine Months EndedSeptember 30,
|                                       |  | 2009                            |     | 2008                           |   | 2009  |  | 2008
|Cost of revenues                       |  | $                               | 225 |                                | $ | 209   |  | $    | 732   |  | $ | 664  
|Research and development               |  |                                 | 204 |                                |   | 282   |  |      | 946   |  |   | 1,040
|Sales and marketing                    |  |                                 | 225 |                                |   | 313   |  |      | 807   |  |   | 979  
|General and administrative             |  |                                 | 142 |                                |   | 221   |  |      | 515   |  |   | 645  
|                                       |  |                                 |     |                                |   |       |  |      |       |  |   |      
|Total stock-based compensation expense |  | $                               | 796 |                                | $ | 1,025 |  | $    | 3,000 |  | $ | 3,328
|                                       |  |                                 |     |                                |   |       |  |      |       |  |   |      

Stock Options:

During the three and nine months ended September 30, 2009, the Company granted zero stock options. During the three and nine months
ended September 30, 2008, the Company granted 1,355,000 and 1,475,000 stock options, respectively.

The Company estimated
the fair value of stock options granted using the Black-Scholes option-pricing model. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The expected
term represents the period that stock-based awards are expected to be outstanding, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to
the terms of the Companys stock-based awards. The expected term was determined in accordance with the simplified method. Under this approach, the expected term would be presumed to be the mid-point between the vesting date and the
end of the contractual term. The use of this approach, with appropriate disclosure, was permitted for a plain vanilla employee stock option for which the value was estimated using a Black-Scholes formula.

Accordingly, the Company will continue to use the simplified method until it has enough historical experience to provide a reasonable
estimate of expected term. The computation of expected volatility is based on the historical and implied volatility of comparable companies from a representative peer group based on industry and market capitalization data. Management makes an
estimate of expected forfeitures and recognizes compensation costs only for those equity awards expected to vest. 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.



15



---

##### Table of Contents

The following weighted average assumptions were used to value options granted during the
three and nine months ended September 30, 2008:



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

During the three months ended September 30, 2009 and 2008, the compensation
expense on stock options, including deferred stock-based compensation, amounted to $0.2 million and $0.4 million, respectively. During the nine months ended September 30, 2009 and 2008, the compensation expense on stock options, including
deferred stock-based compensation, amounted to $1.0 million and $1.3 million, respectively.

Restricted Stock Awards:

During the three months ended September 30, 2009 and 2008, the Company granted 499,375 and 40,000 restricted stock units,
or RSUs, respectively. For the three months ended September 30, 2009 and 2008, the weighted average grant date fair value per share of RSUs granted was $0.77 and $0.91, respectively. During the nine months ended September 30, 2009 and
2008, the Company granted 991,125 and 1,099,105 of RSUs, respectively. For the nine months ended September 30, 2009 and 2008, the weighted-average grant date fair value per share of RSUs granted was $0.63 and $4.71, respectively.

During the three months ended September 30, 2009 and 2008, the compensation expense on restricted stock based awards amounted to $0.6
million in each period. During the nine months ended September 30, 2009 and 2008, the compensation expense on restricted stock based awards amounted to $2.0 million in each period.

Restricted stock activity as of September 30, 2009 was as follows:



|                                |  |                 |   |  |                                      |     
|------------------------------- |  | --------------- | - |  | ------------------------------------ | ----
|                                |  | Number ofShares |   |  | WeightedAverage GrantDate Fair Value
|Nonvested at December 31, 2008  |  | 1,616,030       |   |  | $                                    | 3.75
|Granted                         |  | 991,125         |   |  | $                                    | 0.63
|Vested                          |  | (619,889        | ) |  | $                                    | 4.15
|Forfeited or expired            |  | (37,306         | ) |  | $                                    | 4.77
|                                |  |                 |   |  |                                      |     
|Nonvested at September 30, 2009 |  | 1,949,960       |   |  | $                                    | 2.02
|                                |  |                 |   |  |                                      |     

As of September 30, 2009, 1,949,960 million shares of restricted stock
based awards were outstanding and unvested, with an aggregate intrinsic value of $1.8 million.

Most of the RSUs vest over
four years in equal installments on each of the first through fourth anniversaries of the vesting commencement date. Upon vesting, the RSUs will convert into an equivalent number of shares of common stock. The amount of the expense related to RSUs
is based on the closing market price of the Companys common stock on the date of grant and is amortized on a straight-line basis over the requisite service period.



16



---

##### Table of Contents

Stock Award Activity:

A summary of the Companys stock award activity and related information for the nine months ended September 30, 2009 is set forth
in the following table:



|                                                          |  |                                   |   |  |                             |   |  |                              |      |                                           |      |                         |   |        
|--------------------------------------------------------- |  | --------------------------------- | - |  | --------------------------- | - |  | ---------------------------- | ---- | ----------------------------------------- | ---- | ----------------------- | - | -------
|                                                          |  | Number ofSharesAvailable forGrant |   |  | Number ofOptionsOutstanding |   |  | WeightedAverageExercisePrice |      | WeightedAverageContractualLife (in years) |      | AggregateIntrinsicValue
|Balance at December 31, 2008                              |  | 320,161                           |   |  | 6,094,423                   |   |  | $                            | 1.54 |                                           | 6.69 |                         | $ | 127,358
|Authorized                                                |  | 1,285,651                         |   |  |                             |   |  |                              |      |                                           |      |                         |   |        
|Restricted stock units granted                            |  | (991,125                          | ) |  |                             |   |  |                              |      |                                           |      |                         |   |        
|Restricted stock units cancelled and forfeited            |  | 37,306                            |   |  |                             |   |  |                              |      |                                           |      |                         |   |        
|Options granted                                           |  |                                  |   |  |                             |   |  |                              |      |                                           |      |                         |   |        
|Options exercised                                         |  |                                  |   |  | (95,133                     | ) |  | $                            | 0.35 |                                           |      |                         |   |        
|Options cancelled and forfeited                           |  | 116,876                           |   |  | (116,876                    | ) |  | $                            | 1.78 |                                           |      |                         |   |        
|                                                          |  |                                   |   |  |                             |   |  |                              |      |                                           |      |                         |   |        
|Balance at September 30, 2009                             |  | 768,869                           |   |  | 5,882,414                   |   |  | $                            | 1.55 |                                           | 6.00 |                         | $ | 891,185
|Options vested and expected to vest at September 30, 2009 |  |                                   |   |  | 5,769,651                   |   |  | $                            | 1.54 |                                           | 5.95 |                         | $ | 891,185
|Options exercisable at September 30, 2009                 |  |                                   |   |  | 4,632,873                   |   |  | $                            | 1.38 |                                           | 5.32 |                         | $ | 891,185

NOTE 8  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. During the three months ended
September 30, 2008, the Company incurred total restructuring charges of $0.8 million. During the three months ended March 31, 2009, the Company released an accrual for $39,000 and all related balances were paid in full as of March 31,
2009.

NOTE 9  NET LOSS ALLOCABLE TO COMMON STOCKHOLDERS PER SHARE

Net loss allocable to common stockholders per share is computed 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.

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



|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|-------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                     |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                     |  | 2009                            |        |   | 2008                           |   |        | 2009 |  |   | 2008   |  
|Numerator:                                                           |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Net loss                                                             |  | $                               | (1,630 | ) |                                | $ | (5,413 | )    |  | $ | (7,563 | ) |  | $ | (20,099 | )
|                                                                     |  |                                 |        |  
|Denominator:                                                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Basic weighted-average shares:                                       |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Weighted-average shares used in computing basic net loss per share   |  |                                 | 43,505 |   |                                |   | 42,233 |      |  |   | 43,354 |   |  |   | 41,877  |  
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Basic net loss per common share                                      |  | $                               | (0.04  | ) |                                | $ | (0.13  | )    |  | $ | (0.17  | ) |  | $ | (0.48   | )
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|                                                                     |  |                                 |        |  
|Diluted weighted-average shares:                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Weighted-average shares used in computing diluted net loss per share |  |                                 | 43,505 |   |                                |   | 42,233 |      |  |   | 43,354 |   |  |   | 41,877  |  
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Diluted net loss per common share                                    |  | $                               | (0.04  | ) |                                | $ | (0.13  | )    |  | $ | (0.17  | ) |  | $ | (0.48   | )
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Anti-dilutive shares excluded from net loss per share calculation    |  |                                 | 4,955  |   |                                |   | 3,485  |      |  |   | 5,171  |   |  |   | 2,428   |  
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  



17



---

##### Table of Contents

NOTE 10  SEC INVESTIGATION

On April 3, 2008, the Company received a letter from the SEC informing it that the SEC was conducting a confidential inquiry, or 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, or 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. Keker & Van Nest LLP, or Independent Counsel, was retained as
independent counsel to conduct an investigation. Keker & Van Nest LLP had not previously represented the Company in any matters. 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. The Company provided all the requested documents to SEC. As a result of the SEC Inquiry, the
Company was not able to file timely its quarterly report on Form 10-Q for the first quarter ended March 31, 2008 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 SEC 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, or 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, or 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.

