Form 10-Q

10-Q 1 d10q.htm FORM 10-Q Form 10-Q

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, 2010

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

For the transition period from to

Commission file number 001-33391

Veraz Networks, Inc.

(Exact name of registrant as specified in its charter)

Delaware

94-3409691

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

926 Rock Avenue, Suite 20

San Jose, California 95131

(408) 750-9400

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

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

Indicate by check mark whether the Registrant 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 ¨

Smaller reporting company þ

(Do not check if a smaller

reporting company)

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

As of April 30, 2010, 44,256,292 shares of the Registrant’s common stock were outstanding.

VERAZ NETWORKS, INC AND SUBSIDIARIES

FORM 10-Q

For the Quarterly Period Ended March 31, 2010

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		19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK		27
ITEM 4T. CONTROLS AND PROCEDURES		27

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS		28
ITEM 1A. RISK FACTORS		28
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.		43
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.		43
ITEM 4. (REMOVED AND RESERVED).		44
ITEM 5. OTHER INFORMATION.		44
ITEM 6. EXHIBITS		44
SIGNATURE		45

VERAZ NETWORKS, INC AND SUBSIDIARIES

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Unaudited Condensed Consolidated Balance Sheets

(in thousands)


	March 31, 2010		December 31, 2009

ASSETS
Current assets:
Cash and cash equivalents	$	27,258	$	25,095
Restricted cash		951		608
Short-term investments		3,000		7,899
Accounts receivable, net		27,758		29,959
Inventories		8,255		8,364
Prepaid expenses		1,526		1,718
Other current assets		2,603		3,113
Due from related parties		196		686

Total current assets		71,547		77,442
Property and equipment, net		2,748		3,149
Other assets		122		120

Total assets	$	74,417	$	80,711


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,690	$	6,375
Accrued expenses		12,072		11,493
Income tax payable		470		1,173
Deferred revenue		13,038		14,112
Due to related parties		1,367		1,117

Total current liabilities		32,637		34,270

Stockholders’ equity:
Common stock		44		44
Additional paid-in capital		133,801		133,084
Accumulated other comprehensive income		1,991		2,124
Accumulated deficit		(94,056)		(88,811)

Total stockholders’ equity		41,780		46,441

Total liabilities and stockholders’ equity	$	74,417	$	80,711

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

VERAZ NETWORKS, INC AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Operations

(in thousands, except per share data)


	Three Months Ended March 31,
	2010		2009
Revenues:
IP Products	$	8,186	$	13,050
DCME Products		1,234		1,198
Services		6,650		6,703

Total revenues		16,070		20,951

Cost of Revenues:
IP Products		3,392		5,434
DCME Products		471		487
Services		3,284		2,888

Total cost of revenues		7,147		8,809

Gross profit		8,923		12,142

Operating Expenses:
Research and development, net		5,068		5,208
Sales and marketing		5,674		6,530
General and administrative		3,251		2,808

Total operating expenses		13,993		14,546

Loss from operations		(5,070)		(2,404)
Other income (expense), net		48		(534)

Loss before income taxes		(5,022)		(2,938)
Provision for income taxes		223		70

Net loss	$	(5,245)	$	(3,008)

Net loss per share — basic and diluted	$	(0.12)	$	(0.07)

Weighted average shares outstanding used in computing net loss per share — basic and diluted		44,042		43,165

Related Party Transactions

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


	Three Months Ended March 31,
	2010		2009
Revenues:
IP Products, related party sales	$	31	$	40
Cost of Revenues:
DCME Products, costs arising from related party purchases		494		436
Services, costs arising from related party purchases		—		22
Operating Expenses:
Research and development		15		53
Sales and marketing		15		594
General and administrative		54		54

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

VERAZ NETWORKS, INC AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)


	Three Months Ended March 31,
	2010		2009
Cash flows from operating activities:
Net loss	$	(5,245)	$	(3,008)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		544		718
Stock-based compensation		708		1,152
Provision (release) for doubtful accounts		176		(2)
Other non-cash items		(11)		(50)
Net changes in operating assets and liabilities:
Accounts receivable		1,831		3,447
Inventories		73		2,420
Prepaid expenses and other current assets		676		1,348
Due from related parties		490		87
Accounts payable		(633)		(55)
Accrued expenses		828		(1,348)
Income tax payable		(695)		62
Deferred revenue		(1,176)		(4,290)
Due to related parties		250		(2,513)

Net cash used in operating activities		(2,184)		(2,032)


Cash flows from investing activities:
Restricted cash		(343)		4
Maturities and sales of short-term investments		4,897		1,837
Purchases of short-term investments		—		(14,040)
Purchases of property and equipment		(193)		(396)
Other assets		(2)		(30)

Net cash provided by(used in) investing activities		4,359		(12,625)


Cash flows from financing activities:
Proceeds from the exercise of stock options		9		32

Net cash provided by financing activities		9		32

Effect of exchange rate changes on cash and cash equivalents		(22)		166

Net decrease in cash and cash equivalents		2,162		(14,459)

Cash and cash equivalents at beginning of period		25,096		35,388

Cash and cash equivalents at end of period	$	27,258	$	20,929

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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 March 31, 2010 and for the three months ended March 31, 2010 and 2009 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, 2009.

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, 2009, and include adjustments (consisting of normal recurring adjustments) necessary for the fair presentation of the Company’s financial position as of March 31, 2010, results of operations for the three months ended March 31, 2010 and 2009, and cash flows for the three months ended March 31, 2010 and 2009.

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies of the Company are as follows:

(a) Use of Estimates

The preparation of unaudited 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) Restricted Cash

Generally, restricted cash represents collateral securing guarantee arrangements with banks. The amounts expire upon achievement of certain agreed objectives, typically customer acceptance of the product, completion of installation and commissioning services, or expiration of the term of the product warranty or maintenance period. In addition, during the three months ended March 31, 2010, the Company opened an escrow account for $0.3 million for the civil penalties it may have to pay to the SEC (see Note 9 below).

(c) 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.

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 (8% and 6% of revenues during the three months ended March 31, 2010 and 2009, respectively) and related services (4% of revenues during each of the three months ended March 31, 2010 and 2009, 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, 012 Smile, contributed to 10% or more of the Company’s revenues in the three months ended March 31, 2010, and one customer, Bezeq Limited, contributed 10% of the Company’s revenues in the three months ended March 31, 2009. As of March 31, 2010, no customer contributed to 10% or more of the Company’s accounts receivable. As of December 31, 2009, one of the Company’s customer, TIM Cellular S.A, contributed to 10% or more of the Company’s accounts receivable. To date, the Company has not experienced any material credit issues with TIM Cellular S.A.

(d) 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, licensing of source code 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.

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 and, accordingly, revenue is recognized on subsequent sales of VOIP solutions 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 network.

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.

Revenues are recognized net of sales taxes. 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 three months ended March 31, 2010 and 2009. Shipping and handling costs are included in cost of revenues.

For purposes of classification in the unaudited 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.

(e) Accounts Receivable and Allowance for Doubtful Accounts

Generally, the Company’s receivables are recorded when billed and represent claims against third parties that will be settled in cash. The carrying value of the receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value.

