UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549-1004

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended June 30, 2008

OR

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from              to             .

Commission File Number 000-19462

VERTICAL COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)

Delaware	86-0446453
(State or Other Jurisdiction of Incorporations or Organization)	(I.R.S. Employer Identification No.)

TEN CANAL PARK, SUITE 602, CAMBRIDGE, MA 02141

(Address of Principal Executive Offices including Zip Code)

Registrant’s telephone number, including area code: (617) 354-0600

Securities registered pursuant to Section 12(b) of the Act:

NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, $0.01 PAR VALUE PER SHARE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  x

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definitions of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (as defined in Exchange Act Rule 12b-2).

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  x

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

The aggregate market value of the 9,075,492 shares of common stock held by non-affiliates was approximately $6,171,335 at December 31, 2007, which was the last business day of the registrant’s most recently completed second fiscal quarter, based on the $0.68 closing price for the Registrant’s common stock on the over the counter bulletin board.

As of September 19, 2008, 52,377,272 shares of the registrant’s common stock, par value $0.01, were issued and outstanding.

VERTICAL COMMUNICATIONS, INC.

FISCAL 2008 FORM 10-K

INDEX

		Page
PART I
ITEM 1.	BUSINESS	4
ITEM 2.	PROPERTIES	10
ITEM 3.	LEGAL PROCEEDINGS	10
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	10
PART II
ITEM 5.	MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	12
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	13
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	21
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	21
ITEM 9A(T).	CONTROLS AND PROCEDURES	21
PART III
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE	23
ITEM 11.	EXECUTIVE COMPENSATION	26
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS	30
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS	33
ITEM 14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	34
PART IV
ITEM 15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	35
SIGNATURES		42

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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements reflect our views with respect to future events based upon information available to us at this time. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from these statements. Forward-looking statements are typically identified by the use of the words “believe,” “may,” “could,” “will,” “should,” “expect,” “anticipate,” “estimate,” “project,” “propose,” “plan,” “intend,” and similar words and expressions. Examples of forward-looking statements are statements that describe the proposed development, manufacturing, and sale of our products; pricing trends, the markets for our products, our anticipated capital expenditures, our cost reduction and operational restructuring initiatives, and anticipated regulatory developments; statements with regard to the nature and extent of competition we may face in the future; statements with respect to the sources of and need for future financing; and statements with respect to future strategic plans, goals, and objectives. Forward-looking statements are contained in this report under “Description of Business” included in Item 1 of Part I, “Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of Part II of this Annual Report on Form 10-K. The forward-looking statements are based on present circumstances and on our predictions respecting events that have not occurred, that may not occur, or that may occur with different consequences and timing than those now assumed or anticipated. Actual events or results may differ materially from those discussed in the forward-looking statements as a result of various factors. These cautionary statements are intended to be applicable to all related forward-looking statements wherever they appear in this report. The cautionary statements contained or referred to in this report should also be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. Any forward-looking statements are made only as of the date of this report and Vertical Communications assumes no obligation to update forward-looking statements to reflect subsequent events or circumstances.

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PART I

ITEM 1. BUSINESS

COMPANY OVERVIEW

Vertical Communications, Inc. develops, markets and sells business phone systems – also known as private branch exchange systems (PBXs and IP-PBXs), communications application software, hardware and associated services. We sell our products to business customers through a network of distributors, systems integrators, and independent telephony and data resellers. Most of our end user customers rely upon resellers or systems integrators to implement our products, and these resellers and systems integrators can significantly influence our customers’ purchasing decisions. We market and sell our products in the United States, Europe and Latin America. We also have distributor relationships in Africa, Asia, Australia and the Middle East.

Vertical brings value to our customers through our focus on the specific needs of their businesses. We sell our products to businesses of all sizes and types, with specific focus on small and medium-sized businesses (“SMBs”) up to 500 users per site as well as large, distributed enterprises (“LDEs”) up to several thousand sites in a given organization. As our name implies, we also focus on the communications requirements of these organizations by vertical segment, including retail, restaurant, financial services, healthcare, legal, real estate and professional services. Vertical’s value proposition to these end customers is composed of providing cost-effective, application-rich, flexible and easy to deploy telephony systems as well as investment protection and a strong migration path from traditional legacy systems to next generation IP and application-rich systems. We believe that an ongoing, fundamental shift in the telephony system marketplace centered around a technology shift to Internet Protocol (“IP”) based communications and the resulting opportunity to provide higher value-added communications solutions to customers continues to create significant opportunities for next-generation telecommunications companies like Vertical and will fuel the trend for migration to IP-based systems in our customer base and channels, and provide incremental revenue growth opportunities for our business.

Vertical filed a Form 15 with the Securities and Exchange Commission on July 29, 2008 in order to voluntarily deregister its common stock and expects that the deregistration of its shares will become effective 90 days after the filing of the Form 15. The Company is eligible to voluntarily deregister its shares as it had fewer than 300 shareholders of record as of July 29, 2008.

We maintain a website at www.vertical.com. We are not including the information contained on our website as part of this report, nor are we incorporating the information on our website into this report by reference.

COMPANY HISTORY

The Company was originally incorporated as Artisoft, Inc. in 1982 and reincorporated by merger in Delaware in July 1991. Artisoft manufactured network interface cards and certain other communications devices until the year ended June 30, 1998. From the year ended June 30, 1996 to the year ended June 30, 1998, Artisoft was engaged in the design, development, sales and support of business communications software, including Visual Voice, a computer telephony development toolkit, and LANtastic, a local area network peer-to-peer operating system. Beginning in March 1998, Artisoft focused on the development of computer telephony products and associated services. Artisoft sold the Visual Voice product line in December 1999, and then formally ended its affiliation with Visual Voice in July 2000. In June 2000, Artisoft sold its communications software group, which ended its involvement in the LANtastic product line. From June 2000 on, Artisoft focused on business phone systems suited to larger organizations, initially with the software-based phone system, TeleVantage™.