On January 27, 2009, the Company received a subpoena from the SEC requesting documents related to the Companys business practices
in Vietnam. In connection with such SEC investigation, the Company produced documents and provided testimony relevant to the SECs investigation and is continuing to cooperate with the SEC in its investigation. In November 2009, the Staff of
the SEC contacted the Company concerning some of the transactions described above and the Company is cooperating with the Staff.

At the current time, the Company cannot determine the probability of or quantify the amount of any fines or penalties associated with the SEC matters discussed above.

There were no expenses incurred related to SEC investigation in the three and nine months ended September 30, 2009. During the three
and nine months ended September 30, 2008, the Company had incurred SEC investigation expenses of $0.2 million and $2.3 million, respectively. To date, the Company has incurred expenses related to the SEC investigation of approximately $2.5
million.

NOTE 11  INCOME TAXES

The Company recorded an income taxes provision (benefit) of $1.6 million and $(0.1) million for the three months ended September 30, 2009 and 2008, respectively. The Company recorded income taxes
provision (benefit) of $1.4 million and $(0.6) million for the nine months ended September 30, 2009 and 2008, respectively. The tax provision during the three months ended September 30, 2009 was primarily attributable to the recording of a
valuation allowance related to the deferred tax asset for the operations in Israel. The tax provision during the nine months ended September 30, 2009, was primarily attributable to loss in operations of the Companys subsidiaries, offset
by the recording of a valuation allowance related to the deferred tax asset for the operations in Israel. The tax benefit during the three and nine months ended September 30, 2008 were primarily attributable to the Companys loss on
operations in Israel.

During the three months ended September 30, 2009, the Company performed an assessment of the
realizability of the deferred tax assets for the operations in Israel. As a result of recent cumulative losses and uncertainty regarding future taxable income, the Company determined based on all available evidence, that there was substantial
uncertainty as to the realizability of recorded net deferred tax assets in future periods. Accordingly, the Company recorded a valuation allowance of $1.8 million against all of the net deferred tax assets in Israel.



18



---

##### Table of Contents

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 for calendar years from 2003 through 2008. Additionally, any net operating losses that were generated in those years may also be subject to examination 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 through 2008, France for 2006 through 2008, India for 2005 through 2008, Israel
for 2003 through 2008, Singapore for 2005 through 2008, Russia for 2006 and 2008, and the United Kingdom for 2005 through 2008.

The American Recovery and Reinvestment Act of 2009, or Recovery Act, was signed into law on February 17, 2009, and among other things extended the ability to claim additional first year depreciation, extended the ability to trade bonus
and accelerated depreciation for otherwise deferred tax credits, and reduced the limitation on remuneration paid to executives from $1 million to $0.5 million. The change in the law for the amount of remuneration paid to executives will have no
impact to the tax expense during 2009 and the refundable credit may provide an immaterial benefit during the year as assets are placed into service.

On February 20, 2009, California also enacted new legislation, which among other things provides for the election of single factor apportionment formula beginning in 2011. This legislation had no
impact to the Company during the three and nine months ended September 30, 2009 because of the valuation allowance recorded against the state deferred tax assets.

NOTE 12  SEGMENT AND GEOGRAPHIC INFORMATION

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 or location of end customer. The following
table sets forth revenue and long-lived assets by geographic area (in thousands):



|                                                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|-------------------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                                               |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                                                               |  | 2009                            |        | 2008                           |   | 2009   |  | 2008
|Revenues:                                                      |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Europe, Middle East and Africa                                 |  | $                               | 10,467 |                                | $ | 14,996 |  | $    | 26,730 |  | $ | 38,310
|North America                                                  |  |                                 | 3,377  |                                |   | 4,345  |  |      | 9,091  |  |   | 12,300
|Asia Pacific and India                                         |  |                                 | 2,721  |                                |   | 2,368  |  |      | 10,652 |  |   | 9,521 
|Caribbean and Latin America                                    |  |                                 | 2,131  |                                |   | 1,246  |  |      | 9,994  |  |   | 6,975 
|                                                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|                                                               |  | $                               | 18,696 |                                | $ | 22,955 |  | $    | 56,467 |  | $ | 67,106
|                                                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Foreign countries which contributed more than 10% of revenues: |  |                                 | Russia |                                |   | Russia |  |      | Russia |  |   | Russia



|                        |  |                                 |        |                                |   |        |  |      |        |  |   |       
|----------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                        |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                        |  | 2009                            |        | 2008                           |   | 2009   |  | 2008
|Sales originating from: |  |                                 |        |                                |   |        |  |      |        |  |   |       
|United States           |  | $                               | 7,924  |                                | $ | 9,832  |  | $    | 22,441 |  | $ | 30,968
|Israel                  |  |                                 | 9,312  |                                |   | 12,208 |  |      | 23,633 |  |   | 31,780
|Other foreign countries |  |                                 | 1,460  |                                |   | 915    |  |      | 10,393 |  |   | 4,358 
|                        |  |                                 |        |                                |   |        |  |      |        |  |   |       
|                        |  | $                               | 18,696 |                                | $ | 22,955 |  | $    | 56,467 |  | $ | 67,106
|                        |  |                                 |        |                                |   |        |  |      |        |  |   |       



|                        |  |                   |       |                  |   |      
|----------------------- |  | ----------------- | ----- | ---------------- | - | -----
|                        |  | September 30,2009 |       | December 31,2008
|Long-lived assets, net: |  |                   |       |                  |   |      
|United States           |  | $                 | 1,034 |                  | $ | 1,588
|Israel                  |  |                   | 2,072 |                  |   | 2,613
|Other foreign countries |  |                   | 426   |                  |   | 434  
|                        |  |                   |       |                  |   |      
|                        |  | $                 | 3,532 |                  | $ | 4,635
|                        |  |                   |       |                  |   |      



19



---

##### Table of Contents

|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 Condensed Consolidated Financial Statements and Notes thereto included in
Part 1, Item 1 of this Quarterly Report on Form 10-Q and our Consolidated Financial Statements and Notes thereto for the year ended December 31, 2008, in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on
March 12, 2009. 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, sufficiency of our cash resources,
revenue estimations, plans, objectives, expectations and intentions. In some cases, you can identify forward-looking statements by terms such as anticipates, believes, could, estimates,
expects, intends, may, plans, potential, predicts, projects, should, will, would and similar expressions intended to identify
forward-looking statements. Forward-looking statements reflect our current views with respect to future events, are based on assumptions and are subject to risks, uncertainties and other important factors. 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 from any results expressed or implied by these forward-looking statements. Given these risks,
uncertainties and other important factors, you should not place undue reliance on these forward-looking statements, which speak only as of the date hereof. Except as required by law, we assume no obligation to update any forward-looking statements
publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future.

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 product portfolio consists of bandwidth optimization and NGN switching solutions. Our bandwidth optimization products consist of our I-Gate 4000 family of media gateways, our Secure
Communication software, and our DTX-600 DCME product for voice compression over legacy TDM networks. Our NGN switching solution consists of our ControlSwitch, an IP softswitch and service delivery platform comprised of numerous IMS-compatible
software modules, our Network-adaptive Border Controller, our I-Gate 4000 EDGE SIP Gateway, and our I-Gate 4000 family of media gateways. Our portfolio of products can significantly reduce the cost to build and operate voice services compared to
traditional alternatives and other NGN solutions. In addition, our products offer a standards-compliant platform that enables service providers to increase their revenues through the rapid creation and delivery of new services. 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 Telecom Ltd. 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.

