##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from            to
 Commission
file number 001-33391
 Veraz Networks, Inc.
  Delaware
    
    94-3409691(State or other jurisdiction of
    
    (I.R.S. Employer Identification Number)incorporation or organization)
 926 Rock Avenue, Suite 20
San Jose, California 95131
(408) 750-9400
 o þ
  o o þ
 o þ




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##### 



VERAZ NETWORKS, INC.
 FORM 10-Q
For the Quarterly Period Ended March 31, 2007
 INDEX
 PART I. FINANCIAL INFORMATIONITEM 1. FINANCIAL STATEMENTS
    
    
    3Condensed Consolidated Balance Sheets
    
    
    3Condensed Consolidated Statements of Operations
    
    
    4Condensed Consolidated Statements of Cash Flows
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
    
    
    20ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
    
    
    27ITEM 4. CONTROLS AND PROCEDURES
    
    
    28PART II. OTHER INFORMATIONITEM 1. LEGAL PROCEEDINGS
    
    
    28ITEM 1A. RISK FACTORS
    
    
    28ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
    
    
    47ITEM 3. DEFAULTS ON SENIOR SECURITIES
    
    
    48ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    48ITEM 5. OTHER INFORMATION
    
    
    48ITEM 6. EXHIBITS
    
    
    48SIGNATURES
    
    
    49EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32
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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 VERAZ NETWORKS, INC. AND SUBSIDIARIES
 
 Condensed Consolidated Balance Sheets
 March 31,
    
    
    December 31,2007
    
    
    2006(In thousands, except share and per share data)(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    17,093
    
    
    $
    23,189Restricted cash
    
    
    500
    
    
    
    500Accounts receivable (net of allowances of $93
and $183 as of March 31, 2007 and December 31,
2006, respectively)
    
    
    29,682
    
    
    
    24,451Inventories
    
    
    15,057
    
    
    
    14,203Prepaid expenses
    
    
    3,763
    
    
    
    2,578Deferred tax assets
    
    
    148
    
    
    
    Other current assets
    
    
    2,169
    
    
    
    2,614Due from related parties
    
    
    1,134
    
    
    
    1,452Total current assets
    
    
    69,546
    
    
    
    68,987Property and equipment, net
    
    
    6,784
    
    
    
    7,123Other assets
    
    
    136
    
    
    
    151Total assets
    
    $
    76,466
    
    
    $
    76,261LIABILITIES, REDEEMABLE AND CONVERTIBLE PREFERRED
STOCK, AND STOCKHOLDERS DEFICITCurrent liabilities:Accounts payable
    
    $
    12,184
    
    
    $
    9,042Accrued expenses
    
    
    15,569
    
    
    
    16,519Income tax payable
    
    
    411
    
    
    
    258Current portion of loan payable (net of
unamortized discount of $398 and $433 as of
March 31, 2007 and December 31, 2006,
respectively)
    
    
    2,212
    
    
    
    1,277Current portion of deferred revenue
    
    
    24,202
    
    
    
    27,074Due to related parties
    
    
    5,439
    
    
    
    7,256Total current liabilities
    
    
    60,017
    
    
    
    61,426Loan payable, less current portion (net of
unamortized discount of $95 and $170 as of March
31, 2007 and December 31, 2006, respectively)
    
    
    2,342
    
    
    
    3,147Noncurrent portion of deferred revenue
    
    
    
    
    
    
    454Total liabilities
    
    
    62,359
    
    
    
    65,027Commitments and contingencies (Note 9)Redeemable and convertible preferred stock:Redeemable preferred stock, Series A-1, $0.001
par value; 5,000,048 shares authorized;
5,000,048 shares issued and outstanding at March
31, 2007 and December 31, 2006; liquidation
preference of $8,000
    
    
    15,871
    
    
    
    15,871Redeemable preferred stock, Series A-2, $0.001
par value; 1 share authorized; 1 share issued
and outstanding at March 31, 2007 and December
31, 2006; liquidation preference of $1,000
    
    
    1,349
    
    
    
    1,349Redeemable preferred stock, Series B-1, $0.001
par value; 9,000,000 shares authorized;
9,000,000 shares issued and outstanding at March
31, 2007 and December 31, 2006; liquidation
preference of $13,500
    