Vertical Networks Acquisition. On September 28, 2004, Artisoft acquired substantially all of the assets, other than patents and patent rights, and certain of the liabilities of Vertical Networks Inc. (the “Vertical Assets” or “Vertical Networks”). Artisoft also received a patent license for the use of all of Vertical Networks’ patents and patent applications other than Vertical Networks’ rights under specified patents that do not relate to the business purchased by Artisoft. As a result of the acquisition, Artisoft began doing business as Vertical Communications, and offered customers an expanded product portfolio that then included the TeleVantage and InstantOffice product families (see the “Our Products” section below).

Comdial Acquisition. On September 28, 2005, Vertical acquired the assets and ongoing business of Comdial Corporation, which had previously been in bankruptcy. With the acquisition of the Comdial assets, Vertical expanded its product family again to include a suite of business communications systems and software applications designed for small to medium-sized businesses. (See the “Our Products” section below.) Vertical also expanded its channel footprint substantially, through the addition of more than 825 distributors and resellers.

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Vertical Communications Name Change. On April 21, 2006, the Company officially changed its name to Vertical Communications, Inc.

Vodavi Acquisition. On December 1, 2006, Vertical acquired the assets and ongoing business of Vodavi Technology, Inc., makers of business communications systems and software applications designed for small to medium-sized businesses (see the “Our Products” section below). Vertical also expanded its channel with this acquisition.

OUR PRODUCTS

Vertical offers a large portfolio of next generation (IP-based and converged) and legacy (TDM-based) telephony systems and related applications. The vast majority of the Company’s Research and Development is focused around developing and supporting next generation IP-PBX systems and applications (such as Wave IP 2500, SBX IP 320 and Xcelerator IP, as further described below), and providing a cost-effective migration path for Vertical’s large customer base and dealer channel from existing legacy products to these next-generation products.

Vertical Wave IP 2500. Vertical Wave IP 2500™, launched in October 2007, is the Company’s flagship next-generation business communications solution for both SMBs and LDEs. A highly modular IP-based business communications solution, Wave is able to support small as well as large enterprise requirements, includes native gateway capabilities to support IP as well as non-IP network and endpoints for maximum flexibility, and offers a portfolio of integrated communications applications. A key competitive advantage of Wave is its ‘Applications Inside’ architecture, which enables customers to run a number of business communications applications in addition to IP-PBX services on a single Wave IP-2500 server, and therefore very cost effectively and with easy administration. Wave supports a range of IP and legacy endpoints and offers a cost-effective migration path for Vertical’s existing customer base.

Vertical SBX IP 320. Developed for Vertical by its strategic partner, LG-Nortel, the Vertical SBX IP 320™ gives small businesses access to the advantages of a big company PBX including a rich feature set, robust telephony applications and significant cost-savings associated with Voice over IP (“VoIP”). The SBX IP 320 supports both traditional and IP endpoints and trucking in a single system, so businesses can deploy VoIP immediately, or in the future. With scalability of up to 32 users per system and the capability to network up to 72 systems together, the SBX 320 offers the latest advances in converged IP telephony technology at a price point that can’t be matched.

Xcelerator IP. Xcelerator IP™ offers an integrated data and voice communications solution for small businesses and small office/home office (“SOHO”) customers. It is comprised of an all-in-one wired/wireless data and voice telephony gateway with integrated router and firewall along with a suite of PBX telephony features, auto attendant and voicemail. Xcelerator IP provides a cost-effective option for small businesses and SOHO users by incorporating comprehensive data networking and telephony functions in a single system as well as through enabling use of SIP voice calling which offers significant lower calling costs than traditional PSTN voice services. The IP 2007 handset is a SIP-ready business class phone that is designed for use with Xcelerator IP.

Vertical TeleVantage. Vertical TeleVantage is a software-based IP-PBX and contact center solution. The TeleVantage product family includes the TeleVantage software, the TeleVantage Contact Center solution, and a series of add-on modules with specific functionality. Users can access the system through ViewPoint™, TeleVantage’s award-winning desktop call management tool that allows end users to manage voice communications through a familiar Windows interface. TeleVantage is primarily sold to small and mid-size companies, or to large companies for use in their branch offices or call centers.

TeleVantage is designed to help professionals in SMB organizations to work more productively. The ViewPoint application displays call control features on the computer desktop for easy drag-and-drop and mouse-click call handling. Its telephone user interface provides access to phone features from any desk, mobile or home phone. Advanced features are easily customizable by the user, and call logging and recording are automatic.

For contact center applications, TeleVantage includes a host of advanced call handling features that maximize the value of each customer call, as well as a series of powerful, optional add-in modules including the TeleVantage Enterprise Manager, which connects distributed, multi-side locations into a single, unified telephone system, and TeleVantage Conference Manager, which hosts conference calls completely on the TeleVantage system. Other add-ons include Call Center Scoreboard, Call Classifier and others. Industry-standard application programming interfaces (APIs) enable development of customized applications and tight integration between TeleVantage and applications such as customer resource management (CRM).

Vertical InstantOffice. Vertical InstantOffice consolidates voice, data, networking and voice applications into a single, integrated communications solution that can be centrally managed. InstantOffice is primarily sold to highly distributed large enterprises, such as retailers and restaurants and other businesses that require remote administration and centralized management and reporting on their telecommunications network. InstantOffice includes an integrated communications platform and a series of applications, including custom applications designed specifically for retailers. InstantOffice customers include CVS/pharmacy, Staples, and Apria Healthcare.

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In addition to advanced call handling capabilities, InstantOffice applications include MultiSite Manager, MultiSite Reporter, Fax Manager and Voice Server for developing Integrated Voice Response (IVR) solutions. Available retail applications include prescription refill, “drive-through” ordering automation and targeted on-hold messaging. These applications help retailers maximize the potential of inbound customer calls as a new or expanded sales channel. InstantOffice applications integrate enterprise-level data in real time in response to caller queries to support voice-enabled, customer-driven transactions that deliver a higher level of personalized service to customers, while at the same time ensuring brand consistency across retail locations and serving as a rich source of business intelligence.