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the customers’ failure to make required payments. The Company may record an increase of the allowance if there is a deterioration in past due balances, if economic conditions are less favorable than we had anticipated, or for customer-specific circumstances, such as bankruptcy. Additionally, as many of the Company’s customers are conducting business in emerging markets that can be unpredictable at times due to rapidly changing political and economic conditions, the judgment of management is a significant factor in determining whether an increase in the allowance is warranted. Management considers various factors when making such judgments, including the customer-specific circumstances as well as the general political environment, economic conditions and other relevant matters in determining the collectability of the receivables.

The Company will 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.

(f) Investments

The Company invests in short-term investments. The short-term investments are debt and marketable equity securities and are classified as available-for-sale. Available-for-sale securities are carried at fair value with the unrealized gains and losses, net of tax, reported in stockholders’ equity as a component of accumulated other comprehensive income (loss). Unrealized losses considered to be other than temporary are recognized in 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.

(g) 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. The grants received bear an annual interest at LIBOR as of the date of approval. Royalties payable to the OCS are classified as cost of revenues. During the three months ended March 31, 2010 and 2009, grants received from the OCS were $0.4 million and $0.3 million, respectively. Royalty expenses relating to OCS grants included in cost of IP product revenues for the three months ended March 31, 2010 and 2009 amounted to $0.2 million and $0.5 million, respectively. As of March 31, 2010 and December 31, 2009, the royalty payable amounted to $1.2 million and $0.9 million, respectively. The maximum amount of the contingent liability related to royalties payable to the Israeli Government was approximately $16.1 million as of March 31, 2010.

(h) Comprehensive Loss

The components of comprehensive loss for the three months ended March 31, 2010 and 2009 were as follows (in thousands):


	Three Months Ended
	March 31,
	2010		2009
Net loss	$	(5,245)	$	(3,008)
Foreign currency translation adjustments		(131)		166
Net unrealized losses on investments		(2)		—

Total comprehensive loss	$	(5,378)	$	(2,842)

(i) Stock-Based Compensation

Stock-based compensation cost in connection with grants of restricted stock units (“RSUs”) and stock options to Company employees. Stock-based compensation cost for restricted stock units is measured based on the closing fair market value of the Company’s common stock on the date of grant and expensed on a straight-line basis over the requisite service period. Stock-based compensation cost for stock options is estimated at the grant date based on the options’ 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, interest rates and expected option life. Historically, the Company has not granted any dividends. 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” for a plain vanilla employee stock option for which the value was estimated using a Black-Scholes formula. 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 was permitted as we did not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its equity shares have been publicly traded. 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.

(j) 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 Note 3(h) above).

(k) Recent Accounting Pronouncements

Fair Value Measurements and Disclosures

In January 2010, the FASB issued an update in ASC 820, Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements to amended standards that require additional disclosures about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs for fiscal years beginning after December 15, 2010. Additionally, these amended standards require presentation of disaggregated activity within the reconciliation for fair value measurements using significant unobservable inputs (Level 3) for annual periods beginning after December 15, 2009. The adoption of the guidance did not have a significant impact on the unaudited condensed consolidated financial statements or related footnotes.

In June 2009, the FASB issued new guidance regarding accounting for transfers of financial assets that removes the scope exception from applying consolidations of variable interest entities. The guidance changes the requirements for recognizing financial assets and requires enhanced disclosures. The new requirements are effective for annual periods beginning after November 15, 2009, which was effective for the Company in the first quarter of 2010. The adoption of the guidance did not have a significant impact on the unaudited condensed consolidated financial statements or related footnotes.

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 Company will apply the accounting guidance 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 unaudited condensed consolidated financial statements.

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, or ASU 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 Company will apply the new guidance on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and will become effective during the first quarter of 2011. Early application is permitted. The Company is currently evaluating the impact of this accounting guidance on its unaudited condensed 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 available-for-sale securities, excluding accrued interest components, as presented on the Company’s unaudited condensed consolidated condensed balance sheets as of March 31, 2010 and December 31, 2009. A summary of cash, cash equivalents, and short-term available-for-sale securities as of March 31, 2010 and December 31, 2009 were as follows (in thousands):


Security Description	Percentage of holdings	Amortized Cost		Unrealized Gains (Losses)		Fair Market Value
March 31, 2010
Cash equivalents:
Money market funds	100%	$	16,316	$	—	$	16,316

Total cash equivalents	100%	$	16,316	$	—	$	16,316


Short-term investments:
U.S. Treasury bills	100%	$	2,999	$	1	$	3,000

Total short-term investments	100%	$	2,999	$	1	$	3,000


December 31, 2009
Cash equivalents:
Money market funds	100%	$	11,423	$	—	$	11,423

Total cash equivalents	100%	$	11,423	$	—	$	11,423


Short-term investments:
U.S. Treasury bills	100%	$	7,896	$	3	$	7,899

Total short-term investments	100%	$	7,896	$	3	$	7,899

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 March 31, 2010 are due within 12 months.

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 March 31, 2010 and December 31, 2009, 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 available-for-sale securities assets at fair value on a recurring basis and has determined that these financial assets were level 1 in the fair value hierarchy. The following table sets forth the Company’s financial assets that were accounted for at fair value as of March 31, 2010 (in thousands):


			Fair Value at Reporting Date Using
	Total		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Assets:
Fixed income available-for-sale securities	$	3,000	$	3,000	$	—	$	—
Money market funds		16,316		16,316		—		—

	$	19,316	$	19,316	$	—	$	—

The fixed income available-for-sale securities are included in short-term investments in the unaudited condensed consolidated balance sheet and consist of U.S. Treasury bills issued by the U.S. government.

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 March 31, 2010 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, 2010. 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 three months ended March 31, 2010 and year ended December 31, 2009. 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 unaudited condensed consolidated statements of operations.

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 unaudited 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 allocates support and administrative expenses between research and development, sales and marketing, and general and administrative, in the unaudited condensed consolidated statements of operations. All such relationships (other than in Israel), however, have been terminated on April 30, 2009.

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 unaudited condensed consolidated statements of operations for the three months ended March 31, 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 12^tthanniversary if this sublease is extended pursuant to its terms. The monthly rent for this sublease is approximately $13,000. For the three months ended March 31, 2010 and 2009, ECI Telecom rent is included in general and administrative expense in the unaudited condensed consolidated statements of operations. Additionally, the Company entered into a consulting agreement with ECI Telecom for ECI Telecom 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. The Company paid $2.1 million under the Settlement Agreement to ECI Telecom during 2009 and zero for March 31, 2010 to settle for liabilities recorded pursuant to the agreements described above.

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 employees of the Company. In May 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 March 31, 2010 and 2009, the Company incurred related party research and development expenses owed to Persistent under the Contractor Agreement of zero and $34,000, respectively. The Company had no related payable outstanding as of March 31, 2010 and December 31, 2009.