    
    2,576
    
    
    
    2,576Convertible preferred stock, Series C, $0.001
par value; 36,000,000 shares authorized;
17,532,502 shares issued and outstanding at
March 31, 2007 and December 31, 2006;
liquidation preference of $60,172
    
    
    38,283
    
    
    
    38,283Convertible preferred stock, Series D, $0.001
par value; 5,000,000 shares authorized;
1,523,951 and 996,596 shares issued and
outstanding at March 31, 2007 and December 31,
2006, respectively; liquidation preference of
$9,967 and $6,518 at March 31, 2007 and December
31, 2006, respectively
    
    
    9,877
    
    
    
    6,462Total redeemable and convertible preferred stock
    
    
    67,956
    
    
    
    64,541Stockholders deficit:Common stock, $0.001 par value; 100,000,000 shares
authorized; 13,974,833 and 13,789,287
shares issued and outstanding as of March 31, 2007
and December 31, 2006, respectively
    
    
    14
    
    
    
    14Additional paid-in capital
    
    
    7,517
    
    
    
    6,975Deferred stock-based compensation
    
    
    (600
    )
    
    
    (690
    )Accumulated deficit
    
    
    (60,780
    )
    
    
    (59,606
    )Total stockholders deficit
    
    
    (53,849
    )
    
    
    (53,307
    )Total liabilities, redeemable and convertible
preferred stock, and stockholders deficit
    
    $
    76,466
    
    
    $
    76,261
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VERAZ NETWORKS, INC. AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Operations
(Unaudited)
 Three Months Ended March 31,2007
    
    
    2006(In thousands, except share and pershare data)Revenues:IP Products
    
    $
    17,650
    
    
    $
    8,934DCME Products
    
    
    5,134
    
    
    
    10,182Services
    
    
    4,671
    
    
    
    2,536Total revenues
    
    
    27,455
    
    
    
    21,652Cost of Revenues:IP Products
    
    
    7,196
    
    
    
    3,394DCME Products
    
    
    2,121
    
    
    
    3,910Services
    
    
    2,698
    
    
    
    1,889Total cost of revenues
    
    
    12,015
    
    
    
    9,193Gross profit
    
    
    15,440
    
    
    
    12,459Operating Expenses:Research and development (net of grants from the Office of the Chief
Scientist in Israel of $366 and $298 in the three months ended March
31, 2007 and 2006, respectively
    
    
    7,734
    
    
    
    7,925Sales and marketing
    
    
    5,963
    
    
    
    6,054General and administrative
    
    
    2,353
    
    
    
    2,000Total operating expenses
    
    
    16,050
    
    
    
    15,979Loss from operations
    
    
    (610
    )
    
    
    (3,520
    )Other (expense) income, net
    
    
    (200
    )
    
    
    65Loss before income taxes
    
    
    (810
    )
    
    
    (3,455
    )Income taxes
    
    
    364
    
    
    
    18Net loss
    
    $
    (1,174
    )
    
    $
    (3,473
    )Net loss allocable to common stockholders per share  basic and diluted
    
    $
    (0.08
    )
    
    $
    (0.26
    )Weighted average shares outstanding used in computing net loss
allocable to common stockholders per share  basic and diluted:
    
    
    13,928,106
    
    
    
    13,143,296
 Related Party Transactions
  Three Months Ended March 31,2007
    
    
    2006Revenues:IP Products, related party sales
    
    $
    25
    
    
    $
    252DCME Products, related party sales
    
    
    145
    
    
    
    3,056Cost of Revenues:IP Products, costs arising from related party purchases
    
    
    8
    
    
    
    1,979DCME Products, costs arising from related party purchases
    
    
    1,385
    
    
    
    3,303Operating Expenses:Research and development
    
    
    668
    
    
    
    1,285Sales and marketing
    
    
    855
    
    
    
    1,365General and administrative
    
    
    113
    
    
    
    168
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VERAZ NETWORKS, INC. AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Cash Flows
(Unaudited)
 Three Months Ended March 31,2007
    
    
    2006(In thousands)Cash flows from operating activities:Net loss
    
    $
    (1,174
    )
    
    $
    (3,473
    )Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:Depreciation
    