Other Matters

On April 3, 2008, we received a letter from the SEC informing us that the SEC was conducting 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 counsel to perform an internal investigation. On July 17, 2008, Independent Counsel reported their findings to representatives of the SEC and
subsequently provided all the requested documents to the SEC. On January 27, 2009, we received a subpoena from the SEC indicating that it had commenced a formal investigation into matters related to our business practices in Vietnam. In
connection with such subpoena, we are producing documents and providing testimony relevant to the SECs investigation. In November 2009, the Staff of the SEC contacted us concerning some of the transactions described above and we are
cooperating with the Staff.

At the current time, we cannot determine the probability of or quantify the amount of any fines
or penalties associated with the SEC matters discussed above. For more information regarding the SEC matters discussed above, see Note 10 to our condensed consolidated financial statements elsewhere in this Quarterly Report.



20



---

##### Table of Contents

We are the exclusive worldwide distributor of a line of voice compression telecommunications
products, or DCME, for ECI Telecom under the 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
Telecom manufactures or subcontracts the manufacture of all DCME equipment sold by us 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, 2009. Effective June 30, 2009, the Company and ECI Telecom entered into a Settlement Agreement and General Release (Settlement Agreement) relating to a variety of outstanding
commercial issues between the parties. The Settlement Agreement effected a mutual release of certain claims as of the date of the Settlement Agreement. The Settlement Agreement did not materially impact the Companys financial statements. Some
payments under the Settlement Agreement were made in July 2009.

Critical Accounting Policies and Estimates

There have been no significant changes to our critical accounting policies and estimates during the three and nine months ended
September 30, 2009, 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 12, 2009.

Results of Operations

Comparison of Three Months Ended September 30, 2009 and 2008

Revenues
(amount in thousands).



|                               |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |    
|------------------------------ |  | -------------------------------- | ------ | ------------------------- | ------ | - |  | ----------------------- | ------------------------- |  | ---------- | - |  | - | ------ | - |  | --- | ---
|                               |  | Three Months Ended September 30, |        |                           |        |   |  |                         |                          
|                               |  | 2009                             |        |                           | 2008   |   |  |                         |                           |  |            |  
|                               |  |                                  |        | Percentageof TotalRevenue |        |   |  |                         | Percentageof TotalRevenue |  |            |   |  |   |        |  
|                               |  |                                  |        |                           |        |   |  | Period-to-Period Change |                          
|                               |  | Amount                           |        |                           | Amount |   |  | Amount                  |                           |  | Percentage |  
|Revenues:                      |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |    
|IP Products                    |  | $                                | 10,630 |                           | 57     | % |  | $                       | 15,080                    |  | 66         | % |  | $ | (4,450 | ) |  | (30 | ) %
|DCME Products                  |  |                                  | 520    |                           | 3      |   |  |                         | 2,215                     |  | 10         |   |  |   | (1,695 | ) |  | (77 | )  
|Services                       |  |                                  | 7,546  |                           | 40     |   |  |                         | 5,660                     |  | 24         |   |  |   | 1,886  |   |  | 33  |    
|                               |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |    
|Total revenues                 |  | $                                | 18,696 |                           | 100    | % |  | $                       | 22,955                    |  | 100        | % |  | $ | (4,259 | ) |  | (19 | ) %
|                               |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |    
|Revenue by Geography:          |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |    
|Europe, Middle East and Africa |  | $                                | 10,467 |                           | 56     | % |  | $                       | 14,996                    |  | 66         | % |  | $ | (4,529 | ) |  | (30 | ) %
|North America                  |  |                                  | 3,377  |                           | 18     |   |  |                         | 4,345                     |  | 19         |   |  |   | (968   | ) |  | (22 | )  
|Asia Pacific and India         |  |                                  | 2,721  |                           | 15     |   |  |                         | 2,368                     |  | 10         |   |  |   | 353    |   |  | 15  |    
|Caribbean and Latin America    |  |                                  | 2,131  |                           | 11     |   |  |                         | 1,246                     |  | 5          |   |  |   | 885    |   |  | 71  |    
|                               |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |    
|Total revenues                 |  | $                                | 18,696 |                           | 100    | % |  | $                       | 22,955                    |  | 100        | % |  | $ | (4,259 | ) |  | (19 | ) %
|                               |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |    

IP product revenues decreased by 30% as compared with the same period of 2008. Our
revenues are impacted by the timing and amount of bookings that convert into revenue in the same period as well as bookings from prior periods which convert into revenue in the period. Our bookings are affected by a number of factors, including a
continued tightening of customer budgets in a very difficult worldwide economic environment, slowdown in capital spending in some regions that have placed orders in the past and increased competition in some regions, particularly in the North
America region and the Europe, Middle East and Africa region. As the market continues to demand more sophisticated communications products, we expect that IP revenues as a percentage of total revenue will continue to increase while concurrently DCME
product revenues will continue to decline.

DCME product revenues decreased 77% in the third quarter of 2009 over the same
period last year and was the result of the expected continuing decline in the size of the overall DCME market as customers migrate from traditional voice networks utilizing DCME products over to those using 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 expect our DCME product sales to further decline over time, while there will be some periods where the DCME sales could be
higher or lower than our expectations.



21



---

##### Table of Contents

Total services revenues increased 33% in the third quarter of 2009 over the same period last
year. Our IP services revenues increased to $6.9 million in the third quarter of 2009 from $4.8 million in the third quarter of 2008 due to recognition of installation and commissioning and professional services revenues from a few large deals that
were completed and accepted during the quarter, as well as increased support and maintenance from a larger IP customer installation base. This increase in IP services revenue was offset by a decrease in DCME services revenues of $0.2 million, from
$0.9 million to $0.7 million in the three months ended September 30, 2008 and 2009, respectively. Over time, as with the DCME product revenues, we expect DCME services revenues to decrease as new DCME implementations continue to decrease and
customers migrate to IP networks.

Revenue by Geography

We experienced a combined decrease in revenues of $5.5 million in the North America, Europe, Africa and the Middle East regions for the
quarter ended September 30, 2009 compared to the same period of 2008. The overall regional decreases were as a result of the global recession, which hit customer purchasing patterns in the more established regions of our business particularly
in the third quarter of 2009 and from increased competition in certain markets, mainly in the Africa continent. The decrease in North America, Europe, Africa and the Middle East region was partially offset by an increase in revenues from Russia of
23% for the same period. Russias increase was attributed to the recognition of our multimedia generation network product projects in the quarter ended September 30, 2009. The decreases were also partially offset by increases in Caribbean
and Latin America region for the third quarter as we expanded our products, particularly in Brazil, where total revenues increased by 71% in the third quarter of 2009 over the same period last year. The Asia Pacific and India region also increased
total revenues by $0.4 million as a result of continuing market penetration with new and existing customers. During the three months ended September 30, 2009, revenues were 18% from North America and 82% international as compared to 19% from
North America and 81% international during the three months ended September 30, 2008. Our geographic mix of revenues will vary significantly on a quarterly basis, dependant on the timing of the completion of projects.