Vertical Comdial Products. The Vertical Comdial products include several PBX products that are designed to meet the needs of small to medium-sized organizations or regional offices of large organizations, national retailers, government agencies, and education campuses. The Comdial product family includes the FX II, MP5000 and DX-120 business phone systems and associated applications, as well as a family of analog, digital and IP endpoints.

• FX II. The FX II system targets single-site and multi-site enterprises that depend heavily on both voice and data communications. It supports and leverages both VoIP and digital voice communications, and includes a suite of flexible messaging and call control applications, including Interchange Communications Suite, Corporate Office, Impact Attendant, Corporate Call, Impact Group, and Quick Q automated call distribution (“ACD”). The FX II includes standard capabilities, such as paging, conferencing and DID support, but also includes a built-in, multi-port conference bridge.

• MP5000. The MP5000 platform adds SIP connectivity, increased capacity, peer-to-peer video calling and other features to meet the requirements of larger, multi-site businesses with remote offices and teleworkers. The MP5000 provides application support for call centers, real-time collaborative communications, unified messaging, telecommuting, video calling, hot-desking, meet-me conferencing, IP networking and presence management. The MP5000 is a versatile solution that supports several combinations of endpoints allowing existing customers to leverage their legacy endpoints in concert with SIP endpoints on the same MP5000 system. Both the FX II and MP5000 systems can grow with their users – for example, an FX II chassis can be upgraded to MP5000 specifications with a single blade.

• DX-120. The DX-120 digital system is designed for smaller organizations and provides sophisticated digital telecommunications features in an affordable, ease-to-use and scalable solution. It delivers enterprise-grade performance without the complexity and cost of larger systems. In addition to offering a comprehensive feature set previously available only on high-end PBXs, the DX-120 also supports an integrated voice mail option based on the Corporate Office Voice Messaging software. This combination provides small enterprises with an advanced communications solution at an affordable price. The DX-120’s expandable architecture grows with the small business, allowing room for future expansion.

Vertical Vodavi Products. The Vertical Vodavi products include several PBX products that are designed to meet the needs of small to medium-sized organizations or regional offices of large organizations, national retailers, government agencies, and education campuses. The Vodavi product family includes the XTS-IP, Telenium and StarPlusSTS business phone systems and associated applications, as well as a family of analog, digital and IP endpoints.

• XTS-IP. Designed for SMB organizations not yet ready to move to pure IP, the XTS IP™ converged telephony system supports both traditional digital and VoIP communications. XTS IP enables these organizations to preserve their capital investment as they grow and migrate to VoIP applications at their own pace.

• Telenium IP. Telenium IP™ is a pure IP phone system designed for medium to large organizations needing to network multiple offices. Telenium IP allows enterprises to reliably integrate voice and data on a 100% IP network with the convenience of Web-based system administration and maintenance.

• StarPlusSTS. StarPlus STS™ product family offers digital telephony solutions for small businesses due to its 50-station capacity. STS supports wired, wireless, and console phones as well as a unique door phone speakerphone with a number of voicemail options.

MANUFACTURING AND SUPPLIERS

Wave IP 2500. Vertical designs and distributes the hardware on which the Wave IP 2500 software operates, including phones and custom server hardware. We do not manufacture the hardware portion of the Wave product ourselves. Our Wave products are manufactured by third parties using commercially available components in the manufacture of the custom hardware incorporated into the product.

SBX IP 320. We obtain our SBX IP 320 products under a supply arrangement with LG-Nortel Co., Ltd. (“LGN”). We obtain all of our traditional commercial grade telephones and replacement parts for such telephones from LG Sritahi InfoComm (Thailand) Co., Ltd., (“LGICTH”), a joint venture between LGN and Srithai Group, a Thailand-based entity. We make all purchases pursuant to an agreement on a purchase order basis.

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Xcelerator IP. We do not manufacture the hardware utilized by the Xcelerator IP products ourselves, but hold inventory for purposes of distribution to our dealers and distributors. Our Xcelerator products are manufactured by a third party.

InstantOffice Manufacturing. Vertical designs and distributes the hardware on which the InstantOffice software operates, including phones and custom server hardware. We do not manufacture the hardware portion of the InstantOffice product ourselves, and we hold only limited amounts of inventory for purposes of replacements of systems or parts as required for field support. Our InstantOffice products are manufactured by third parties using commercially available components in the manufacture of the custom hardware incorporated into the product.

TeleVantage Manufacturing. We do not manufacture any of the hardware necessary to be used in conjunction with our TeleVantage software-based phone system. Our software is delivered to our customers either electronically, via CD-ROM or loaded onto a certified system by our distributors or resellers. Our distributors provide Dialogic^® voice processing hardware and Host Media Processing (HMP) software for sale with TeleVantage.

Comdial Manufacturing. We design and distribute the hardware comprising most of the Comdial products, including phones and custom server hardware. We do not manufacture the hardware utilized by the Comdial products ourselves, but hold inventory for purposes of distribution to our dealers and distributors. Our Comdial products are manufactured by third parties using commercially available and custom components.

Vodavi Manufacturing. We obtain our telephone systems, some of our telephony applications, and our commercial grade telephones under supply arrangements with various third-party manufacturers, including LG-Nortel Co., Ltd. (“LGN”). We also purchase certain voice processing products from third parties on an OEM basis. We obtain a majority of our telephone systems, voice mail products and IP-based commercial grade telephones from LGN, which owns the rights to produce this equipment.

We currently maintain a $5.0 million insurance policy to cover lost revenue in the event of significant interruptions in purchases from our overseas manufacturers.

SEASONALITY

Substantially all of our Wave, SBX, TeleVantage, Comdial and Vodavi product family revenue in each fiscal quarter results from orders booked in that quarter. A significant percentage of these bookings and sales to major distributors on a quarterly basis historically has occurred during the last month of the quarter and is usually concentrated in the latter half of that month.

The sales of our InstantOffice products are primarily dependent on the implementation schedules of our large customers and, therefore, do not demonstrate any consistent seasonality. As a by-product of the InstantOffice sales cycle and process, we sometimes have a backlog of orders for some InstantOffice customers. These orders are typically scheduled for delivery at the discretion of the customers and as such are not necessarily indicative of levels of future sales during any period.