    
    966
    
    
    
    750Provision for doubtful accounts
    
    
    (90
    )
    
    
    (39
    )Accretion of loan payable
    
    
    20
    
    
    
    Amortization of debt issuance cost
    
    
    110
    
    
    
    Stock-based compensation
    
    
    481
    
    
    
    81Deferred income taxes
    
    
    (189
    )
    
    
    Net changes in operating assets and liabilities:Accounts receivable
    
    
    (5,096
    )
    
    
    (5,327
    )Inventories
    
    
    (854
    )
    
    
    (3,034
    )Prepaid expenses and other current assets
    
    
    (479
    )
    
    
    (1,635
    )Due from related parties
    
    
    318
    
    
    
    771Accounts payable
    
    
    3,015
    
    
    
    3,976Accrued expenses
    
    
    (950
    )
    
    
    (1,933
    )Income tax payable
    
    
    153
    
    
    
    Deferred revenue
    
    
    (3,326
    )
    
    
    8,799Due to related parties
    
    
    (1,817
    )
    
    
    (4,370
    )Net cash used in operating activities
    
    
    (8,912
    )
    
    
    (5,434
    )Cash flows from investing activities:Restricted cash
    
    
    
    
    
    
    949Short-term investments
    
    
    
    
    
    
    500Purchases of property and equipment, net
    
    
    (280
    )
    
    
    (942
    )Other assets
    
    
    11
    
    
    
    (10
    )Net cash (used in) provided by investing activities
    
    
    (269
    )
    
    
    497Cash flows from financing activities:Proceeds from the exercise of stock options
    
    
    151
    
    
    
    84Proceeds from issuance of Series D convertible preferred stock
    
    
    3,449
    
    
    
    Issuance cost for Series D convertible preferred stock
    
    
    (34
    )
    
    
    Proceeds from borrowings
    
    
    
    
    
    
    15,000Payments of offering costs
    
    
    (481
    )
    
    
    Net cash provided by financing activities
    
    
    3,085
    
    
    
    15,084Net (decrease) increase in cash and cash equivalents
    
    
    (6,096
    )
    
    
    10,147Cash and cash equivalents at beginning of period
    
    
    23,189
    
    
    
    20,437Cash and cash equivalents at end of period
    
    $
    17,093
    
    
    $
    30,584Supplemental disclosure of cash flow information:Cash paid:Interest
    
    $
    123
    
    
    $
    Income taxes
    
    $
    11
    
    
    $
    3
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VERAZ NETWORKS, INC. AND SUBSIDIARIES
 
 Notes to Condensed Consolidated Financial Statements
 (1) The Company
    (2) Basis of Presentation
    (3) Out-of-period adjustment
  6




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Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements
  Year ended December 31, 2006PreviouslyReported
    
    As RevisedBalance Sheet:Inventories
    
    $
    13,956
    
    
    $
    14,203Stockholders deficit
    
    
    (53,554
    )
    
    
    (53,307
    )Statement of Operations:Loss from operations
    
    
    (14,160
    )
    
    
    (13,913
    )Net loss
    
    $
    (13,917
    )
    
    $
    (13,670
    )Net loss allocable to common
stockholders per share  basic and
diluted
    
    $
    (1.04
    )
    
    $
    (1.02
    )
 (4) Significant Accounting Policies
  (a) Use of Estimates
  (b) Deferred Offering Costs
  (c) Concentrations
    7




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Three Months Ended March 31,2007
    
    2006(unaudited)
    
    (unaudited)Revenues:ECI Telecom and its subsidiaries
    
    
    *
    
    
    
    15
    %Classica
    
    
    14
    %
    
    
    23
    %Belgacom
    
    
    *
    
    
    
    14
    %
 March 31,
    
    December 31,2007
    
    2006(unaudited)Accounts Receivable and Due from Related Parties:Classica
    
    
    22
    %
    
    
    16
    %
 
 *
    
    Represents less than 10% (d) Revenue Recognition
  Reporting Revenue Gross as a
Principal versus Net as an Agent
 Revenue Recognition
 8




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Revenue Arrangements with
Multiple Deliverables.
  Software Revenue Recognition Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions.
         9