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



|                       |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|---------------------- |  | -------------------------------- | ------ | ------------------------- | ------ | - |  | ----------------------- | ------------------------- |  | ---------- | - |  | - | ------ | - |  | --- | --
|                       |  | Three Months Ended September 30, |        |                           |        |   |  |                         |                          
|                       |  | 2009                             |        |                           | 2008   |   |  |                         |                           |  |            |  
|                       |  |                                  |        | Percentageof TotalRevenue |        |   |  |                         | Percentageof TotalRevenue |  |            |   |  |   |        |  
|                       |  |                                  |        |                           |        |   |  | Period-to-Period Change |                          
|                       |  | Amount                           |        |                           | Amount |   |  | Amount                  |                           |  | Percentage |  
|Cost of Revenues:      |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|IP Products            |  | $                                | 3,614  |                           | 34     | % |  | $                       | 5,344                     |  | 35         | % |  | $ | (1,730 | ) |  | (32 | )%
|DCME Products          |  |                                  | 211    |                           | 41     |   |  |                         | 878                       |  | 40         |   |  |   | (667   | ) |  | (76 | ) 
|Services               |  |                                  | 2,920  |                           | 39     |   |  |                         | 3,148                     |  | 56         |   |  |   | (228   | ) |  | (7  | ) 
|                       |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|Total cost of revenues |  | $                                | 6,745  |                           | 36     | % |  | $                       | 9,370                     |  | 41         | % |  | $ | (2,625 | ) |  | (28 | )%
|                       |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|Gross Profit:          |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|IP Products            |  | $                                | 7,016  |                           | 66     | % |  | $                       | 9,736                     |  | 65         | % |  | $ | (2,720 | ) |  | (28 | )%
|DCME Products          |  |                                  | 309    |                           | 59     |   |  |                         | 1,337                     |  | 60         |   |  |   | (1,028 | ) |  | (77 | ) 
|Services               |  |                                  | 4,626  |                           | 61     |   |  |                         | 2,512                     |  | 44         |   |  |   | 2,114  |   |  | 84  |   
|                       |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|Total gross profit     |  | $                                | 11,951 |                           | 64     | % |  | $                       | 13,585                    |  | 59         | % |  | $ | (1,634 | ) |  | (12 | )%
|                       |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   

Cost of Revenues. The decrease in sales of IP and DCME products resulted in a
corresponding decrease in cost of product revenues, combined also with higher direct margins on product revenues. Although overall cost of revenues decreased primarily as a result of the decrease in total revenues, we continue to incur the fixed
overhead costs. The total cost of revenues decrease of $2.6 million can be attributed to the combined effect of higher margins for our products and services, as well as, to a lesser extent, lower allocated overhead costs and our restructuring
activities in the third quarter of 2008.

While services revenues increased 33%, the cost of services revenues decreased 7%
compared to the same period in 2008. The decrease was a mainly a result of lower outside professional services due to continued monitoring and control of expenditures. The cost of services revenues will vary from period to period depending on the
timing of projects being implemented, which may not be in the same period in which the corresponding revenue is recognized.

Gross Margin.Gross margin, which is gross profit as a percentage of revenue, increased to 64% from 59% for the three months ended September 30, 2009 and 2008, respectively. This increase is primarily attributable to the higher
margins attained in services revenues in the current quarter, which increased from 44% in the three months ended September 30, 2008 to 61%, as well as, for IP product margins increasing from 65% to 66% in the three months ended
September 30, 2009.



22



---

##### Table of Contents

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.

DCME product gross margins have remained relatively flat in the third quarter of 2009 over the same period last year because
our hardware costs are a fixed percentage of our customer order amounts, and we anticipate this trend to continue.

The
increase in services gross margin in the third quarter of 2009 compared to the same period of 2008 was attributable to higher service revenue mainly from recognition of revenues on completed and accepted installation services, maintenance support
due to our increased customer installation base, our reduced cost structure in 2009 over 2008, and the normal recognition timing differences that occur between services expenses and services revenues.

We expect services expenses to remain fairly constant in the following quarters, with margins continuing to improve as a result of growing
services and maintenance revenue throughout the remainder of the year.

Operating Expenses (amount in thousands).



|                              |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |       |   
|----------------------------- |  | -------------------------------- | ------ | ------------------------- | ------ | - |  | ----------------------- | ------------------------- |  | ---------- | - |  | - | ------ | - |  | ----- | --
|                              |  | Three Months Ended September 30, |        |                           |        |   |  |                         |                          
|                              |  | 2009                             |        |                           | 2008   |   |  |                         |                           |  |            |  
|                              |  |                                  |        | Percentageof TotalRevenue |        |   |  |                         | Percentageof TotalRevenue |  |            |   |  |   |        |  
|                              |  |                                  |        |                           |        |   |  | Period-to-Period Change |                          
|                              |  | Amount                           |        |                           | Amount |   |  | Amount                  |                           |  | Percentage |  
|Operating Expenses:           |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |       |   
|Research and development, net |  | $                                | 4,527  |                           | 24     | % |  | $                       | 5,612                     |  | 24         | % |  | $ | (1,085 | ) |  | (19   | )%
|Sales and marketing           |  |                                  | 5,290  |                           | 28     |   |  |                         | 8,158                     |  | 36         |   |  |   | (2,868 | ) |  | (35   | ) 
|General and administrative    |  |                                  | 2,088  |                           | 11     |   |  |                         | 3,528                     |  | 15         |   |  |   | (1,440 | ) |  | (41   | ) 
|Restructuring charges         |  |                                  |       |                           |       |   |  |                         | 794                       |  | 3          |   |  |   | (794)  |   |  | (100) |   
|Total operating expenses      |  | $                                | 11,905 |                           | 64     | % |  | $                       | 18,092                    |  | 79         | % |  | $ | (6,187 | ) |  | (34   | )%
|                              |  |                                  |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |       |   

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, or OCS. We record grants received from the OCS as a reduction of research and development expenses. Grants received from the OCS were $0.5 million and $0.6 million
in the three months ended September 30, 2009 and 2008. Of the $1.1 million decrease in research and development expenses, $0.2 million is attributed to decreased employee and related expenses, and $0.3 million pertains to lower expenses for
outside professional services and lower depreciation and supply purchases of $0.4 million as part of our overall monitoring of expenses and reduction in asset purchases. The employee related cost decrease of $0.2 million resulted from lower
headcount of approximately 35% when compared to the third quarter of 2008. The decrease in headcount stems from the restructuring activities in the third quarter of 2008.

We expect research and development expenses to remain approximately at the current expenditure levels on an absolute basis during the remaining quarter of 2009, and to decrease as a percentage of total
revenues as revenues increase through the last quarter of the year.

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. Of the $2.9 million decrease in
sales and marketing expenses, $0.8 million was primarily attributable to the reduction in salaries and benefits resulted from headcount reductions of approximately 12% as part of our restructuring activities as well as lower employee related taxes
in foreign jurisdictions. Costs for agent commission expenses were $0.7 million lower due to fewer deals that involved sales agents, particularly in Russia. Spending on outside professional services was reduced by $0.5 million as we reduced our
outside sales and marketing support services, including certain ECI Telecoms sales and marketing support services as part of our tight monitoring of costs. Additionally, travel expenses decreased by $0.3 million and commission expenses
decreased by $0.3 million due to lower sales from the same period in 2008 and lower overhead expense allocations of $0.1 million.

We expect sales and marketing expenses to increase throughout the year as sales personnel meet their maximum annual commission tiers. However, sales and marketing expenses will also be impacted by the nature of sales arrangements which may
include agent commissions and related expenses that will increase or decrease expenses based on the usage of third party agents.



23



---

##### Table of Contents

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. Of the $1.4 million decrease in general and
administrative expenses, $1.1 million relates to lower amounts recorded in our allowance for doubtful accounts, including a reversal of $0.6 million due to the collection of receivables previously reserved and a decrease in SEC investigation costs
from $0.2 million to zero in 2009. We reverse an allowance for doubtful accounts if there is significant improvement in the facts or circumstances pertaining to the customer for which the original allowance for doubtful accounts relates or the
amounts are collected from the customer. Historically, the allowance for doubtful accounts has been adequate to cover the actual losses from uncollectible accounts. The SEC investigation costs in 2008 related to legal fees, costs for our independent
auditors as well as other consultants. We do not anticipate incurring expenses from the ongoing SEC investigation in 2009 to be at the same extent as we did in 2008.

We expect expenses and costs associated with our general and administrative functions to increase on an absolute basis, and to increase as a percentage of total revenues as revenues increase throughout
remainder of the year.

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. We incurred total restructuring charges of $0.8 million of costs during the three months of 2008 and zero cost in same period of 2009. During the three months ended March 31, 2009, we released an accrual for fixed
assets of $39,000 and all related balances were paid in full as of March 31, 2009.