NOTE 6 – BALANCE SHEET COMPONENETS

(a) Inventories

The following tables provide details of inventories as of March 31, 2010 and December 31, 2009 (in thousands):


	March 31, 2010		December 31, 2009
Finished products	$	2,700	$	2,600
Work in process at customers’ locations		2,432		2,424
Raw material and components		3,123		3,340

Total inventories	$	8,255	$	8,364

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(d)). 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.

(b) Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Estimated useful lives used consist of three years for furniture, computer equipment, and related software, and five years for production, engineering, and other equipment. Depreciation of leasehold improvements is computed using the shorter of the remaining lease term or five years. The Company has leased its office buildings, equipment and cars and is considered operating leases.

The following tables provide details of inventories as of March 31, 2010 and December 31, 2009 (in thousands):


	March 31, 2010		December 31, 2009
Property and equipment, net:
Computer equipment and software	$	11,911	$	11,811
Production, engineering and other equipment		9,493		9,450
Furniture and fixtures		597		598
Leasehold improvements		294		293

		22,295		22,152
Accumulated depreciation		(19,547)		(19,003)

Total property and equipment, net	$	2,748	$	3,149

NOTE 7 – STOCK-BASED COMPENSATION

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


	Three Months Ended March 31,
	2010		2009
Cost of revenues	$	176	$	261
Research and development		225		382
Sales and marketing		181		304
General and administrative		126		205

Total stock-based compensation expense	$	708	$	1,152

Stock Options:

During the three months ended March 31, 2010 and 2009, the Company granted zero stock options.

During the three months ended March 31, 2010 and 2009, the compensation expense on stock options, including deferred stock-based compensation, amounted to $0.3 million and $0.4 million, respectively.

Restricted Stock Awards:

During the three months ended March 31, 2010 and 2009, the Company granted 431,225 and 483,575 restricted stock units, or RSUs, respectively. For the three months ended March 31, 2010 and 2009, the weighted average grant date fair value per share of RSUs granted was $0.83 and $0.47, respectively.

During the three months ended March 31, 2010 and 2009, the compensation expense on restricted stock based awards amounted to $0.4 million and $0.8 million, respectively.

Restricted stock activity as of March 31, 2010 was as follows:


	Number of Shares	Weighted Average Grant Date Fair Value

Nonvested at December 31, 2009	2,154,108	$1.88
Granted	431,225	$0.83
Vested	(480,699)	$3.85
Forfeited or expired	(16,962)	$4.27

Nonvested at March 31, 2010	2,087,672	$1.20

As of March 31, 2010, 2,087,672 shares of restricted stock based awards were outstanding and unvested, with an aggregate intrinsic value of $2.1 million. As of December 31, 2009, 2,154,108 shares of restricted stock based awards were outstanding and unvested, with an aggregate intrinsic value of $2.0 million. During the three months ended March 31, 2010 and 2009, aggregate intrinsic value of vested restricted stock based awards was $0.4 million and $0.3 million, respectively.

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.

Stock Award Activity:

A summary of the Company’s stock award activity and related information for the three months ended March 31, 2010 is set forth in the following table:


	Number of Shares Available for Grant	Number of Options Outstanding	Weighted Average Exercise Price	Weighted Average Contractual Life (in years)	Aggregate Intrinsic Value

Balance at December 31, 2009	444,204	5,885,531	$1.54	5.78	$905,623
Authorized	1,310,574	—	—
Restricted stock units granted	(431,225)	—	—
Restricted stock units cancelled and forfeited	16,962	—	—
Options granted	—	—	—
Options exercised	—	(18,873)	$0.40
Options cancelled and forfeited	39,645	(39,645)	$2.98

Balance at March 31, 2010	1,380,160	5,827,013	$1.53	5.59	$973,841

Options vested and expected to vest at March 31, 2010		5,744,337	$1.53	5.55	$972,286
Options exercisable at March 31, 2010		4,789,017	$1.45	5.02	$959,591

The total intrinsic value of options exercised was zero and $10,000 during the three months ended March 31, 2010 and 2009, respectively.

NOTE 8 – 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 Ended March 31,
	2010		2009
Numerator:
Net loss	$	(5,245)	$	(3,008)


Denominator:
Basic and diluted weighted-average shares:
Weighted-average shares used in computing basic net loss per share		44,042		43,165

Basic and diluted net loss per common share	$	(0.12)	$	(0.07)

Anti-dilutive shares excluded from net loss per share calculation		4,559		16,688

NOTE 9 – 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 January 2010, the Company reached a tentative resolution with the staff of the SEC regarding the matters described above. Under the terms of the resolution, the Company will consent, without admitting or denying the allegations, to the entry of an injunction prohibiting violations of the non-fraud provisions of the FCPA and to pay a civil penalty of $0.3 million. The agreement requires approval by the SEC and is subject to court approval.

The Company had no expenses incurred related to the SEC inquiry in the three months ended March 31, 2010 and 2009. As of March 31, 2010, the Company has incurred expenses related to the SEC investigation of approximately $3.0 million.

NOTE 10 – INCOME TAXES

The Company recorded an income taxes provision of $0.2 million and $0.1 million for the three months ended March 31, 2010 and 2009, respectively. The tax provision during the three months ended March 31, 2010 was attributable to foreign income and withholding taxes on the income earned by certain foreign operations of the Company. The tax provision during the three months ended March 31, 2009 was primarily attributable to foreign income taxes on the income of the Company’s profitable foreign operations.

Our net deferred tax assets remain at zero at March 31, 2010. Based on all available evidence, the Company has concluded that it is more likely than not that all of the deferred tax assets will not be recovered, and a valuation allowance against deferred tax assets is necessary. As a result of recent cumulative losses and uncertainty regarding future taxable income, the Company has determined, based on all available evidence, that there was substantial uncertainty as to the realizability of the deferred tax asset in future periods and accordingly the Company maintained a full valuation allowance against our net deferred tax assets in the first quarter of 2010.

The Company files U.S. federal income tax returns as well as income tax returns in various states and foreign jurisdictions. The Company may be subject to examination by the Internal Revenue Service, or IRS, for calendar years from its inception in 2001 through 2008. Additionally, any net operating losses that were generated in those years may also be subject to examination by the IRS, in the tax year the net operating loss is utilized. In addition, the Company may be subject to examination in the following foreign jurisdictions for the years specified: Brazil for 2007 through 2009, France for 2007 through 2008, India for 2005 through 2009, Israel for 2008 and 2009, Singapore for 2005 through 2008, Russia for 2006 through 2008, and the United Kingdom for 2005 through 2009.