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(e) Stock-Based Compensation
 Accounting for Stock Issued to Employees Accounting for Certain Transactions Involving Stock
Compensation, an Interpretation of APB Opinion No. 25 Accounting for Stock-Based Compensation Accounting for Stock-Based  Compensation
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Transition and Disclosure
   Share-Based Payment
 Disclosure About Fair Value of Financial Instruments
  Three Months EndedMarch 31, 2007(unaudited)Expected term in years
    
    
    6.25Risk-free interest rate
    
    
    4.78
    %Volatility
    
    
    74
    %Dividend yield
    
    
    Estimated fair value per share of underlying common stock
    
    $
    11.50
  11




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(f) Net Loss Allocable to Common Stockholders per Share
 Earnings per Share
  Three Months Ended March 31,2007
    
    2006(Unaudited)
    
    (Unaudited)Stock options
    
    
    7,706,113
    
    
    
    7,335,857Stock options granted outside of plans
    
    
    60,000
    
    
    
    73,499Warrants
    
    
    16,225
    
    
    
    16,225Series C convertible preferred stock
    
    
    17,532,502
    
    
    
    17,482,502Series D convertible preferred stock
    
    
    1,993,325
    
    
    
    
 Participating Securities and the Two-Class Method
under FASB Statement 128
  (g) Recent Accounting Pronouncements
 The Fair Value Option for Financial Assets and
Financial Liabilities, Including an Amendment of FASB Statement No. 115
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Fair Value Measurements
 (5) Related Party Transactions
      13




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(6) Inventories
  March 31,
    
    
    December 31,2007
    
    
    2006(Unaudited)Finished products
    
    $
    2,369
    
    
    $
    1,413Work in process at customers locations
    
    
    7,721
    
    
    
    8,056Raw material and components
    
    
    4,967
    
    
    
    4,734$
    15,057
    
    
    $
    14,203
  Restatement and Revision of Accounting Research Bulletins, Chapter
4: Inventory Pricing
 (7) Factoring
 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
  (8) Loan
   14




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PrincipalNine months ended December 31, 2007
    
    $
    1,713Year ended December 31, 2008
    
    
    3,287Total payments
    
    $
    5,000
 Interest on Receivables and Payables
 (9) Commitments and Contingencies
 (a) Leases
  Nine months ended December 31, 2007
    
    $
    1,663Year ended December 31, 2008
    
    
    1,716Year ended December 31, 2009
    
    
    1,066Year ended December 31, 2010
    
    
    809Year ended December 31, 2011
    
    
    560Total
    
    $
    5,814
 (b) Office of the Chief Scientist Grants
  (c) Guarantees
  15




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(d) Purchase Commitments
  (10) Income Taxes
   Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109.
   (11) Reverse Stock Split
  16




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(12) Preferred Stock
   Shares
    
    
    Liquidation
    
    
    Aggregate
    
    
    AggregateShares
    
    
    Issued and
    
    
    Preference
    
    
    Liquidation
    
    
    RedemptionAuthorized
    
    
    Outstanding
    
    
    per Share
    
    
    Preference
    
    
    ValueRedeemable preferred stock:Series A-1
    
    
    5,000,048
    
    
    
    5,000,048
    
    
    $
    1.60
    
    
    $
    8,000
    
    
    $
    5Series A-2
    
    
    1
    
    
    
    1
    
    
    $
    1,000,000
    
    
    
    1,000
    
    
    
    Series B-1
    
    
    9,000,000
    
    
    
    9,000,000
    
    
    $
    1.50
    
    
    
    13,500
    
    
    
    9Subtotal
    
    
    14,000,049
    
    
    
    14,000,049
    
    
    
    
    
    
    
    22,500
    
    
    
    14Convertible preferred stock:Series C
    
    
    36,000,000
    
    
    
    17,532,502
    
    
    $
    3.432
    
    
    
    60,172
    
    
    
    Series D
    
    
    5,000,000
    
    
    
    1,523,951
    
    
    $
    6.54
    
    
    
    9,967
    
    
    
    55,000,049
    
    
    
    33,056,502
    
    
    
    
    
    
    $
    92,639
    
    
    $
    14
 Classification and Measurement of Redeemable Securities
   (13) Warrants
  (14) Stock Option Plans
   17