Other income (expense), net.Other income (expense), net consists primarily of interest income earned on cash, cash equivalents and short and long-term investments, foreign currency exchange gains (losses) and collection fees offset by interest expense and bank charges.
Other income (expense), net decreased from $1.1 million in other income to an expense of $(0.1) million for the three months ended September 30, 2008 and 2009, respectively. The difference was primarily due to a $1.1 million decrease in foreign
currency exchange gains on certain balance sheet items that are denominated in foreign currency at September 30, 2009 compared to the same period in 2008. In the three months ended September 30, 2009, other income (expense) included an
additional expense of $0.4 million resulting from the correction of prior period error. We determined that the amount was immaterial to the full fiscal year results. Interest income decreased by $0.1 million resulting from lower interest rates, and
lower cash, cash equivalents and short term investment balances compared to the same period of 2008.

Provision (benefit)
for income taxes. We made a provision (benefit) for income taxes of $1.6 million and $(0.2) million for the three months ended September 30, 2009 and 2008, respectively. During the three months ended September 30, 2009 the tax
provision was primarily attributable to the Companys profitable foreign operations and the recording of a valuation allowance related to the deferred tax asset for the operations in Israel. During the three months ended September 30,
2009, the Company determined that as a result of recent cumulative losses and uncertainty regarding future taxable income, that there was substantial uncertainty as to the realizability of recorded net deferred tax assets in future periods.
Accordingly, the Company recorded a valuation allowance of $1.8 million against all of the net deferred tax assets. The tax benefit during the three months ended September 30, 2008 was primarily attributable to our loss on operations in Israel.

Net loss.Net loss was $1.6 million and $5.4 million for the three months ended September 30, 2009 and 2008,
respectively. The net loss improved in the three months ended September 30, 2009 compared to the same period of 2008, primarily from the reduction of operating expenses of $6.2 million from expense control monitoring and the restructuring
actions taken in 2008.



24



---

##### Table of Contents

Comparison of Nine Months Ended September 30, 2009 and 2008

Revenues (amount in thousands).



|                               |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |     |   
|------------------------------ |  | ------------------------------- | ------ | ------------------------- | ------ | - |  | ----------------------- | ------------------------- |  | ---------- | - |  | - | ------- | - |  | --- | --
|                               |  | Nine Months Ended September 30, |        |                           |        |   |  |                         |                          
|                               |  | 2009                            |        |                           | 2008   |   |  |                         |                           |  |            |  
|                               |  |                                 |        | Percentageof TotalRevenue |        |   |  |                         | Percentageof TotalRevenue |  |            |   |  |   |         |  
|                               |  |                                 |        |                           |        |   |  | Period-to-Period Change |                          
|                               |  | Amount                          |        |                           | Amount |   |  | Amount                  |                           |  | Percentage |  
|Revenues:                      |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |     |   
|IP Products                    |  | $                               | 33,635 |                           | 60     | % |  | $                       | 45,520                    |  | 68         | % |  | $ | (11,885 | ) |  | (26 | )%
|DCME Products                  |  |                                 | 2,428  |                           | 4      |   |  |                         | 5,030                     |  | 7          |   |  |   | (2,602  | ) |  | (52 | ) 
|Services                       |  |                                 | 20,404 |                           | 36     |   |  |                         | 16,556                    |  | 25         |   |  |   | 3,848   |   |  | 23  |   
|                               |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |     |   
|Total revenues                 |  | $                               | 56,467 |                           | 100    | % |  | $                       | 67,106                    |  | 100        | % |  | $ | (10,639 | ) |  | (16 | )%
|                               |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |     |   
|Revenue by Geography:          |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |     |   
|Europe, Middle East and Africa |  | $                               | 26,730 |                           | 47     | % |  | $                       | 38,310                    |  | 58         | % |  | $ | (11,580 | ) |  | (30 | )%
|North America                  |  |                                 | 9,091  |                           | 16     |   |  |                         | 12,300                    |  | 18         |   |  |   | (3,209  | ) |  | (26 | ) 
|Asia Pacific and India         |  |                                 | 10,652 |                           | 19     |   |  |                         | 9,521                     |  | 14         |   |  |   | 1,131   |   |  | 12  |   
|Caribbean and Latin America    |  |                                 | 9,994  |                           | 18     |   |  |                         | 6,975                     |  | 10         |   |  |   | 3,019   |   |  | 43  |   
|                               |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |     |   
|Total revenues                 |  | $                               | 56,467 |                           | 100    | % |  | $                       | 67,106                    |  | 100        | % |  | $ | (10,639 | ) |  | (16 | )%
|                               |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |     |   

IP product revenues decreased 26% on lower bookings in the nine months ended
September 30, 2009 as compared with the same period of 2008. The decrease in IP product bookings was a result of the slowdown of the global economy. In addition, less revenue was recognized from prior years bookings on VOIP solutions in
the nine months of 2009, as compared to 2008. The IP revenues were also impacted as fewer projects were completed and accepted in the nine months ended September 30, 2009 than in the same period of 2008. The timing and amount of bookings is
affected by a number of factors, including a continued tightening of customer budgets in a very difficult worldwide economic environment. the slowdown in capital spending in some regions that have placed orders in the past and increased competition
in some regions, particularly in the North America region and the Europe, Middle East and Africa region, and specifically Russia. As the market continues to demand more sophisticated communications products, we expect that IP revenues as a
percentage of total revenue will continue to increase while concurrently DCME product revenues will continue to decline.

DCME
product revenues decreased 52% in the nine months ended September 30, 2009 over the same period last year and was the result of the expected continuing decline in the size of the overall DCME market as customers migrate from traditional voice
networks utilizing DCME products over to those increasingly using 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 increased 23% in the nine months ended September 30, 2009 over the same period last year. Our IP services revenues increased to $18.0 million in the nine months of 2009 from $13.2
million in the nine months of 2008 due to recognition of revenues from large deals on completed and accepted projects for professional services, and increased support and maintenance from a larger IP customer installation base. This increase in IP
services revenue was offset by a decrease in DCME services revenues of $0.9 million, from $3.3 million to $2.4 million in the nine months ended September 30, 2008 and 2009, respectively. Over time, as with the DCME product revenues, 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 total revenues of $10.6 million primarily resulted from a decrease in
sales in the Europe, Middle East and Africa region and in the North America region due to the economic downturn. The decrease in North America, Europe, Africa and the Middle East region was partially offset by an increase in revenues from Russia of
12% for the same period. The Caribbean and Latin America region experienced a significant increase due to the expansion of our products, particularly Brazil. There was also a $1.1 million increase in the Asia Pacific and India region as a result of
continuing market penetration with new and existing customers. During the nine months ended September 30, 2009, revenues were 16% from North America and 84% international as compared to 18% from North America and 82% international during the
nine months ended September 30, 2008. The geographic mix of revenues will vary significantly on a quarterly basis, dependant on the timing of the completion of projects.



25



---

##### Table of Contents

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



|                   |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|------------------ |  | ------------------------------- | ------ | ------------------------- | ------ | - |  | ----------------------- | ------------------------- |  | ---------- | - |  | - | ------ | - |  | --- | --
|                   |  | Nine Months Ended September 30, |        |                           |        |   |  |                         |                          
|                   |  | 2009                            |        |                           | 2008   |   |  |                         |                           |  |            |  
|                   |  |                                 |        | Percentageof TotalRevenue |        |   |  |                         | Percentageof TotalRevenue |  |            |   |  |   |        |  
|                   |  |                                 |        |                           |        |   |  | Period-to-Period Change |                          
|                   |  | Amount                          |        |                           | Amount |   |  | Amount                  |                           |  | Percentage |  
|Cost of Revenues:  |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|IP Products        |  | $                               | 13,565 |                           | 40     | % |  | $                       | 18,527                    |  | 41         | % |  | $ | (4,962 | ) |  | (27 | )%
|DCME Products      |  |                                 | 943    |                           | 39     |   |  |                         | 1,958                     |  | 39         |   |  |   | (1,015 | ) |  | (52 | ) 
|Services           |  |                                 | 8,769  |                           | 43     |   |  |                         | 10,982                    |  | 66         |   |  |   | (2,213 | ) |  | (20 | ) 
|                   |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|Total revenues     |  | $                               | 23,277 |                           | 41     | % |  | $                       | 31,467                    |  | 47         | % |  | $ | (8,190 | ) |  | (26 | )%
|                   |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|Gross Profit:      |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|IP Products        |  | $                               | 20,070 |                           | 60     | % |  | $                       | 26,994                    |  | 59         | % |  | $ | (6,924 | ) |  | (26 | )%
|DCME Products      |  |                                 | 1,485  |                           | 61     |   |  |                         | 3,072                     |  | 61         |   |  |   | (1,587 | ) |  | (52 | ) 
|Services           |  |                                 | 11,635 |                           | 57     |   |  |                         | 5,573                     |  | 34         |   |  |   | 6,062  |   |  | 109 |   
|                   |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   
|Total gross profit |  | $                               | 33,190 |                           | 59     | % |  | $                       | 35,639                    |  | 53         | % |  | $ | (2,449 | ) |  | (7  | )%
|                   |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |        |   |  |     |   