BACKLOG

At June 30, 2008, the Company had a backlog of $1.0 million of which $0.4 million related to Comdial products, $0.3 million related to Instant Office products, $0.2 million related to Wave products and $0.1 million related to Vodavi products, all of which is expected to be fulfilled during fiscal 2009. At June 30, 2007, the Company had a backlog of $0.6 million of which $0.3 million related to InstantOffice, $0.2 million related to Comdial and $0.1million related to Vodavi. At June 30, 2006 the Company had a backlog of $2.6 million of which $2.1 million related to InstantOffice and $0.5 million related to Comdial.

The timing of new product announcements and introductions by us, or significant product returns by major customers to us, could also result in material fluctuations in quarterly operating results. The timing of orders from large enterprise customers – historically associated with our InstantOffice product family – could also result in material fluctuations in quarterly operating results. We are actively marketing our Wave product family to these large enterprise customers, which might create material fluctations in the future for our quarterly operating results.

MARKETING, SALES AND DISTRIBUTION

Distribution and Resale of the Company’s Products. Vertical’s principal marketing strategy is to create reseller and customer demand for our products and to use distributors and system integrators to meet this demand.

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Our products are sold to small and medium-sized businesses through our relationships with systems integrators, resellers and distributors – called Vertical Business Partners. Business Partners are selected for their sales ability, technical expertise, reputation and financial resources, and are responsible for selling, installing and supporting our products. Business Partners are supported by our regional sales managers and inside sales representatives, who are dedicated to assisting with sales and installation.

We also sell our InstantOffice products to large, distributed enterprises through our relationships with strategic business partners including AT&T, IBM and Fujitsu, who sell, install and support the product line and provide value-added services to InstantOffice customers. For example, large enterprise customers typically require the coordinated sales and support across multiple geographic areas that these strategic partners can provide. We have a large enterprise sales force dedicated to assisting AT&T, IBM and Fujitsu in their sales efforts.

Marketing. Our marketing programs have three primary objectives:

• to create brand name recognition of Vertical and its products, positioning Vertical as a strong player in the telephony space;

• to generate sales leads for our resellers, distributors and systems integrators; and

• to support the sales efforts of our Business Partners through market development funding, sales tools and training, and turn-key marketing campaign materials designed for use by our Partners in their own marketing programs.

Marketing activities that address the first two objectives include frequent participation in industry trade shows, Web-based marketing programs, flash-based product demos, direct mail, advertising in vertical trade publications, public relations activities, executive participation in press briefings, roadshows, lead generation campaigns and Webinars. In addition, we communicate with our Business Partners via a steady stream of email-based product and technical updates, seminar materials, presentations and special promotions. We further support our Business Partner sales efforts via Partner extranets that are populated with product materials, presentations and selling tools. We also conduct marketing and sales training to assist our resellers, distributors and systems integrators with growing their business.

SIGNIFICANT CUSTOMERS

We sell our products through a variety of channels of distribution, including system integrators, distributors, resellers and OEMs. For the years ended June 30, 2008 and 2007, the largest of the distributors of our Comdial, Vodavi, Wave and SBX products, Graybar, accounted for 16% and 16%, respectively, of total net sales. The loss of this distributor would be likely to have a material adverse effect on our business and our results of operations.

COMPETITION

Our TeleVantage and InstantOffice products principally compete with PBXs, call centers and voice applications offered by companies such as Nortel, Avaya and NEC, and with IP-PBX products offered by Cisco Systems, Inc., Shoretel and 3Com Corporation. Our Comdial and Vodavi products compete with many PBX and IP-PBX vendors serving the small to mid-size business market, some of which have significantly greater financial, marketing, and technical resources than we do.

In addition, because the market for our products is subject to rapid technological change, as the market evolves, we may face competition in the future from companies that do not currently compete in the software- and server-based phone systems market, including companies that currently compete in other sectors of the technology, communications and software industries. Competition from these potential market entrants may take many forms, including offering products and applications similar to those we offer as part of a larger, bundled offering.

ENGINEERING, RESEARCH AND DEVELOPMENT

Our ability to compete is also dependent upon the timely introduction of new products to the marketplace and the timely enhancement of existing products. Our engineering and product development team develops software and hardware to provide advanced call handling and voice applications to integrate voice-based technology into the overall business intelligence systems of organizations ranging from small to mid-size businesses to large distributed enterprises. The products include but are not limited to IP-PBX systems, unified communications software, call center software, interactive voice response (IVR) software, telecommunications systems management software and vertical industry-specific applications. In addition, we are currently making a substantial investment in the unified engineering and product management team that is working on Vertical Wave, our next-generation

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IP-PBX product family, which is launched in fiscal 2008. Wave is designed to address the fast-growing demand for IP-based and application rich telephony solutions and provide a smooth migration path to next generation capabilities for our current installed base, which includes customers of our Comdial, Vodavi, TeleVantage and InstantOffice product lines.

Product development expenses totaled approximately $16.0 million, $13.6 million and $11.6 million in the years ended June 30, 2008, 2007 and 2006, respectively.

INTELLECTUAL PROPERTY

We have a number of registered trademarks, including “Vertical,” “Wave IP 2500,” “SBX IP 320,” “TeleVantage,” “InstantOffice,” “Comdial,” and “Vodavi.” These registered trademarks have the effect of helping us identify and distinguish our corporate brand and product names from others in the marketplace and protecting us from unauthorized use of these trademarks. These registered trademarks are of material importance to us because they identify our name and our lines of products.

We own various patents and intend to continue to seek patents on our inventions used in our products. We also license from third parties the rights to the software included in certain of our products. These licenses generally give us a non-exclusive right to use and sell the licensed software included in our products during the term of the applicable agreement. We pay the licensors fees based on the number of units that we purchase from them.

From time to time, we have been subject to proceedings or claims alleging infringement of intellectual property rights of third parties. Such matters have required us to expend significant sums in litigation and/or in licensing fees. Moreover, such claims could result in significant damages being awarded, and/or the requirement to develop non-infringing technology, or acquire additional licenses to the technology that is the subject of the asserted infringement, any of which could have a material adverse effect on our business. We rely upon copyright, trademark, patents and trade secret protection to protect our proprietary rights in our products and processes; however, there can be no assurance that these protections will be adequate to deter misappropriation of our technologies or independent third-party development of potentially infringing technologies.