NOTE 11 – 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 is required to disclose certain information regarding operating segments, products and services, geographic areas of operation and major customers. 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 property and equipment, net by geographic area (in thousands):


	Three Months Ended March 31,
	2010		2009
Revenues:
Europe, Middle East and Africa	$	7,398	$	8,645
North America		4,080		3,170
Asia Pacific and India		1,797		5,548
Caribbean and Latin America		2,795		3,588

Total revenues by geographic area	$	16,070	$	20,951

Foreign countries which contributed more than 10% of revenues		Israel		None

	Three Months Ended March 31,
	2010		2009
Sales originating from:
United States	$	6,978	$	8,132
Israel		7,309		8,160
Other foreign countries		1,783		4,659

Total sales by geographic area	$	16,070	$	20,951


	March 31,		December 31,
	2010		2009
Property and equipment, net:
United States	$	760	$	910
Israel		1,641		1,845
Other foreign countries		347		394

Total property and equipment, net by geographic area	$	2,748	$	3,149

NOTE 12 – SUBSEQUENT EVENTS

On May 12, 2010, Veraz Networks, Inc. (“Veraz”) entered into an Acquisition Agreement (“Acquisition Agreement”), by and between Veraz and Dialogic Corporation, a British Columbia corporation (“Dialogic”), pursuant to which Veraz will acquire all of the outstanding shares in the capital of Dialogic in exchange for shares of Veraz common stock (the “Arrangement”). Upon consummation of the transactions contemplated by the Acquisition Agreement, Dialogic will become a wholly-owned subsidiary of Veraz. Pursuant to the Acquisition Agreement, 110,580,900 shares of Veraz common stock will be issued to the Dialogic shareholders. After taking into account the issuance of stock options to purchase Veraz common stock in exchange for Dialogic stock options, the Dialogic shareholders and optionholders will hold approximately 70% and existing Veraz stockholders and optionholders will hold approximately 30% of the outstanding securities of Veraz following the closing.

Acquisition Agreement

Pursuant to the terms of the Acquisition Agreement, Veraz will acquire all of Dialogic’s outstanding common and preferred shares in the capital of Dialogic in exchange for shares of Veraz common stock. The Arrangement will be carried out pursuant to a Plan of Arrangement pursuant to the British Columbia Business Corporations Act as set forth in the Acquisition Agreement. Upon the completion of the Arrangement, the Dialogic shareholders will be entitled to receive an aggregate of 110,580,900 shares of Veraz common stock. All outstanding options to purchase Dialogic common shares will be exchanged for options to purchase Veraz common stock.

Each of Veraz and Dialogic has made customary representations, warranties and covenants in the Acquisition Agreement, including, among others, covenants: (a) to conduct their respective businesses in the ordinary course during the interim period between the execution of the Acquisition Agreement and the consummation of the Arrangement; (b) not to engage in certain kinds of transactions during such period or solicit or engage in discussions with third parties regarding other proposals to be acquired, in each case subject to specified exceptions; and (c) to seek approval from stockholders of Veraz and shareholders of Dialogic in connection with the transaction.

Consummation of the Arrangement is subject to customary conditions, including: (a) the approval of the Arrangement by the shareholders of Dialogic and the approval by the stockholders of Veraz of the issuance of shares of Veraz common stock; (b) absence of any applicable restraining order, injunction or governmental litigation prohibiting the Arrangement; (c) the absence of material adverse effect with respect to each of Veraz and Dialogic; (d) the accuracy of the representations and warranties of each party, subject to specified materiality thresholds; (e) performance in all material respects by each party of its obligations under the Acquisition Agreement; (f) completion of the restructuring of Dialogic’s indebtedness; (g) the approval of the Arrangement by the Supreme Court of British Columbia; and (h) antitrust approvals, including expiration of termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act. The Acquisition Agreement contains certain termination rights for both Veraz and Dialogic in certain circumstances, some of which may require Veraz to pay Dialogic a termination fee of $1,500,000 and an expense reimbursement of up to $1,000,000 or Dialogic to pay Veraz a termination fee of $3,000,000 and an expense reimbursement of up to $1,000,000.

The foregoing description of the Acquisition Agreement does not purport to be complete and is qualified in its entirety by reference to the Acquisition Agreement and the Plan of Arrangement, which are filed as Exhibit 2.1 to the Form 8-K filed on May 14, 2010 (“Dialogic 8-K”), and are incorporated into this report by reference.

The Acquisition Agreement and the Plan of Arrangement govern the contractual rights between the parties in relation to the Arrangement. We have included the above summary of certain terms of the Acquisition Agreement and the Plan of Arrangement and attached the Acquisition Agreement and Plan of Arrangement as an exhibit to the Dialogic 8-K to provide you with information regarding the terms of the Acquisition Agreement and the Plan of Arrangement. This summary and report are not intended to modify or supplement any factual disclosures about Veraz in our public reports filed with the SEC. In particular, the Acquisition Agreement, the Plan of Arrangement and related summaries are not intended to be, and should not be relied upon as, disclosures regarding any facts and circumstances relating to Veraz or Dialogic. The representations and warranties contained in the Acquisition Agreement have been negotiated with the principal purpose of establishing the circumstances in which a party may have the right not to close the Arrangement if the representations and warranties of the other party prove to be untrue due to a change in circumstance or otherwise, and allocates risk between the parties, rather than establishing matters as facts. The representations and warranties may also be subject to a contractual standard of materiality different from those generally applicable under the securities laws.

Support and Voting Agreements

At the same time that the Acquisition Agreement was entered into, certain shareholders of Dialogic (the “Specified Dialogic Shareholders”) entered into a Support Agreement (the “Dialogic Support Agreement”) with Veraz and certain stockholders of Veraz (the “Specified Veraz Stockholders”) each entered into a Voting Agreement (the “Veraz Voting Agreement”) with Dialogic.

The Dialogic Support Agreement provides that each of the Specified Dialogic Shareholders will, among other things, vote its Dialogic common and preferred shares in favor of the Arrangement and against an alternative transaction. The Dialogic Support Agreement will terminate upon the earliest of: (a) the completion of the Arrangement; (b) mutual agreement among Veraz and the Specified Dialogic Shareholders; or (c) the termination of the Acquisition Agreement in accordance with its terms.

The Veraz Voting Agreements provide that each of the Specified Veraz Stockholders will, among other things, vote its shares of Veraz common stock in favor of the issuance of Veraz common stock to Dialogic shareholders pursuant to the Acquisition Agreement and against an alternative transaction. Each Veraz Voting Agreement will terminate upon the earlier of: (a) completion of the Arrangement; (b) the termination of the Acquisition Agreement in accordance with its terms; or (c) mutual agreement by Dialogic and the Specified Veraz Stockholder.

The foregoing descriptions of the Dialogic Support Agreement and the Veraz Voting Agreement do not purport to be complete and are qualified in their entirety by reference to the Dialogic Support Agreement and the form of Veraz Voting Agreement, both of which are filed as Exhibits 99.2 and 99.3 to the Dialogic 8-K and are incorporated herein by reference.

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, 2009, in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 16, 2010. 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 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

SEC Investigation

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, the Independent Counsel reported its 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 produced documents and provided testimony relevant to the SEC’s investigation. In January 2010, we reached a tentative resolution with the staff of the SEC regarding the matters described above. Under the terms of the resolution, we will consent, without admitting or denying the allegations, to the entry of an injunction prohibiting violations of the non-fraud provisions of the FCPA and to pay a civil penalty of $0.3 million. The agreement requires approval by the SEC and is subject to court approval. For more information regarding the SEC matters discussed above, see Note 9 to our unaudited condensed consolidated financial statements elsewhere in this Quarterly Report.