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WeightedNumber of
    
    
    
    
    
    
    
    
    
    AverageShares
    
    Number of
    
    Weighted
    
    Contractual
    
    AggregateAvailable
    
    Options
    
    Average
    
    Life
    
    Intrinsicfor Grant
    
    Outstanding
    
    Exercise Price
    
    (in Years)
    
    ValueBalance at December 31, 2006
    
    
    298,597
    
    
    
    7,823,874
    
    
    $
    1.12Granted (unaudited)
    
    
    (86,500
    )
    
    
    86,500
    
    
    $
    11.50Exercised (unaudited)
    
    
    
    
    
    
    (185,546
    )
    
    $
    0.81Cancelled and forfeited (unaudited)
    
    
    18,715
    
    
    
    (18,715
    )
    
    $
    2.01Balance at March 31, 2007 (unaudited)
    
    
    230,812
    
    
    
    7,706,113
    
    
    $
    1.24

    
    
    7.35
    
    
    $
    75,252Options vested and expected to vest
at March 31, 2007 (unaudited)
    
    
    
    
    
    
    7,596,809
    
    
    $
    1.22

    
    
    7.33
    
    
    $
    74,352Options exercisable at March 31, 2007 (unaudited)
    
    
    
    
    
    
    4,880,575
    
    
    $
    0.63

    
    
    6.69
    
    
    $
    50,623
 (15) Segment and Geographic Information
 Disclosures about Segments of an Enterprise and Related Information
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Three Months Ended March 31,2007
    
    
    2006(Unaudited)
    
    
    (Unaudited)Revenues:Europe, Middle East and Africa
    
    $
    14,996
    
    
    $
    16,825North America
    
    
    4,754
    
    
    
    3,653Asia Pacific and India
    
    
    4,489
    
    
    
    775Caribbean and Latin America
    
    
    3,216
    
    
    
    399$
    27,455
    
    
    $
    21,652Foreign countries which contributed more than
10% of revenues:
    
    Russia
    
    RussiaBelgium
 Three Months Ended March 31,2007
    
    
    2006(Unaudited)
    
    
    (Unaudited)Sales originating from:United States
    
    $
    14,041
    
    
    $
    5,951Israel
    
    
    11,417
    
    
    
    15,701Other foreign countries
    
    
    1,997
    
    
    
    $
    27,455
    
    
    $
    21,652March 31,
    
    
    December 31,2007
    
    
    2006(Unaudited)Long-lived assets, net:United States
    
    $
    3,226
    
    
    $
    3,256Israel
    
    
    3,029
    
    
    
    3,311Other foreign countries
    
    
    529
    
    
    
    556$
    6,784
    
    
    $
    7,123
 (16) Subsequent Events
  19




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 The following discussion and analysis should be read in conjunction with our Consolidated
Financial Statements and Notes thereto for the year ended December 31, 2006, included in our
Prospectus, filed with the Securities and Exchange Commission on April 5, 2007. The discussion in
this Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties,
such as statements of our future financial operating results, plans, objectives, expectations and
intentions. Our actual results could differ materially from those discussed here. See Risk
Factors in Item 1A of Part II for factors that could cause future results to differ materially.
 Overview
      Critical Accounting Policies and Estimates
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
    
    Revenue recognition
    
    Allowance for doubtful accounts
    
    Stock-based compensation
    
    Accounting for income taxes
 Revenue recognition .
 Reporting Revenue Gross as a Principal versus Net as an Agent.
 Revenue Recognition Revenue Arrangements with Multiple Deliverables
 Software Revenue Recognition , Modification of SOP 97-2, Software Revenue Recognition, with
Respect to Certain Transactions.
   
    
    Vendor-specific objective evidence, or VSOE, of fair value for IP services:Beginning in the third quarter of 2006, we established VSOE of fair value for IP services
(installation, training and consulting). We limit our assessment of VSOE of fair value to
the price charged when the same element is sold separately. Accordingly, assuming all other
revenue recognition criteria are met, revenue is recognized upon delivery of the hardware
and software using the residual method. We expect that our estimates and assumptions used to
determine the timing and amount of revenue recognized for IP services will be more
consistent. We are not likely to materially change our pricing practices in the future.
    