Cost of Revenues. The decrease in sales of IP and DCME products resulted in a
corresponding decrease in cost of product revenues, combined also with higher direct margins on product revenues. Although overall cost of revenues decreased primarily as a result of the decrease in total revenues, we continue to incur the fixed
overhead costs. The overall decrease in cost of revenues includes the benefit from a correction of an error of $0.2 million that was corrected in the six months ended June 30, 2009 but related to the prior year. We do not believe that
correcting the error in first half of 2009 is material to the nine months ended September 30, 2009 or the expected results for the year 2009.

Although services revenues increased 23%, the cost of services revenues decreased 20% compared to the same period in 2008. The decrease was a result of lower salaries and related costs of $0.4 million due
to lower headcount from the restructuring activities in the third quarter of 2008, decreased outside consulting and professional services of $1.0 million and reduced travel related costs of $0.5 million. The cost of services revenues will vary from
period to period depending on the timing of projects being implemented, which may not be in the same period in which the corresponding revenue is recognized. We expect cost of service revenues to slightly increase as services revenue increases
throughout the year.

Gross Margin.Gross margin, which is gross profit as a percentage of revenue, increased to 59%
from 53% for the nine months ended September 30, 2009 and 2008, respectively. This increase is primarily attributable to the higher margins attained on services revenues in the nine months ended September 30, 2009, which increased from 34%
in the nine months ended September 30, 2008 to 57% in the nine months ended September 30, 2009.

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.

DCME product gross margins have remained relatively flat
in the nine months ended September 30, 2009 over the same period last year because our hardware costs are a fixed percentage of our customer order amounts, and we anticipate this trend to continue.

The increase in services gross margin in the nine months ended September 30, 2009 compared with to the same period of 2008 was
attributable to higher services revenue mainly from maintenance support due to our increased customer installation base, the timing of services expenses, which may not be in the same period as when the services revenues are recognized and our
reduced cost structure in 2009 over 2008. We expect our services margins to improve during the remaining period of 2009 over the corresponding periods in 2008 due to expected growth in our services revenue in the remaining period of 2009 as compared
to the same period in 2008.



26



---

##### Table of Contents

Operating Expenses (amount in thousands).



|                              |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |      |   
|----------------------------- |  | ------------------------------- | ------ | ------------------------- | ------ | - |  | ----------------------- | ------------------------- |  | ---------- | - |  | - | ------- | - |  | ---- | --
|                              |  | Nine Months Ended September 30, |        |                           |        |   |  |                         |                          
|                              |  | 2009                            |        |                           | 2008   |   |  |                         |                           |  |            |  
|                              |  |                                 |        | Percentageof TotalRevenue |        |   |  |                         | Percentageof TotalRevenue |  |            |   |  |   |         |  
|                              |  |                                 |        |                           |        |   |  | Period-to-Period Change |                          
|                              |  | Amount                          |        |                           | Amount |   |  | Amount                  |                           |  | Percentage |  
|Operating Expenses:           |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |      |   
|Research and development, net |  | $                               | 14,078 |                           | 25     | % |  | $                       | 20,747                    |  | 31         | % |  | $ | (6,669  | ) |  | (32  | )%
|Sales and marketing           |  |                                 | 17,457 |                           | 31     |   |  |                         | 22,957                    |  | 34         |   |  |   | (5,500  | ) |  | (24  | ) 
|General and administrative    |  |                                 | 7,863  |                           | 14     |   |  |                         | 12,155                    |  | 18         |   |  |   | (4,292  | ) |  | (35  | ) 
|Restructuring charges         |  |                                 |       |                           |       |   |  |                         | 794                       |  | 1          |   |  |   | (794    | ) |  | (100 | ) 
|                              |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |      |   
|Total operating expenses      |  | $                               | 39,398 |                           | 70     | % |  | $                       | 56,653                    |  | 84         | % |  | $ | (17,255 | ) |  | (30  | )%
|                              |  |                                 |        |                           |        |   |  |                         |                           |  |            |   |  |   |         |   |  |      |   

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. Grants received from the OCS were $1.8 million in the nine months ended September 30, 2008 compared to $1.6 million for the nine months
ended September 30, 2009. The decrease in research and development expenses was primarily due to a $3.2 million decrease in employee and related expenses and a decrease in consulting expenses of $1.6 million. The primary driver of the employee
related cost decrease resulted from headcount reductions as part of our restructuring activities in the third quarter of 2008. Headcount associated with research and development activities decreased 32% as of September 30, 2009 as compared to
the same period of 2008. Decreases in direct equipment supplies and depreciation expenses also contributed an additional $1.0 million in expense reductions as we reduced our spending on capital purchases.

We expect research and development expenses to remain approximately at the current expenditure levels on an absolute basis during the
remaining quarter of 2009, and to decrease as a percentage of total revenues as revenues increase throughout the year.

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. Of the $5.5 million decrease in sales and marketing expenses, employee related expenses were lower by $1.1 million from headcount reductions of approximately 7% as part of our restructuring activities as well
as lower employee related taxes in foreign jurisdictions. Spending on consulting services was reduced by $1.2 million as we reduced our outside sales and marketing support services, including certain ECI Telecoms sales and marketing support
services and travel expenses by $1.0 million as we controlled our spending. Expenses were $1.3 million lower due to fewer deals that involved sales agents, particularly in Russia. Also, spending on marketing programs was reduced by $0.6 million. The
expense decreases were partially offset by an increase in equipment testing costs of $0.2 million.

We expect sales and
marketing expenses to increase in the last quarter as sales personnel meet their higher annual commission tiers. However, sales and marketing expenses will also be impacted by nature of sales arrangements which may include agent commissions and
related expenses that will increase or decrease expenses based on the usage of third party agents.

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. The $4.3 million decrease in general and administrative expenses was primarily a result of the $2.3 million decrease in expenses associated with the SEC investigation, which included costs related to legal fees, costs for
our independent auditors as well as other consultants in the nine months ended September 30, 2009. We do not anticipate incurring expenses from the ongoing SEC investigation in 2009 to the same extent we experienced in 2008. The decrease also
related to a lower allowance for doubtful accounts of $1.5 million, which included a reversal of $0.6 million due to the collection of receivables previously reserved. We reverse an allowance for doubtful accounts if there is significant improvement
in the facts or circumstances pertaining to the customer for which the original allowance for doubtful accounts relates or the amounts are collected from the customer. Historically, the allowance for doubtful accounts has been adequate to cover the
actual losses from uncollectible accounts.

We expect expenses and costs associated with our general and administrative
functions to increase on an absolute basis, and to increase as a percentage of total revenues as revenues increase during the last quarter of the year.



27



---

##### 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. We incurred total restructuring charges of $0.8 million of costs during the nine months of 2008 and zero cost in same period of 2009. During the three months ended March 31, 2009, we released an accrual
for fixed assets of $39,000 and all related balances were paid in full as of March 31, 2009.