The business telecommunications industry is characterized by rapid technological change. Industry participants often find it necessary to develop products and features similar to those introduced by others, with incomplete knowledge of whether patent protection may have been applied for or may ultimately be obtained by competitors or others. The telecommunications manufacturing industry has historically witnessed numerous allegations of patent infringement and considerable related litigation among industry participants. As noted above, we have received claims of patent infringement from several parties seeking substantial sums and have been sued in federal court for patent infringement. In response to prior infringement claims, we have pursued settlements and/or have obtained nonexclusive licenses entitling us to utilize the patented technologies or processes that are widely licensed and used in the telecommunications manufacturing industry. These licenses will either expire at the end of the patent license or the end of an agreed-to period. Currently, we are negotiating with certain parties concerning the licensing of patented technologies.

EMPLOYEES

As of June 30, 2008, we had 243 full-time employees, including approximately 113 in sales, marketing and customer support, 96 in engineering and product development, and 34 in general and administration functions. Our future success will depend in large part on our continued ability to retain highly skilled and qualified personnel. None of our employees are represented by a labor union. We have not experienced any work stoppages and believe that our relations with our employees are good.

INTERNATIONAL BUSINESS

We also market and sell our products in international markets. For the years ended June 30, 2008, 2007 and 2006, international sales accounted for 2%, 3% and 2% respectively, of total net sales. Less than 2% of our assets were deployed to support our international business for each of those years.

The majority of our sales to non-U.S. customers are in U.S. dollars. These customers may be affected by fluctuations in exchange rates and government regulations. Currency fluctuations in particular may make our products more expensive, in local currency, to our customers. To date, our operations have not been affected materially by currency fluctuations.

We intend to expand our presence in international markets and we cannot assure you that we will compete successfully in international markets or meet the service and support needs of foreign customers. Our future results could be harmed by a variety of factors relating to international operations, including:

• difficulties in enforcing agreements and collecting receivables through the legal systems of foreign countries;

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• the longer payment cycles associated with many foreign customers;

• the possibility that foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade;

• fluctuations in exchange rates, which may affect product demand and adversely affect the profitability in U.S. dollars of products and services provided by us in foreign markets where payment is made in local currency;

• our ability to obtain U.S. export licenses and other required export or import licenses or approvals;

• changes in the political, regulatory or economic conditions in a country or region; and

• problems with protecting our intellectual property in foreign countries.

ITEM 2. PROPERTIES

As of June 30, 2008, we leased property as detailed in the following table:

Location	Approximate Size	Owned or Leased	Expiration Date	Lease Intended Use
Cambridge, Massachusetts	11,202 sq ft.	Leased	September, 2012	Office
Santa Clara, California	24,907 sq ft.	Leased	July, 2010	Office
Phoenix, Arizona	54,014 sq ft.	Leased	December, 2011	Office/Warehouse
Phoenix, Arizona	19,180 sq ft.	Leased	May, 2009	Warehouse
Charlottesville, Virginia	26,375 sq ft.	Leased	Monthly	Office
Sarasota, Florida	67,832 sq ft.	Leased	Monthly	Office
Lawrenceville, Georgia	1,000 sq ft.	Leased	October, 2008	Office
Munich, Germany	2,000 sq ft.	Leased	January, 2009	Office
Total	206,510 sq ft.

Our corporate headquarters is located in Cambridge, Massachusetts. We maintain engineering laboratories, software development facilities, testing and product development facilities and customer support in our Santa Clara, California, Phoenix, Arizona and Charlottesville, Virginia offices. We maintain warehouses in our Phoenix, Arizona location. The Sarasota, Florida location includes offices for customer support, operations, information technology, human resources and finance. We maintain sales and customer support functions in our Munich, Germany office.

We believe our properties are currently adequate to meet our needs for the foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

From time to time we are involved in various claims and other legal proceedings which arise in the normal course of our business. Such matters are subject to many uncertainties and outcomes that are not predictable. However, based on the information available to us and after discussions with legal counsel, we do not believe any such proceedings will have a material adverse effect on our business, results of operations, financial position or liquidity. We cannot provide assurance, however that damages that result in a material adverse effect on our financial position or results of operations will be not be imposed in these matters.

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

On March 3, 2008, our Board of Directors approved an amendment to our Amended and Restated Certificate of Incorporation, as amended, to increase the number of authorized shares of our common stock, par value $0.01 per share from 250,000,000 to 750,000,000. On March 7, 2008, the holders of approximately 59.3% of our voting securities, voting as a single class on an as-converted basis, approved the amendment by written consent.

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Upon filing of the Amendment with the Secretary of State of Delaware, the number of authorized shares of Common Stock was increased from 250,000,000 to 750,000,000.

The Board determined that this increase in the number of authorized shares of Common Stock was necessary and in the best interest of the Company and its stockholders to provide the Company with available Common Stock to satisfy its obligations under its outstanding equity securities and for any other corporate purposes.

For a complete description of the matters submitted to a vote of the stockholders, see the Definitive Information Statement filed on April 10, 2008.

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PART II

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

Market Information

At June 30, 2008, our common stock was quoted on the OTC Bulletin Board under the symbol VRCC.OB.

The following table presents the high and low bid prices of our Common Stock for each quarter of the fiscal years ended June 30, 2008 and 2007 as reported by the OTC Bulletin Board. These quotations may reflect inter-dealer prices, without related mark-up, markdown or commission and may not necessarily represent actual transactions.

	2008				2007
	High		Low		High		Low
First Quarter, ending September 30	$	1.57	$	0.64	$	1.01	$	0.35
Second Quarter, ending December 31	$	1.24	$	0.55	$	1.10	$	0.38
Third Quarter, ending March 31	$	0.70	$	0.08	$	1.07	$	0.68
Fourth Quarter, ending June 30	$	0.12	$	0.06	$	0.95	$	0.60

We filed a Form 15 with the Securities and Exchange Commission on July 29, 2008 in order to voluntarily deregister our common stock and expect that the deregistration of our shares will become effective 90 days after the filing of the Form 15. The Company is eligible to voluntarily deregister its shares as it had fewer than 300 shareholders of record as of July 29, 2008.