Subsequent Event

Acquisition Agreement

Support and Voting Agreements

Recently Issued Accounting Pronouncements

See Note 3(k) of the Consolidated Financial Statements for a full description of the recent accounting pronouncement including the expected date of adoption and effect on results of operations and financial condition.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial position and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States pursuant to the rules and regulations of the Securities and Exchange Commission. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We base our estimates on historical experience, knowledge of current conditions and beliefs of what could occur in the future given available information. If actual results differ significantly from management’s estimates and projections, there could be a material effect on our financial statements. The accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results, and which required the most subjective judgment by us, are the following:

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revenue recognition;

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stock-based compensation;

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accounting for income taxes; and

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accounts receivable and allowance for doubtful accounts.

Revenue recognition. DCME product revenues consist of revenues from the sale of our DCME hardware products. IP product revenues consist of revenues from the sale of the I-Gate 4000 family of media gateway hardware products, our ControlSwitch family of softswitch modules, a license of our source code, and our Secure Communications Software. Services revenues consist of revenues from separately-priced maintenance and extended warranty contracts, post-contract customer support, or PCS, installation, training and other professional services.

All of our IP products may be sold in a bundled arrangement that includes PCS, installation, training and other professional services. When sold in a bundled arrangement, our media gateway hardware is referred to as a static trunking solution and when sold in a bundled arrangement that includes our softswitch module software is referred to as a VoIP solution. When our Secure Communications Software is sold in a bundled arrangement with DCME hardware we refer to this sale as a Secure Communications solution and 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.

We recognize 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 primary estimates and assumptions in our revenue recognition polices are as follows:

• Vendor-specific objective evidence, or VSOE, of fair value for IP services: 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.

• 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.

Stock-based compensation. We estimate the fair value of the stock options granted using the Black-Scholes option-pricing model which require the input of highly subjective assumptions, which represents our best estimate. 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 following are the key assumptions used to determine the stock based compensation expense:

Expected Stock Price Volatility — 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.

Expected Term of Option — 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. We determined the expected term in accordance with the “simplified method” for a plain vanilla employee stock option for which the value was estimated using a Black-Scholes formula. 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 was permitted as we did not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time our equity shares have been publicly traded.

Expected Dividend Yield — The dividend yield assumption is based on our history and expectation of dividend payouts. We use a dividend yield of zero, as we have never paid cash dividends and do not expect to pay dividends in the future.

Expected Risk Free Interest Rate — The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option.

Forfeiture Rate — The forfeiture rate is based on a review of recent forfeiture activity and expected future employee turnover.

Accounting for income taxes. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating losses and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary in order to reduce deferred tax assets to the amounts expected to be recovered.

We account for uncertainty in income taxes using a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely to be realized upon ultimate settlement. An uncertain tax position is considered effectively settled on completion of an examination by a taxing authority if certain other conditions are satisfied. The adoption did not have a material impact on our financial position or results of operations.

Accounts receivable and allowance for doubtful accounts. Generally, our receivables are recorded when billed and represent claims against third parties that will be settled in cash. The carrying value of the receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value.

We maintain an allowance for doubtful accounts for estimated losses resulting from the customers’ failure to make required payments. We may record an increase of the allowance if there is a deterioration in past due balances, if economic conditions are less favorable than we had anticipated, or for customer-specific circumstances, such as bankruptcy. Additionally, as many of our customers are conducting business in emerging markets that can be unpredictable at times due to rapidly changing political and economic conditions, the judgment of management is a significant factor in determining whether an increase in the allowance is warranted. Management considers various factors when making such judgments, including the customer-specific circumstances as well as the general political environment, economic conditions and other relevant matters in determining the collectability of the receivables.

We will 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.

Results of Operations

Comparison of Three Months Ended March 31, 2010 and 2009

Revenues (amount in thousands).


	Three Months Ended March 31,
	2010				2009				Period-to-Period Change
	Amount		Percentage of Total Revenue		Amount		Percentage of Total Revenue		Amount		Percentage
Revenues:
IP Products	$	8,186	51	%	$	13,050	62	%	$	(4,864)	(37)	%
DCME Products		1,234	8			1,198	6			36	3
Services		6,650	41			6,703	32			(53)	(1)

Total revenues	$	16,070	100	%	$	20,951	100	%	$	(4,881)	(23)	%

Revenue by Geography:
Europe, Middle East and Africa	$	7,398	47	%	$	8,645	42	%	$	(1,247)	(14)	%
North America		4,080	25			3,170	15			910	29
Asia Pacific and India		1,797	11			5,548	26			(3,751)	(68)
Caribbean and Latin America		2,795	17			3,588	17			(793)	(22)

Total revenues	$	16,070	100	%	$	20,951	100	%	$	(4,881)	(23)	%

IP product revenues for the quarter ended March 31, 2010 decreased 37% as compared with the same period of 2009. For the first quarter of 2010, we recognized $3.2 million less of our opening deferred revenue balance, as well as $1.7 million less for orders received and recognized in the same period, as compared to the first quarter of 2009. The decrease in IP revenues year over year is also attributable to fewer projects which were completed and accepted in the first quarter of 2010 than the same period in 2009. The timing and amount of orders and subsequent acceptance is affected by a number of factors, including a continued tightening of customer budgets, the slowdown in capital spending and increased competition experienced in connection with the global recession. 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 slightly decline.

DCME product revenues in the first quarter of 2010 increased 3% as compared with the same period in 2009. Although there was a slight increase in DCME product revenues year over year, we expect DCME revenues to decline over the foreseeable future as customers migrate from traditional voice networks, including DCME products, to IP products. However, 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.

Services revenues decreased 1% in the first quarter of 2010 over the same period in 2009. Our IP services revenues were $6.0 million in the first quarter of 2010 as compared with $5.9 million in the same period of 2009. The increase in the first quarter of 2010 was primarily due to a $0.5 million increase in IP maintenance revenue from our existing customer base, offset by a $0.4 million decrease in installation and consulting services in 2010 compared to 2009. However, the increase in IP services revenue was offset by a decrease in DCME services revenue of $0.2 million in the first quarter of 2010 over the same period in 2009, primarily due to a decrease in installation services. Over time we expect DCME services revenues to decrease as new DCME implementations continue to decrease, customers migrate to IP products and customers remove DCME equipment from their networks and terminate maintenance and support.