Other income (expense),
net.Other income (expense), net consists primarily of interest income earned on cash, cash equivalents and short term investments, foreign currency exchange gains (losses) and collection fees offset by interest expense and bank charges. Other
income (expense), net, was $24,000 in the nine months ended September 30, 2009, as compared with other income, net of $0.2 million in the nine months ended September 30, 2008. The difference was primarily due to lower interest income of
$0.7 million resulting from lower interest rates, and lower cash, cash equivalents and short term investment balances. The decrease was also due to lower foreign currency exchange losses of $0.6 million in the first nine months of 2009, on certain
balance sheet items that are denominated in foreign currency. In the three months ended September 30, 2009, other income (expense) included an additional expense of $0.4 million resulting from the correction of prior period error. We determined
that the amount was immaterial to the full fiscal year results.

Provision (benefit) for income taxes. We made a
provision (benefit) for income taxes of $1.4 million and $(0.7) million for the nine months ended September 30, 2009 and 2008, respectively. During the nine months ended September 30, 2009 the tax provision was primarily attributable to
the Companys profitable foreign operations and the recording of a valuation allowance related to the deferred tax asset for the operations in Israel. During the nine months ended September 30, 2009, the Company determined that as a result
of recent cumulative losses and uncertainty regarding future taxable income, that there was substantial uncertainty as to the realizability of recorded net deferred tax assets in future periods. Accordingly, the Company recorded a valuation
allowance of $1.8 million against all of the net deferred tax assets. The tax benefit during the nine months ended September 30, 2008 was primarily attributable to our loss on operations in Israel.

Net loss.Net loss was $7.6 million and $20.1 million for the nine months ended September 30, 2009 and 2008, respectively. The
net loss decreased in the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008, due to decrease in operating expenses of $17.3 million from expense control monitoring and the restructuring actions
taken in 2008.

Liquidity and Capital Resources

At September 30, 2009, we had unrestricted cash, cash equivalents, and short-term investments and long-term investments of $32.3 million, a decrease from $38.0 million from December 31, 2008.

We anticipate our cash and related balances to increase in aggregate for the next 12 months as revenues increase and
operating expenses decrease moderately from savings due to the restructuring completed in 2008. As a result, we believe that our existing cash, cash equivalents, short-term investments and long-term investments will meet our normal operating and
capital expenditure needs for at least the next twelve months.

Operating Activities

Net cash used in our operating activities was $5.9 million and $19.7 million during the nine months ended September 30, 2009 and 2008,
respectively.

Net cash used in our operating activities in the nine months ended September 30, 2009 was primarily
attributable to our net loss of $7.6 million. The amount of cash used related to a decrease in deferred revenues of $4.0 million and decreases in accrued payroll and expenses of $3.9 million, offset by a decreases in inventories of $4.3 million,
accounts receivable of $3.7 million, prepaid expenses and other current assets of $1.3 million and related party, net, by $5.2 million. Further, we incurred non-cash costs of $2.0 million for depreciation, $3.0 million of stock-based compensation
and $1.2 million of deferred tax assets. Our working capital decreased to $42.9 million as of September 30, 2009, from $47.1 million as of December 31, 2008.

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.



28



---

##### Table of Contents

Investing Activities

Net cash used in our investing activities was $14.0 million and $0.8 million during the nine months ended September 30, 2009 and 2008.

Investing activities in the nine months ended September 30, 2009 consisted primarily of net purchases of short-term
investments of $10.3 million and purchases of long-term investments of $2.8 million, as well as purchases of property and equipment of $0.8 million.

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.

Financing Activities

Net cash provided by our financing activities was $58,000 for the nine months ended September 30, 2009 for proceeds received from the
exercise of stock options.

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.

Off-Balance Sheet Arrangements

At September 30, 2009, 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

The majority of our revenues, costs of sales
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 and Brazilian Real would have fluctuated by 10%, in the nine months ended September 30, 2009, the effect of our local currency expenses, excluding the impact of any foreign currency forward contracts, would have
increased or decreased by $1.4 million.

We are also impacted by assets or liabilities that are denominated in a currency
other than a subsidiarys functional currency. Our intercompany long-term loan with our Brazilian subsidiary is denominated in U.S. dollars, while the Brazilian subsidiarys functional currency is the Brazilian Real. However, our long-term
certificate of deposit is denominated in Brazilian Real and changes in value related to the Brazilian Real are a component of our shareholders equity. The impact of a change in the foreign exchange rate between the U.S. dollar and the Brazilian Real
during the nine months ended September 30, 2009 resulted in the decrease in the amounts payable in Brazilian Real from December 31, 2008, therefore a gain of $0.3 million at September 30, 2009 is recorded in other income. We also had
foreign currency risk related to cash, and accounts receivable that are denominated in local currency for subsidiaries with U.S. dollar functional currencies. At September 30, 2009, we had in cash and accounts receivable amounts in Russian
Rubles, Euros, Indian Rupees and New Israeli Shekel. Due to the impact of changes in foreign currency exchange rates between the U.S. Dollar and these other currencies, we recorded in other income (expense) a net amount of $(0.6) million.



29



---

##### Table of Contents

Interest Rate Sensitivity

We had cash, cash equivalents, restricted cash, short-term and long-term investments totaling $32.3 million at September 30, 2009. These
amounts were invested primarily in money market funds and treasury securities. 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. We purchased a long-term investment in the form of a certificate of deposit denominated in Brazilian Real which will mature in 2011. The rate is based on a monthly rate determined by the Central Bank of Brazil. Although the rates
are subject to change, we can withdraw the cash with one month interest penalty. Due to the liquidity of the long-term investment, we do not believe that a 10% change in interest rates would have a material impact on our financial position and
results of operations. The interest earned of $24,000 at September 30, 2009 is recorded in other income (expense) in the Consolidated Statement of Operations.

Forward Contracts

In general, we have operating expenses in foreign
currencies and the changes in exchange rates, and in particular a strengthening or weakening of the U.S. dollar will affect our operating expenses as it is expressed in U.S. dollars when there has been significant volatility in foreign currency
exchange rates.

We may enter into foreign currency forward contracts with financial institutions to protect against foreign
exchange risks associated with certain expenses in New Israeli Shekels. Generally, our practice is to hedge a majority of our material foreign exchange exposures, typically for thirty days. A majority of our revenue, expense, and capital purchasing
activities are transacted in U.S. dollars. However, we may choose not to hedge certain foreign exchange exposures for a variety of reasons, including but not limited to immateriality, accounting considerations, and the prohibitive economic cost of
hedging particular exposures. Our forward contracts reduce, but do not always entirely eliminate, the impact of currency exchange rate movements. Beginning second quarter of 2009, we purchased forward foreign exchange contracts to mitigate the risk
of changes in foreign exchange rates on 75% of the identified New Israeli Shekel expenses. During the nine months ended September 30, 2009, the benefit of the forward contracts recorded in other income (expense), net was $0.4 million,
respectively.



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

Evaluation
of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) under 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, 2009, subject to the limitations described below, 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.

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 errors 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.

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, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



30



---

##### Table of Contents

PART II. OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

From
time to time we are involved in legal proceedings arising in the ordinary course of our business. We believe there is no litigation pending that could have, individually or in the aggregate, a material adverse effect on our results of operations or
financial condition.



|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. Our business faces significant risks, and the risks described below may not be
the only risks we face. It is not possible to predict or identify all such factors and, therefore, you should not consider the following risks to be a complete statement of all the potential risks or uncertainties that we face. If any of these risks
occur, our business, results of operations or financial condition could suffer, the market price of our common stock could decline and you could lose all or part of your investment in our common stock.

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 an economic slowdown and a global recession. Continuing market upheavals, including specifically the lack of credit currently available in the market, may have an adverse affect on us because we are dependent on capital
budgets and confidence of our customers, and some of our customers are dependant on obtaining credit to finance purchases of our products. Our revenues are likely to decline in such circumstances. Factors such as business investment, and the
volatility and strength of the capital markets 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, more volatile capital markets, fewer options to obtain credit and lower consumer spending, the demand for our products could be adversely affected. Adverse changes in the economy and continuing
recession, particularly in Russia and domestically, could affect earnings negatively and could have a material adverse effect on our business, results of operations, and financial condition.