On September 19, 2008, the high and low sales prices for our common stock on the OTC bulletin board were $.05 and $.05, respectively.

Shareholders

As of September 19, 2008, there were 52,377,272 shares of our common stock issued and outstanding and held by approximately 292 shareholders of record. This number counts each broker dealer and clearing corporation who hold shares for their customers as a single shareholder.

Dividend Policy

We have not paid a cash dividend on our common stock and do not anticipate doing so in the foreseeable future. Pursuant to the agreements executed in connection with the acquisitions of Vertical Networks, Comdial and Vodavi, we cannot pay any cash dividends on any shares of our capital stock without the prior written consent of M/C Venture Partners. Further, the Credit Agreement and the Loan Agreement (see Note 8 to the Consolidated Financial Statements) prohibit us from declaring any dividends on our shares of Common Stock.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information about the securities authorized for issuance under our equity compensation plans. In accordance with the rules of the SEC, the information in the table is presented as of June 30, 2008, the end of our most recently completed fiscal year.

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)	(b)		(c)
Equity compensation plans approved by security holders	18,269,560	$	1.00	57,145,591
Equity compensation plans not approved by security holders	—		—	—
Total	18,269,560	$	1.00	57,145,591

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Recent Sales of Unregistered Securities

On August 28, 2008, the Company entered into a third amendment to the Credit Agreement, pursuant to which the principal amount of the Term Note was increased to $17.5 million resulting in $2.5 million additional proceeds, less costs, to the Company. The Company agreed to issue an additional warrant to purchase 14.5 million shares of our common stock at an exercise price of $.01 per share to the Lender in conjunction with this increase.

Issuer Purchases of Equity Securities

During the fiscal year ended June 30, 2008, the Company did not purchase any of its equity securities.

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

Forward-Looking Statements

This Annual Report on Form 10-K, including, without limitation, the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements. These statements relate to future events or to our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by the use of words such as “expect,” “intend,” “may,” “would,” “could,” “plan,” “seek,” “potential,” “continue,” or the negative of these terms or other comparable terminology. You should not place undue reliance on forward-looking statements since they involve known and unknown risks, uncertainties and other factors which are, in some cases, beyond our control and which could materially affect actual results, levels of activity, performance or achievements. Factors that may cause actual results to differ materially from current expectations include, but are not limited to:

• our history of losses and expectation of incurring future losses;

• failure to increase the sales of our products;

• the current economic and market conditions which could negatively impact our ability to sell our products in both domestic and international markets;

• continued inability to achieve profitability;

• the loss of any of our key customers;

• the introduction of competitive products, including other software- or server-based phone systems;

• slower than expected development of the software- or server-based phone system market or any event that causes software- or server-based phone systems to be less attractive to customers;

• deteriorating financial performance;

• failure to protect our intellectual property; and

• the inability to become a significant player within the IP-PBX telephony market.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. Any forward-looking statement you read in this Annual Report on Form 10-K reflects our current views with respect to future events and is subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

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Critical Accounting Policies

Revenue Recognition

The Company recognizes revenue for the sale of its Wave, InstantOffice and TeleVantage products pursuant to Statement of Position (“SOP”) 97-2, Software Revenue Recognition, and SOP 98-9, Software Revenue Recognition With Respect to Certain Transactions. For revenue generated by the sale of Comdial and Vodavi products, where the Company has determined that the software is incidental, the Company follows Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition. Generally, the Company recognizes revenue when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, the product has been shipped or the services have been provided to the customer, the sales price is fixed or determinable and collectability is reasonably assured. The Company reduces revenue for estimated customer returns, rotations and sales rebates when such amounts are estimable. When not estimable, the Company defers revenue until the product is sold to the end customer or the customer’s rights expire. As part of its product sales price, the Company provides telephone support, which is generally utilized by the customer shortly after the sale. The cost of the phone support is not significant but is accrued in the financial statements. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue.

The Company defers revenue on shipments to Toshiba until the product is resold by Toshiba to its customers. The deferral of revenue is due to the Company’s inability to reasonably estimate potential future stock rotations resulting from future product releases and their effect on future revenue as Toshiba purchases the TeleVantage software and license keys in bulk amounts and maintains an inventory for future sales to customers. For all other TeleVantage license sales, assuming that all other revenue recognition criteria have been met, revenue is recognized at the time of delivery of the software to the customer.

Revenue from delivered elements of one-time charge licensed software is recognized at the inception of the license term using the residual method, provided we have vendor-specific objective evidence (“VSOE”) of the fair value of each undelivered element. Revenue is deferred for the fair value of the undelivered elements based upon the price of these elements when sold separately. Revenue is also deferred for the entire arrangement if VSOE does not exist for each undelivered contract element. Examples of undelivered elements in which the timing of delivery is uncertain include contractual elements that give customers rights to any future upgrades at no additional charge or future maintenance that is provided within the overall price. The revenue that is deferred for any contract element is recognized when all of the revenue recognition criteria have been met for that element. Revenue for annual software subscriptions is recognized ratably over the length of the software subscription. Certain contracts for the sale of telephone systems acquired with Vertical Networks in September 2004 were determined to be bundled with software subscriptions with lengths of up to five years from the date of acquisition. The revenue and cost of sales of the systems under these contracts have been deferred and will be amortized ratably over the length of the associated software subscription, as the Company does not have VSOE for these subscription agreements.

Due to the lengthy period of time over which we amortize the revenue and cost of goods sold related to these systems, the revenue and cost of goods sold we report in any one period excludes certain of the revenue and cost of goods sold relating to shipments in that period and includes revenue and costs of goods sold relating to shipments made in prior periods. As a result, our reported revenue and costs of goods sold may not necessarily be indicative of our ability to generate customer orders in a particular period. The difference between reported revenue and costs of goods sold and customer orders in any period could be either positive or negative, and cannot be reliably predicted from period to period. The following tables demonstrate this effect by showing the amount of revenue, cost of goods sold and gross profit from systems shipped during the year ended June 30, 2008 that was deferred at each quarter end (in thousands).