Revenue by Geography

We experienced a combined decrease in revenues of $5.8 million in the following regions: Asia Pacific and India, Europe, Africa and Middle East, and Caribbean and Latin America regions for the quarter ended March 31, 2010 compared to the same period of 2009. The total revenues decreased primarily in the Asia Pacific and India region by $3.8 million as a result of lower product revenues recognized, particularly in India. India revenues decreased due to new government regulations requiring additional certifications for purchasing equipment from vendors beginning in 2010. This has slowed down the process for receiving orders. The negative impact of these new government regulations for receiving orders is expected to lessen beginning in the second quarter of 2010 as the Company gains experience with the new order process. Of the $1.2 million decrease in the Europe, Africa and the Middle East region, $0.6 million was attributed to the lower revenue recognition in Russia during the quarter ended March 31, 2010. The Caribbean and Latin America region total revenues decreased by $0.8 million in the first quarter of 2010 over the same period of 2009 as a result of decreases in IP product revenues of $0.4 million and services revenues of $0.4 million. The decreases in revenue in these regions were partially offset by an increase in the total revenues recognized from product revenue arrangements in the North America region of $0.9 million. This increase is primarily due to orders from resellers received during 2010 for the U.S. Government as compared to the same period in 2009. During the three months ended March 31, 2010, total revenues were 25% from North America and 75% international as compared to 15% from North America and 85% international during the three months ended March 31, 2009. 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 March 31,
	2010				2009				Period-to-Period Change
	Amount		Percentage of Total Revenue		Amount		Percentage of Total Revenue		Amount		Percentage
Cost of Revenues:
IP Products	$	3,392	41	%	$	5,434	42	%	$	(2,042)	(38)	%
DCME Products		471	38			487	41			(16)	(3)
Services		3,284	49			2,888	43			396	14

Total cost of revenues	$	7,147	44	%	$	8,809	42	%	$	(1,662)	(19)	%

Gross Profit:
IP Products	$	4,794	59	%	$	7,616	58	%	$	(2,822)	(37)	%
DCME Products		763	62			711	59			52	7
Services		3,366	51			3,815	57			(449)	(12)

Total gross profit	$	8,923	56	%	$	12,142	58	%	$	(3,219)	(27)	%

Cost of Revenues. The decrease in sales of IP products resulted in a corresponding decrease in cost of product revenues, and we experienced higher direct margins on product revenues. However, although our services revenues decreased by $0.1 million, our services cost increased by $0.4 million as we continued to incur the fixed overhead services costs for personnel. The cost of services revenues increased 14% compared to the same period in 2009. The increase was mainly a result of a $0.5 million increase in salaries and related benefits in connection with overall headcount increases, particularly in Brazil and Israel, partially offset by lower outside professional services of $0.2 million due to our continued monitoring of expenditures.

Gross Profit. Total gross profit decreased by $3.2 million to $8.9 million in the first quarter of 2010. The decrease primarily was a result of a decline in IP product gross profit to $4.8 million in 2010 from $7.6 million over the same quarter in 2009. This decrease of $2.8 million represents a 37% decrease in IP product revenues. Services gross profit decreased to $3.4 million in the first quarter of 2010 from $3.8 million over the same period last year, representing a decrease of $0.4 million, or 12%. This decrease in services gross profit is due to lower services revenues and higher services costs. Gross profit on services revenue will vary from period to period depending upon the projects being implemented, which may not be in the same period in which the corresponding revenue is recognized.

Gross Margin. Total gross margin, which is gross profit as a percentage of revenue, decreased to 56% in the first quarter of 2010 from 58% in the same quarter in 2009. IP gross margins remained relatively flat on a year over year basis. IP product gross margin may fluctuate on a quarterly and yearly basis due to changes in the IP product mix, 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 year over year as our hardware costs are a fixed percentage of our customer order amounts, and we anticipate this trend to continue.

The decrease in services gross margin year over year was due to increases in fixed services costs resulting from headcount increases, partially offset by minimizing consulting and other variable costs, while the services revenues decreased marginally. The timing of the services expenses may not be in the same period as when the services revenues are recognized.

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 March 31,
	2010				2009				Period-to-Period Change
	Amount		Percentage of Total Revenue		Amount		Percentage of Total Revenue		Amount		Percentage of Total Revenue
Research and development, net	$	5,068	32	%	$	5,208	25	%	$	(140)	(3)	%
Sales and marketing		5,674	35			6,530	31			(856)	(13)
General and administrative		3,251	20			2,808	13			443	16

Total operating expenses	$	13,993	87	%	$	14,546	69	%	$	(553)	(4)	%

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. Research and development expenses year over year did not materially change. Grants received from the OCS were $0.4 million in the three months ended March 31, 2010 as compared with $0.3 million in the three months ended March 31, 2009, which resulted in the decrease in research and development expenses by $0.1 million. Research and development expenses for the first quarter of 2010 included a $0.2 million increase in salaries and benefits in connection with research and development headcount increases as well as supply purchases of $0.1 million, which were offset by decreases in stock based compensation of $0.2 million and depreciation expenses of $0.1 million.

We expect research and development expenses to remain approximately at the current expenditure levels on an absolute basis during the remainder of 2010.

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 $0.9 million decrease in sales and marketing expenses, $0.6 million was primarily attributable to the decrease in salaries and benefits resulted from lower headcount in 2010. Other reductions in expenses included a $0.4 million decrease in outside sales and marketing consulting costs and a $0.1 million decrease in agent commissions. These reductions were partially offset by an increase in sales commission expenses of $0.2 million for sales incentive programs initiated in the first quarter of 2010.

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.

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 $0.4 million increase in general and administrative expenses in the first quarter of 2010 over the same period in 2009, $0.3 million related to costs incurred primarily for legal and consulting costs related to our pursuit of strategic alliance opportunities.

We expect expenses and costs associated with our general and administrative functions to increase on an absolute basis related to legal, audit and consulting fees during the remaining quarters of 2010 as we close our acquisition of Dialogic Corporation.

Other income (expense), net. Other income (expense), net consists primarily of interest income earned on cash and cash equivalents and short-term investments and foreign currency exchange gains (losses) offset by interest expense and bank charges. Other income (expense), net, was $48,000 in the first quarter of 2010 as compared with other expense of $(0.5) million in the first quarter of 2009. The year over year increase in other income was primarily due to foreign exchange gains of $40,000 recognized in the first quarter of 2010 as compared to foreign exchange losses of $0.6 million recognized in the first quarter of 2009.

Provision for income taxes. We made a provision for income taxes of $0.2 million and $0.1 million for the three months ended March 31, 2010 and 2009, respectively. During the three months ended March 31, 2010, the tax provision was attributable to both the Company’s profitable foreign operations and withholding taxes on the income earned by certain foreign operations of the Company, while during the three months ended March 31, 2009, the tax provision was primarily attributable to the Company’s profitable foreign operations only. Our calculation of provision for income taxes is based on the discrete method. Significant components affecting the tax rate include various foreign taxes, nondeductible stock compensation charges, minimum taxes and recognition of valuation allowances against deferred tax assets.

Net loss. Net loss was $5.2 million and $3.0 million for the three months ended March 31 2010 and 2009, respectively. The net loss increased in the three months ended March 31 2010 compared to the same period of 2009 primarily from the $4.9 million decrease in revenues.

Liquidity and Capital Resources

As of March 31, 2010, we had unrestricted cash and cash equivalents and short-term investments of $30.3 million, a decrease from $33.0 million as of December 31, 2009.

We anticipate our cash and related balances will increase in aggregate over the next 12 months as we continue to monitor operating expense. We believe that our existing cash, cash equivalents and short-term investments will meet our normal operating and capital expenditure needs for at least the next 12 months. We do not currently, and did not as of March 31, 2010, maintain any auction rate securities.

Operating Activities

Net cash used in our operating activities was $2.2 million and $2.0 million during the three months ended March 31, 2010 and 2009, respectively.