    VSOE for PCS based on renewal rates:VSOE for PCS in IP solutions is based on the premise that the stated renewal rates in the
contractual arrangements will be enforced when the customer renews their PCS after the
initial term. Historically, 100% of the customers that have chosen to renew have renewed at
the stated renewal rate. We have no
reason to believe that our customers will not renew the PCS at the stated renewal rate.
 21




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
    
    Extended payment terms:Our arrangement fees are generally due within one year or less from the later of the date of
delivery or acceptance. Some arrangements may have payment terms extending beyond these
customary terms. We have experienced collectibility issues on arrangements where payment
terms have extended beyond one year. Therefore, on arrangements with these terms, the fees
are considered not to be fixed or determinable. Our collection history supports that we
recognize revenue based on the assumption that collection is probable when our fees are
negotiated under our customary terms.
 Allowance for doubtful accounts .
 Stock-based compensation . Accounting for Stock Issued to Employees Accounting for
Certain Transactions Involving Stock Compensation an Interpretation of APB Opinion No. 25 Accounting for Stock-Based
Compensation Accounting for Stock-Based Compensation 
Transition and Disclosure
   Share-Based Payment
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Disclosure About Fair Value of Financial Instruments
  Three Months EndedMarch 31, 2007Expected term in years
    
    
    6.25Risk-free interest rate
    
    
    4.78
    %Volatility
    
    
    74
    %Dividend yield
    
    
    Estimated fair value per share of underlying common stock
    
    $
    11.50
    Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans
 Accounting for income taxes .
 Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109.
 23




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Results of Operations
 Revenues.
    Cost of revenues.
    24




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Gross profit.
  Research and development expenses, net.
  Sales and marketing expenses.
  General and administrative expenses.
  Other (expense) income, net.
 25




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Income taxes.
 Net loss.
 Liquidity and Capital Resources
  Operating Activities
    Investing Activities
    26




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Financing Activities
    Contractual Obligations and Commitments
  Payment DueApril 1, 2007
    
    
    January 1, 2008
    
    
    January 1, 2010through
    
    
    through
    
    
    throughTotal
    
    
    December 31, 2007
    
    
    December 31, 2009
    
    
    December 31, 2011Contractual Obligations:Debt obligations
    
    $
    5,459
    
    
    $
    2,006
    
    
    $
    3,453
    
    
    $
    Operating lease obligations
    
    
    5,814
    
    
    
    1,663
    
    
    
    2,782
    
    
    
    1,369Purchase commitments
    
    
    2,247
    
    
    
    2,247
    
    
    
    
    
    
    
    Total
    
    $
    13,520
    
    
    $
    5,916
    
    
    $
    6,235
    
    
    $
    1,369
 Off-Balance Sheet Arrangements
  
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 Foreign Currency Risk
   Interest Rate Sensitivity
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ITEM 4. CONTROLS AND PROCEDURES
 Limitations of Disclosure Controls and Procedures and Internal Control Over Financial
Reporting
  Disclosure Controls and Procedures
   Changes in Internal Control Over Financial Reporting
  
 PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 1A. RISK FACTORS
 Risks Related to Our Business
 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.
  
    
    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;
    
    changes in the regulation of communications services; and
    
    general global economic conditions.
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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 revenue and operating results may be adversely impacted if the market for IP products does not
develop as we expect or if sales of our IP products and other products do not make up for expected
declines in revenue from our DCME products.
  Our accountants have identified and reported to us material weaknesses for the years ended December
31, 2003, 2004 and 2005, relating to our internal controls over financial reporting. If we fail to
maintain proper and effective internal controls, our ability to produce accurate financial
statements could be impaired, which could adversely affect our operating results, our ability to
operate our business and our stock price.
 An Audit of Internal
Control Over Financial Reporting Performed in Conjunction With an
Audit of Financial Statements
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
    
    Personnel:From April 2005 through March 2007, we hired several experienced employees in
key financial management positions, including our Chief Financial Officer, Worldwide
Financial Controller, and Director of Financial Planning and Analysis. In addition, we
created new financial management and administrative positions, and hired experienced and
qualified employees for such new positions as follows: Director of Accounting, Director of
Financial Reporting and Compliance, General Counsel, General Accounting Manager and Revenue
Manager. We plan to continue to evaluate our personnel needs and hire experienced and
qualified employees as appropriate.
    