	Deferred Revenue		Deferred Cost of Goods Sold		Deferred Gross Profit
June 30, 2008	$	742	$	408	$	334
March 31, 2008		649		369		280
December 31, 2007		—		—		—
September 30, 2007		490		273		217

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The following table details the amount of revenue, cost of goods sold and gross profit from systems shipped during prior reporting periods that was recognized at each quarter end for the 12-month period ended June 30, 2008 (in thousands).

	Recognition of Revenue Deferred in Prior Period		Recognition of Cost of Goods Sold Deferred in Prior Period		Recognition of Gross Profit Deferred in Prior Period
June 30, 2008	$	2,224	$	1,243	$	981
March 31, 2008		2,056		1,144		912
December 31, 2007		2,075		1,151		924
September 30, 2007		2,001		1,112		889

As a result of the revenue and cost of goods sold deferral related to current period shipments of systems, the revenue and cost of goods sold reflected in our Consolidated Financial Statements may not be indicative of our ability to generate sales of our product into the marketplace in the current annual period. Likewise, recognition in the current or a future period of revenue and cost of goods sold related to shipments of systems that occurred in prior years may cause the impression that we are generating a higher volume of sales of our telephone systems into the market in that period than is the case.

Revenue from time and material service contracts is recognized as the services are provided. Revenue from fixed price, long-term service or development contracts is recognized over the contract term, using a proportional performance model, based on the percentage of services that are provided during the period compared with the total estimated services to be provided over the entire contract. Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent.

Warranty

We provide a limited warranty to our customers ranging from one year to five years depending on the product, including repair or replacement of defective equipment. Our contract manufacturing partners are responsible for the first year or for the entire five years, depending on the product, of the warranty repair work. We provide for the estimated cost of product warranties at the time the revenue is recognized. We calculate our warranty liability based on historical product return rates and estimated average repair costs. While we engage in various product quality programs and processes, our warranty obligation may be affected by product failure rates and the ability of our contract manufacturers to satisfy warranty claims. The outcome of these items could differ from our estimates and revisions to the warranty estimates could be required.

Accounts Receivable

We provide allowances for doubtful accounts for estimated losses from the inability of our customers to satisfy their accounts as originally contemplated at the time of sale. We calculate these allowances based on the detailed review of certain individual customer accounts, historical collection rates and our estimation of the overall economic conditions affecting our customer base. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

We also provide reserves for returns and sales incentives to reduce revenue and accounts receivable for product returns and other credits we may grant to customers. Such reserves are recorded at the time of sale and are calculated based on the historical information (such as rates of product returns) and the specific terms of sales programs, taking into account any other known information about likely customer behavior. If actual customer behavior differs from our expectations, additional reserves may be required. Also, if we determine that we can no longer accurately estimate amounts for returns and sales incentives, we would not be able to recognize revenue until the customers exercise their rights, or such rights lapse, whichever is later.

Inventory

We measure our inventories at lower of cost or market on a first in, first out basis. We also provide allowances for excess and obsolete inventory equal to the difference between the cost of our inventory and the estimated market value based upon assumptions about product life cycles, product demand and market conditions. If actual product life cycles, product demand or market conditions are less favorable than those projected by management, additional inventory allowances or write-downs may be required.

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Long-lived Assets, including Goodwill and Other Intangibles

Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”) establishes a single accounting model for long-lived assets to be disposed of by sale. For long-lived assets that are held for use, when circumstances suggest that there may be an impairment, we compare the forecasted undiscounted net cash flows to the carrying amount. If the long-lived asset is determined to be unable to recover the carrying amount, then it is written down to fair value. A considerable amount of judgment is required in calculating this impairment charge, principally in determining financial forecasts. Unanticipated changes in market conditions could have a material impact on our projected cash flows. Differences in actual cash flows as compared to the projected cash flows could require us to record an impairment.

SFAS No. 142, “Goodwill and Other Intangible Assets” includes requirements to test goodwill and indefinite lived intangible assets for impairment rather than amortize them. Goodwill and other indefinite lived intangible assets must be tested for impairment on at least an annual basis. The Company’s goodwill arose from the acquisitions of Vertical Networks, Comdial and Vodavi and is tested annually. Although the goodwill was deemed to not be impaired when it was tested in fiscal year 2008, there can be no assurances that subsequent reviews will not result in material impairment charges. A considerable amount of judgment is required in calculating this impairment analysis, principally in determining discount rates, financial forecasts and allocation methodology. Unanticipated changes in market conditions could have a material impact on our projected cash flows. Differences in actual cash flows as compared to the projected discounted cash flows could require us to record an impairment loss.

Results of Operations

The following table sets forth certain items from our consolidated statements of operations (in thousands of dollars) for the fiscal years ended June 30, 2008, 2007, and 2006, together with the percentage of total revenue which each such item represents:

	Year Ended June 30, (in thousands)
	2008					2007					2006
				% of Revenue					% of Revenue					% of Revenue
Revenue	$	72,594		100.0	%	$	79,148		100.0	%	$	55,535		100.0	%
Cost of goods sold		38,799		53.4	%		42,362		53.5	%		25,632		46.2	%
Gross profit		33,795		46.6	%		36,786		46.5	%		29,903		53.8	%
Operating expenses:
Marketing and selling		19,292		26.6	%		16,668		21.1	%		16,962		30.5	%
Research and product development		15,985		22.0	%		13,618		17.2	%		11,552		20.8	%
General and administrative		14,307		19.7	%		15,857		20.0	%		16,182		29.1	%
Amortization of intangible assets		2,437		3.4	%		1,900		2.4	%		1,094		2.0	%
Total operating expenses		52,021		71.7	%		48,043		60.7	%		45,790		82.5	%
Operating loss		(18,226	)	-25.1	%		(11,257	)	-14.2	%		(15,887	)	-28.6	%
Other income (expense), net		(9,279	)	-12.8	%		(4,413	)	-5.6	%		514		0.9	%
Loss from continuing operations before income taxes		(27,505	)	-37.9	%		(15,670	)	-19.8	%		(15,373	)	-27.7	%
Provision for income taxes		1,032		1.4	%		349		0.0	%		626		1.1	%
Net income (loss)	$	(28,537	)	-39.3		$	(16,019	)	-20.0		$	(15,999	)	-28.8	%