Net cash used in our operating activities in the three months ended March 31, 2010 was primarily attributable to a decrease in our operating liabilities, offset by a greater decrease in operating assets. Our net loss adjusted for non-cash items such as depreciation, stock compensation and provision for doubtful debts accounted for $1.4 million of the cash used in operations. The decrease in operating assets was driven by lower accounts receivable, mainly from our overall revenue decrease in the first quarter of 2010 as well as from our cash collection efforts, decreases in inventory balances and reductions in prepaid expenses and other current assets. Our decrease in operating liabilities is primarily attributable to decreases in deferred revenue from lower revenue and lower accounts payable, partially offset by increases in related party liabilities and accrued expenses. Our working capital decreased to $38.9 million as of March 31, 2010 from $43.2 million as of December 31, 2009.

Net cash used in our operating activities in the three months ended March 31, 2009 was primarily attributable to our net loss of $3.0 million. The amount of cash used related to a decrease in deferred revenues of $4.3 million and decreases in accrued payroll and expenses of $1.3 million, offset by a decreases in inventories of $2.4 million, accounts receivable of $3.4 million, prepaid expenses and other current assets of $1.3 million and related party, net, by $2.4 million. Further, we incurred non-cash costs of $0.7 million for depreciation and $1.2 million of stock-based compensation. Our working capital decreased to $45.5 million as of March 31, 2009, from $47.1 million as of December 31, 2008.

Investing Activities

Net cash used in our investing activities was $4.4 million and $12.6 million in the three months ended March 31, 2010 and 2009, respectively.

Investing activities in the three months ended March 31, 2010 consisted primarily of purchases of net short-term investments of $4.9 million, as well as purchases of property and equipment of $0.2 million.

Investing activities in the three months ended March 31, 2009 consisted primarily of net purchases of short-term investments of $12.2 million as well as purchases of property and equipment of $0.4 million.

Financing Activities

Net cash provided by our financing activities was $9,000 and $32,000 in the three months ended March 31, 2010 and 2009, respectively. Net cash provided by our financing activities in the three months ended March 31, 2010 and 2009 primarily consisted of proceeds received from exercise of stock options.

Off-Balance Sheet Arrangements

At March 31, 2010, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, special purpose or variable interest 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 had increased or decreased by 10%, the effect of our local currency expenses, excluding the impact of any foreign currency forward contracts, would have increased or decreased by $0.5 million in the three months ended March 31, 2010.

We also had foreign currency risk related to cash, accounts receivable and accounts payable that are denominated in local currency for subsidiaries with U.S. dollar functional currencies. At March 31, 2010 and December 31, 2009, we had in cash and accounts receivable in the following currencies: 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 expense of $37,000 and $0.2 million in the three months ended March 31, 2010 and the year ended December 31, 2009, respectively.

We are also impacted by assets or liabilities that are denominated in a currency other than a subsidiary’s functional currency. Our intercompany short-term balances with our Brazilian subsidiary are denominated in U.S. dollars, while the Brazilian subsidiary’s functional currency is the Brazilian Real. The impact of a change in the foreign exchange rate for the intercompany short-term balances between the U.S. dollar and the Brazilian Real during the three months ended March 31, 2010 and the year ended December 31, 2009 resulted in the increase and decrease, respectively in the amounts payable in Brazilian Real. Therefore, at March 31, 2010 and December 31, 2009, a loss of $3,000 and a gain of $0.4 million were recorded in other income (expense), net.

Interest Rate Sensitivity

We had cash, cash equivalents, restricted cash, and short-term investments totaling $31.2 million at March 31, 2010. 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.

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 March 31, 2010, 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 March 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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 have declined and are likely to continue 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 domestically and in Russia, could affect earnings negatively and could have a material adverse effect on our business, results of operations, and financial condition.

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. To maintain the listing of our common stock on NASDAQ we are required to meet certain listing requirements, including a minimum closing bid price of $1.00 per share. Our common stock has recently traded near or below the $1.00 minimum bid price, and had been as low as $0.93 per share as of May 7, 2010. If our common stock trades below the $1.00 minimum bid price for 30 consecutive business days, we would likely receive a deficiency notice. Following the receipt of a deficiency notice, we expect that we would have 180 calendar days to regain compliance by having our common stock trade over the $1.00 minimum bid price for at least a 10-day period. If we were to fail to regain compliance during the grace period, our common stock would be delisted. If we fail to comply with the listing standards of NASDAQ, we may seek to implement a reverse stock split, which 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. Alternatively, we may consider transferring to The NASDAQ Capital Market, provided we met the transfer criteria, which is a lower tier market, or our common stock may be delisted and traded on the over-the-counter bulletin board network. Moving our listing to The NASDAQ Capital Market could adversely affect the liquidity of our common stock. If our common stock were to be delisted by NASDAQ, we could face significant material adverse consequences, including:

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a limited availability of market quotations for our common stock;

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a reduced amount of news and analyst coverage for us;

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a decreased ability to issue additional securities or obtain additional financing in the future;

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reduced liquidity for our stockholders;

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potential loss of confidence by collaboration partners and employees; and

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loss of institutional investor interest and fewer business development opportunities.

We may find it difficult to integrate recent and potential future business combinations, which could disrupt our business, dilute stockholder value, and adversely affect our operating results.

We entered into an acquisition agreement with Dialogic Corporation on May 12, 2010, pursuant to which we will acquire all of the outstanding common and preferred stock of Dialogic. Integrating Dialogic’s business and assets and any businesses or assets we may acquire in the future could add significant complexity to our business and additional burdens to the substantial tasks already performed by our management team. In the future, we may not be able to identify suitable acquisition candidates, and if we do, we may not be able to complete these acquisitions on acceptable terms or at all. In connection with our recent and possible future acquisitions, we may need to integrate operations that have different and unfamiliar corporate cultures. Likewise, we may need to integrate disparate technologies and product offerings, as well as multiple direct and indirect sales channels. The key personnel of the acquired company may decide not to continue to work for us. These integration efforts may not succeed or may distract our management’s attention from existing business operations. Our failure to successfully manage and integrate acquisitions could seriously harm our business.

We may not realize the anticipated benefits from an acquisition.

Acquisitions involve the integration of companies that have previously operated independently. We expect that acquisitions may result in financial and operational benefits, including increased revenue, cost savings and other financial and operating benefits. We cannot be certain, however, that we will be able to realize increased revenue, cost savings or other benefits from any acquisition, or, to the extent such benefits are realized, that they are realized timely. Integration may also be difficult, unpredictable, and subject to delay because of possible cultural conflicts and different opinions on product roadmaps or other strategic matters. We may integrate or, in some cases, replace, numerous systems, including those involving management information, purchasing, accounting and finance, sales, billing, employee benefits, payroll and regulatory compliance, many of which may be dissimilar. Difficulties associated with integrating an acquisition’s service and product offering into ours, or with integrating an acquisition’s operations into ours, could have a material adverse effect on the combined company and the market price of our common stock.