    Training:Since April 2005, the majority of our finance and administration staff have
participated in one or more continuing professional education courses, industry roundtables
or other formal and informal training courses. In addition, we have conducted in-house
training (one-on-one, and in group settings) concerning various matters (i.e. the revenue
recognition process, closing process, etc.) for the finance, administration and sales staff.
The objective of this training is to strengthen the general proficiency and specific
knowledge of our employees, as well as improve internal controls over financial reporting.
We plan to continue to conduct such training in the future.
    
    Internal Process:We have steadily made improvements in our internal processes. The
objective of such internal process improvements has been to remediate the material
weaknesses and significant deficiencies, and achieve an overall improvement in internal
controls over financial reporting. Such process improvements have included, but are not
limited to, the establishment of a centralized electronic database of key contracts,
accounting records and related documentation, increased uniformity and consistency with
respect to customer contracts, accounting records and related documentation, and increased
level of management review of key processes, particularly the revenue cycle and sales
process. We plan to continue to evaluate our internal controls and make improvements as
appropriate.
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We have not been profitable and our losses could continue.
  Our limited operating history makes it difficult to evaluate our current business and future
prospects.
  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.
    
    
    provide extremely high reliability, compression rates and voice quality;
    
    scale and deploy easily and efficiently;
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
    
    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.
  Our business is dependent upon our relationship with ECI Telecom Ltd. and certain of its
subsidiaries and affiliates, or ECI, and ECI is our largest stockholder and a significant
technology and commercial partner of ours. If ECIs business is adversely affected or 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.
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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.
  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.
   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.
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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 expect that a majority of the revenues generated from our products, especially our IP products,
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.
  
    
    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 of our customers;
    
    new product introductions by our competitors;
    
    geopolitical risks and uncertainties in countries where our customers or our own facilities are located; or
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
    
    failure of our products to perform as expected.
 Our quarterly operating results have fluctuated significantly in the past and may continue to
fluctuate in the future, which could lead to volatility in the price of our common stock.
  
    
    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;
    
    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 and amount of deferred revenues;
    
    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.
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If we do not respond rapidly to technological changes or to changes in industry standards, our
products could become obsolete.
  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.
  
    
    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.
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
    
    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.
 We intend to expand our operations and increase our expenditures in an effort to grow our business.
If we are not able to manage this growth and expansion, or if our business does not grow as we
expect, our operating results may suffer.
  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.
   We rely on indirect channel partners for a significant portion of our revenue. Our failure to
effectively develop and manage these third party distributors, systems integrators and resellers
specifically and our indirect sales channel generally, and disruptions to the processes and
procedures that support our indirect sales channels could adversely affect our ability to generate
revenues from the sale of our products.
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We may face risks associated with our international sales that could impair our ability to grow our
revenues.
  
    
    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;
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
    
    certification and qualification requirements for doing business in foreign jurisdictions;
    
    inadequate protection for intellectual property rights in certain countries;
    
    less stringent adherence to ethical and legal standards by prospective customers in
certain foreign countries, including compliance with the Foreign Corrupt Practices Act;
    
    potentially adverse tax consequences; 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.
    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.
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We have a substantial employee presence in India and the hiring and retention of skilled employees
in India has become increasingly difficult. If we are unable to hire and retain skilled employees
in India and elsewhere, we may not be able to execute our business strategy.
  We have no internal hardware manufacturing capabilities and we depend exclusively upon contract
manufacturers to manufacture our hardware products. In particular, our I-Gate 4000 media gateways
are exclusively manufactured for us by Flextronics (Israel) Ltd., or Flextronics. We buy our DCME
products from ECI who subcontracts manufacturing of these products to Flextronics. 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 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.
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Failure to manage expenses and inventory risks associated with meeting the demands of our customers
may adversely affect our business or results of operations.
  If we are not able to obtain necessary licenses of third-party technology at acceptable prices, or
at all, our products could become obsolete.
  Failures by our strategic partners or by us in integrating our products with those provided by our
strategic partners could seriously harm our business.
  
    
    a loss of, or delay in, recognizing revenues;
    
    increased service, support and warranty costs and a diversion of development resources; and
    
    network performance penalties.
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
    
    a loss of customers and market share; and
    
    a failure to attract new customers or achieve market acceptance for our products.
 Our ability to compete and our business could be jeopardized if we are unable to protect our
intellectual property.
   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.
  