We received a letter regarding a confidential informal inquiry by the SEC, or SEC Inquiry, and in January 2009 received a subpoena from the SEC as
well. Cooperation with such governmental actions 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 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 SEC Inquiry, which had a
material adverse effect on our financial condition and results of operations in 2008 and may, in future quarters, also have a material adverse effect on our financial condition and results of operations. Further, the SEC 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.

Further, on January 27, 2009, we received a subpoena from the SEC requesting the production of certain documents relating to the
Companys business practices in Vietnam. We are in the process of responding to this subpoena. In November 2009, the Staff of the SEC contacted the Company concerning some of the transactions described above and the Company is cooperating with
the Staff.

As a result of the SEC Inquiry and the subpoena, criminal or civil charges could be filed against us and we could
be required to pay significant fines or penalties in connection with the SEC 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.



31



---

##### Table of Contents

If we fail 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, and our business will be harmed.

Our common stock
is currently listed on The NASDAQ Global Market, or NASDAQ. Our stock has traded below $1.00 per share over the last twelve months. On September 15, 2009 we received a staff deficiency letter from The Nasdaq Stock Market indicating that, for
the last 30 consecutive business days, the bid price for our common stock had closed below the minimum $1.00 per share requirement for continued inclusion on the Nasdaq Global Market under Marketplace Rule 5450(a)(1), or the Rule. Further, the
Nasdaq notice informed us that in accordance with Marketplace Rule 5810(c)(3)(A), we have been given 180 calendar days, or until March 15, 2010, to regain compliance with the Rule. If we do not regain compliance with the Rule by
March 15, 2010, Nasdaq will provide written notification to Veraz that its common stock may be delisted. At that time, Veraz may appeal Nasdaqs delisting determination to a Nasdaq Listing Qualifications Panel. There can be no assurance
that, if Veraz does appeal the Nasdaq Staffs Determination, such appeal would be successful. 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 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.

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 U.S. and global economies. In October 2008, the
global financial markets experienced significant losses due to the failure of many financial institutions. The governments of the United States and several foreign countries instituted bailout plans 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.
| | - |  | -----------------------------------------------------



32



---

##### Table of Contents

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 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. For example, 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.

Although we undertook a restructuring initiative in 2008 to streamline our operations and to reduce our overall cash burn rate, we have not had sustained profits and our losses could continue.

In the nine months ended September 30, 2009 and the year ended December 31, 2008, we used $5.9 million and
$15.8 million, respectively to fund our operating activities and we have never generated sufficient cash to fund our operations. During the third quarter of 2008, we undertook 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 was 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 further reduce expenses 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 have not had sustained profits and our losses could continue.

We
have experienced significant losses in the past and never 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 and for the year ended December 31, 2008, we recorded net losses of approximately $21.0 million. For the first nine months of 2009, we recorded a loss of $7.6 million.
As of December 31, 2007 and 2008, our accumulated deficit was $56.2 million and $77.2 million, respectively. 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., 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., and Sonus Networks, Inc. While some of the established competitors are
exiting the market, we are seeing increasingly intense competition from Huawei, who leverages its broad product portfolio and significant financial resources to compete with us for our switching business.



33



---

##### Table of Contents

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;
| | - |  | -------------------------------------



| |  |  | 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.

At the time we entered into our agreements with ECI, ECI was our affiliate. Additionally, the agreements were negotiated in the overall
context of the 2002 acquisition of certain assets and businesses from ECI. 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 overlapping business opportunities. ECI may make strategic choices that are not in the best interest of the company or its stockholders. 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 unaffiliated 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 $1 million 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 with us 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.
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 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. If such efforts fail, our business would be materially harmed. 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.

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 with us on reasonable terms or at all.



34



---

##### Table of Contents

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.

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 25% 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 other funds that have appointed Ashmore Investment Management Limited as their investment manager which maintains dispositive and/or voting power. In
addition, ECI 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 and any sales may be difficult and may depress the price of our stock.

Our revenue and operating results may be adversely impacted if sales of our IP products and other products are unstable, 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 lower 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. Further, if our expected DCME sales decrease below $1 million in a calendar year ECI may terminate the DCME Agreement.

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 their purchase of our products from them. As we seek to sell more products to these large telecommunications providers, we may be required to agree to less favorable 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.



35



---

##### Table of Contents

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.

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 127 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.
| | - |  | -----------------------------------------------



36



---

##### Table of Contents

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;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 that quarter. Therefore, any such revenue shortfall would likely have a direct negative effect on our operating results for
that quarter. For these and other reasons, 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, such a decline in our stock price may cause
stockholders to initiate securities class action lawsuits. Whether or not meritorious, litigation brought against us could result in substantial costs and diversion of time and attention of our management. Our insurance to cover claims of this sort,
if brought, may not be adequate.



37



---

##### Table of Contents

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. 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, 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 correct 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.
| | - |  | ------------------------------



38



---

##### Table of Contents

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,
particularly IP switching products, have lengthy sales cycles, which typically extend from three to 12 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 and among product types. The length of a customers deployment period will impact our ability to recognize revenue related 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, or 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 historically utilized ECI as
an agent for selling our IP and DCME products in Russia and an affiliate of ECI provided services for us in Russia. During the nine months ended September 30, 2009, and fiscal years ended December 31, 2008, 2007, and 2006, $6.5 million,
$13.2 million, $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. We have terminated our relationship with ECI in
Russia and are endeavoring to establish a direct sales and services team in the region. We may not successfully develop that direct sales and services team and our sales and revenue in the region could continue to weaken and our business and results
of operations could be adversely effected.

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,
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.



39



---

##### Table of Contents

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

For the nine months ended September 30, 2009, and fiscal years ended December 31, 2008, 2007, and
2006 revenues from outside North America were approximately $47.4 million, $77.6 million, $93.1 million, and $81.8 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;
| | - |  | ----------------------------------------------------------------



| |  |  | 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 or duty consequences;
| | - |  | ---------------------------------------------



| |  |  | unfavorable foreign exchange movements, particularly the continued devaluation of the U.S. 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
Securities Exchange Act of 1934, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or 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 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.



40



---

##### Table of Contents

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, Douglas 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. 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, one or more other members of our executive management or sales team or other key employees,
none of whom are bound by employment agreements 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, which 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.
Further, our contract manufacturers may choose to limit the amount of credit available to us which will impact our ability to timely order and procure products.

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 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. We are in the process of qualifying a second manufacturing facility for Flextronics and there will be additional costs and complexity associated with manufacturing at multiple sites. 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.



41



---

##### Table of Contents

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.

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. 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, 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.
| | - |  | ---------------------------------------------------------------------------------



42



---

##### Table of Contents

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.

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 received in the past and may receive 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.



43



---

##### Table of Contents

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 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 as the European Union 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 and similar rules and regulations in other countries. China is in the final approval stage of compliance programs
which will harmonize with the European Union WEEE and Recycling of Hazardous Substances 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,
but 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. If the market for our Class 5 products does not develop or if we are unable to further develop the required features, we may need to reduce or cancel our development efforts or conclude an agreement with a third party to license
the Class 5 solution.

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 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 Software Revenue Recognition literature. 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 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. In the past we have had to defer recognition for license fees, and may
have to do so again in the future. Such deferral may be as a result of 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;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



44



---

##### Table of Contents

| |  |  | 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.

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, threats against Israel and the recent Israeli conflict in Gaza, 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 154 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 Office of the Chief Scientist of the Israeli Ministry of Industry, Trade, and Labor, or the OCS. Therefore, we 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.



45



---

##### Table of Contents

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
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 or
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 6. | EXHIBITS
|------- | --------

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



|        |  |                                                                                                                                                                                  
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description of document                                                                                                                                                          
|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    



46



---

##### Table of Contents

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 16, 2009 |  |  |  | By:                  |  | /s/    Albert J. Wood                             
|                        |  |  |  | Name:                |  | Albert J. Wood                                    
|                        |  |  |  | Title:               |  | Chief Financial Officer                           
|                        |  |  |  |                      |  | (Principal Financial and Chief Accounting Officer)



47



---

##### Table of Contents

EXHIBIT INDEX



|        |  |                                                                                                                                                                                  
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description of document                                                                                                                                                          
|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