Our retention of PageMill Partners to assist the Company in examining strategic alliance, divestitures, and acquisition opportunities may result in the loss of sales to current and new customers, stricter terms with vendors, may be diversion of management’s time and attention, and ultimately may not succeed.

As announced on March 11, 2010 in a press release, PageMill Partners has been retained to assist the Company in examining our strategic alliance, divestitures, and acquisition opportunities. We believe that some of our customers and/or vendors may become concerned about the possible impact of such a transaction on the product strategy and future direction of the Company. If our business relationships are modified, reduced or terminated, with certain customers or vendors, our business will suffer. Further, the continuing review of strategic alliances, divestitures, and acquisition opportunities 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. Finally, there can be no assurances that any appropriate strategic alliance, divestitures, and acquisition opportunity will be found.

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.

We are exposed to the risks associated with the volatility of the U.S. and global economies, including specifically the continued volatility in certain global markets, such as Portugal, Italy, Greece and Spain where we have historically successfully sold our products. The difficulty in obtaining credit in these markets and decreased visibility regarding whether or when there will be sustained growth periods for sales of our products in these and other markets 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, may have an adverse effect on our business and operations. In addition, it is expected that this recent economic turmoil and the resulting 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:

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capital spending levels of service providers;

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competition among service providers;

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pricing pressures in the telecommunications equipment market;

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end user demand for new services;

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service providers’ emphasis on generating revenues from traditional infrastructure instead of migrating to emerging networks and technologies;

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lack of or evolving industry standards;

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consolidation in the telecommunications industry; and

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changes in the regulation of communications services.

We cannot make assurances of the rate or extent to which the telecommunications equipment industry will grow, if at all. Demand for our solutions and our IP products in particular will depend on the magnitude and timing of capital spending by service providers as they extend and migrate their networks. Furthermore, industry growth rates may not be as forecast, resulting in spending on product development well ahead of market requirements. The telecommunications equipment industry from time to time has experienced, and appears to be currently experiencing, a downturn. In response to the current downturn, service providers have slowed 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 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 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 20 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 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 have undertaken a concerted effort to reduce costs, including restructuring efforts, 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 three months ended March 31, 2010 and for the year ended December 31, 2009, 2008, and 2007, we used $2.2 million, $4.5 million, $15.8 million, and $12.7 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 reduction in force affecting 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. We have continued to focus significant efforts on reducing costs during 2009. There can be no assurance that we will be able to reduce spending as planned or that unanticipated costs will not occur. Any 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 years ended December 31, 2008 and December 31, 2009, we recorded net losses of approximately $21.0 million and $11.6 million, respectively. For the three months ended March 31, 2010, we recorded a loss of $5.2 million. As of December 31, 2008 and 2009, our accumulated deficit was $77.2 and $88.8 million, respectively. We have never generated sufficient cash to fund our operations and can give no assurance that we will generate net income.

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. 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. In November 2009, the Staff of the SEC contacted the Company concerning some of the transactions described above. In January 2010, the Company and the staff of the SEC reached a tentative resolution of the matters described above. Under the terms of the resolution, the Company, without admitting or denying the allegations, will consent to the entry of an injunction prohibiting violations of the non-fraud provisions of the FCPA and to pay a civil penalty of $0.3 million. The agreement requires approval by the SEC and is subject to court approval.

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 to a lesser degree in 2009 and will, in future quarters, including at least the first quarter of 2010, 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.

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

For the three months ended March 31, 2010 and for the fiscal years ended December 31, 2009, 2008, and 2007 revenues from outside North America were approximately $12.0 million, $63.4 million, $77.6 million, and $93.1 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:

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

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certification and qualification requirements relating to our products;

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the impact of recessions in economies outside the United States;

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

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certification and qualification requirements for doing business in foreign jurisdictions;

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inadequate protection for intellectual property rights in certain countries;

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

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potentially adverse tax or duty consequences;

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unfavorable foreign exchange movements, particularly the continued devaluation of the U.S. dollar, which could result in decreased revenues and/or increased expenses; and

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political and economic instability.

Additionally, as many of our customers are conducting business in emerging markets that can be unpredictable at times due to rapidly changing political and economic conditions, the judgment of management is a significant factor in determining whether an increase in the allowance is warranted. Management considers various factors in making such judgments, including the customer-specific circumstances as well as the general political environment, economic conditions and other relevant matters in determining the collectability of the receivables. We will record a reversal of the allowance if there is significant improvement in collection rates. Historically, the allowance has been adequate to cover the actual losses from uncollectible accounts. Such reversals may negatively impact our results of operations.

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, which leverages its broad product portfolio and significant financial resources to compete with us for our switching business.

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:

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provide extremely high reliability, compression rates, and voice quality;

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scale and deploy easily and efficiently;

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interoperate with existing network designs and other vendors’ equipment;

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support existing and emerging industry, national, and international standards;

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provide effective network management;

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are accompanied by comprehensive customer support and professional services;

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

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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.

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:

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

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the length and variability of the sales cycle for our products;

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new product introductions and enhancements by our competitors and us;

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

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

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the mix of products sold such as between NGN sales and sales of bandwidth optimization products;

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

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

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

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

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

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

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

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

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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.

We have historically conducted a significant amount of business with ECI Telecom Ltd., or ECI. If our relationship with ECI is adversely affected our business could be harmed and our results of operations could be negatively affected.

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. In addition, ECI beneficially owns a significant percentage of our common stock. If the value of the shares of our common stock 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 light of the potential volatility in our stock price as previously noted we cannot assure you that the DCME Agreement will be extended or renewed at all or on reasonable commercial terms. In the event of the occurrence of one of these termination events. In addition, our relationship with ECI could be adversely affected by a divestment of our common stock or by declining in our stock price. We do not currently have an independent ability to produce DCME products and have not entered into arrangements with any third party that would enable us to obtain DCME or similar products in the event that ECI ceases to provide us with DCME products. Should ECI 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 may 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.

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 over the shares of our common stock held by ECI. In addition, ECI is no longer traded on NASDAQ and has requested that we register their shares under a S-3 registration statement. As a result of the change in ownership and the request for registration, 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 bandwidth optimization 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. Further, we have seen increasing fluctuation on an annual basis for our bandwidth optimization products. 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.

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 133 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:

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consolidation in the telecommunications industry affecting our customers;

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

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

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

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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;

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new product introductions by our competitors;

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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.

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:

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cancellation of orders or other losses of or delays in revenues;

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loss of customers and market share;

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harm to our reputation;

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

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

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

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costly and time-consuming legal actions by our customers.

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

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

•

loss of customers and market share;

•

a failure to attract new customers in new geographies;

•

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

•

network performance penalties.

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

Our products, 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.

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.

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, 2010, to be filed in early 2011. 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.

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.

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.

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.

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 Financial Accounting Standards Board, or 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 American Institute of Certified Public Accountants 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;

•

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 155 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. 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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. (REMOVED AND RESERVED).

ITEM 5. OTHER INFORMATION.

None.

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

32.0		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

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: May 17, 2010	By:	/s/ Albert J. Wood
		Name: Albert J. Wood
		Title:	Chief Financial Officer
			(Principal Financial and Accounting Officer)

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

32.0		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