    
    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.
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Doug Sabella, our President and Chief Executive Officer, was recently named as a defendant in a
class action lawsuit related to his employment with a prior employer and in the event this lawsuit
consumes a significant
portion of Mr. Sabellas time and diverts his attention from his performance as our President and
Chief Executive Officer, then our business may be harmed.
  If we acquire or invest in other companies, assets or technologies and we are not able to integrate
them with our business, or we do not realize the anticipated financial and strategic goals for any
of these transactions, our financial performance may be impaired.
  
    
    we may find that the acquired company, asset or technology does not further our business
strategy, that we overpaid for the company, asset or technology or that the economic
conditions underlying our acquisition decision have changed;
    
    we may have difficulty integrating the assets, technologies, operations or personnel of
an acquired company, or retaining the key personnel of the acquired company;
    
    our ongoing business and managements attention may be disrupted or diverted by
transition or integration issues and the complexity of managing geographically or culturally
diverse enterprises;
    
    we may encounter difficulty entering and competing in new product or geographic markets,
and we may face increased competition, including price competition or intellectual property
litigation; and
    
    we may experience significant problems or liabilities associated with product quality,
technology and legal contingencies relating to the acquired business or technology, such as
intellectual property or employment matters.
  Regulation of the telecommunications industry could harm our operating results and future
prospects.
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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.
   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.
   We have invested substantially in our enhanced access switching solution and we may be unable to
achieve and maintain substantial sales.
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Recent rulemaking by the Financial Accounting Standards Board, or FASB, requires us to expense
equity compensation given to our employees and may impact our ability to effectively utilize equity
compensation to attract and retain employees.
  Future interpretations of existing accounting standards could adversely affect our operating
results.
  Software Revenue Recognition Software
Revenue Recognition with Respect to Certain Transactions
 
    
    software arrangements that include undelivered elements for which we do not have vendor
specific objective evidence, or VSOE, of fair value;
    
    requirements that we deliver services for significant enhancements and modifications to
customize our software for a particular customer;
    
    material acceptance criteria or other identified product-related issues; or
    
    payment terms extending beyond our customary terms.
  Product liability claims related to our customers networks could result in substantial costs.
  45




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Risks Related to Our Operations in Israel
  Increased political, economic and social instability in the Middle East, may adversely affect our
business and operating results.
    Our operations may be disrupted by the obligations of our personnel to perform military service.
  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.
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
    
    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.
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 a) Sales of Unregistered Securities
    (b) Use of Proceeds from Public Offering of Common Stock
 47




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ITEM 3. DEFAULTS ON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5. OTHER INFORMATION
  
 ITEM 6. EXHIBITS
  Exhibit
    
    Description of document3.1
    
    Amended and Restated Certificate of Incorporation of the Registrant (1)3.2
    
    Amended and Restated Bylaws of the Registrant (1)4.1
    
    Reference is made to Exhibits 3.1 and 3.24.2
    
    Specimen stock certificate (1)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 200231.2
    
    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 200232
    
    Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
 
 (1)
    
    Filed as an exhibit to Veraz Networks, Inc. Registration Statement on Form S-1 (No. 333-138121)
and incorporated herein by reference. 48




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SIGNATURE
  Veraz Networks, Inc.Date: May 15, 2007
    By:
    /s/ Al WoodAl WoodChief Financial Officer (Principal
Financial and Chief Accounting Officer) 49




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EXHIBIT INDEX
 Exhibit
    
    Description of document3.1
    
    Amended and Restated Certificate of Incorporation of the Registrant (1)3.2
    
    Amended and Restated Bylaws of the Registrant (1)4.1
    
    Reference is made to Exhibits 3.1 and 3.24.2
    
    Specimen stock certificate (1)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 200231.2
    
    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 200232
    
    Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
 
 (1)
    
    Filed as an exhibit to Veraz Networks, Inc. Registration Statement on Form S-1 (No. 333-138121)
and incorporated herein by reference.