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Year Ended June 30, 2008 Compared to Year Ended June 30, 2007

Revenue

Our revenues were $72.6 million for the fiscal year ended June 30, 2008 compared to revenues of $79.1 million for the fiscal year ended June 30, 2007. Total revenues decreased $6.5 million, or (8.2%), for fiscal 2008 compared to fiscal 2007. The decrease in net revenue is primarily attributable to lower sales of our legacy products due to significant competitive pressures in the small to medium business marketplace, lower sales of Xcelerator IP and to lower sales to one of our largest retail chain customers. Our recently launched next generation products (Wave IP 2500 and SBX IP350) were developed to provide more cost-effective IP-based systems and applications and we expect these products to improve revenue momentum in the future.

Our reported revenue includes shipping and handling charges and is recorded net of reserves for sales returns, discounts and customer incentive programs.

We distribute our products internationally. International product revenue was 2%, 3% and 2% of total net revenue for fiscal years 2008, 2007 and 2006, respectively. Our international revenue continued to increase at the same pace as its underlying domestic business, and as we continue to focus on and strengthen our distribution efforts in international geographic regions, we expect that our international component will continue to grow in importance to our overall revenue.

Cost of Goods Sold and Gross Margin

Cost of goods sold (“COGS”) is primarily comprised of materials, manufacturing, shipping and repair of our products. In addition, amortization of technology-based intangible assets associated with our acquisitions of Vertical Networks, Comdial and Vodavi and royalties paid to third parties are included in cost of sales. COGS decreased by approximately $3.6 million, or (8.5%), to $38.8 million for the fiscal year ended June 30, 2008 compared with $42.4 million for the fiscal year ended June 30, 2007. The decrease in COGS from fiscal 2007 to fiscal 2008 was primarily attributable to lower sales of our legacy products.

Gross profit percentage increased slightly from 46.5% of net revenue to 46.6% of net revenue in 2008. The increase was attributable to the increased sales of software related products to our large enterprise customers.

Operating Expenses

Our operating expenses are comprised of:

• Sales and marketing costs, which consist primarily of salaries and employee benefits for sales and marketing employees, travel, advertising, tradeshows and various other marketing programs;

• Product development costs, which consist primarily of salaries and employee benefits for engineering and technical personnel;

• General and administrative expenses, which generally represent salaries and employee benefits costs of executive, administrative, operations, finance, human resource and IT personnel, as well as professional fees, insurance costs, consulting fees, administrative expenses and depreciation;

• Stock-based, non-cash compensation expense; and

• Amortization of intangible assets acquired from Vertical Networks, Comdial and Vodavi.

Our operating expenses were $52.0 million for the fiscal year ended June 30, 2008, an increase of $4.0 million or 8.3%, from $48.0 million for the fiscal year ended June 30, 2007. The increase in operating expenses is a result of increased product development costs related to our next generation products and increased sales and marketing expenses to promote the new products.

Marketing and selling expenses. Total marketing and selling expenses increased $2.6 million, or 15.6%, to $19.3 million for the fiscal year ended June 30, 2008 compared with the fiscal year ended June 30, 2007 expenses of $16.7 million. As a percentage of revenues, marketing and selling expenses were 26.6% for fiscal 2008 and 21.1% for fiscal 2007. The increase in marketing and selling expenses from fiscal 2007 to fiscal 2008 was primarily attributable to the increase in travel expense and marketing programs to promote our new products.

Research and product development expenses. Total research and product development expenses increased $2.4 million, or 17.4%, to $16.0 million for the fiscal year ended June 30, 2008 compared with the fiscal year ended June 30, 2007 expenses of $13.6 million. As a percentage of revenues, research and product development expenses were 22.0% for fiscal 2008 and 17.2% for fiscal 2007. The increase in product development expenses from the levels for fiscal 2007 to the levels for fiscal 2008 was due to the additional personnel and related costs for ongoing research and product development efforts related to the next generation product lines.

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General and administrative expenses (“G&A”). Total G&A expenses decreased $1.6 million, or 10.1%, to $14.3 million for the fiscal year ended June 30, 2008 compared with the fiscal year ended June 30, 2007 expenses of $15.9 million. As a percentage of revenues, G&A expenses were 19.7% for fiscal 2008 and 20.0% for fiscal 2007. The decrease in G&A expenses from fiscal 2007 to fiscal 2008 was primarily driven by elimination of overhead redundancies.

G&A expense also includes liquidated damages that we are accruing related to certain equity financings. There were no liquidated damages recorded for the fiscal year ended June 30, 2008 compared with $1.0 million recorded for the fiscal year ended June 30, 2007, representing a decrease of $1.0 million.

Amortization of intangible assets. Amortization of the intangible assets acquired in the acquisitions of Vertical Networks, Comdial and Vodavi was $2.4 million for the fiscal year ended June 30, 2008 compared with $1.9 million for the same period in 2007 representing an increase of $0.5 million, or 26.3%. This increase was attributable primarily to the full year amortization of the intangible assets acquired in the Vodavi acquisition.

Operating Loss

For the fiscal year ended June 30, 2008, our operating loss increased $7.0 million, or 62.0%, to ($18.2) million on revenue of $72.6 million, from an operating loss of ($11.3) million on revenue of $79.1 million for the fiscal year ended June 30, 2007. As discussed above, the factors primarily affecting this increase in operating loss were lower gross profit as a result of the decline in legacy product sales and an increase in operating expenses.

Included in the operating loss are non-cash compensation expense related to restricted stock and stock option grants of $6.3 million in 2008 compared with $5.1 million in 2007 and depreciation and amortization (for other than the acquired intangibles) expense of $1.3 million compared with $1.5 million in 2007.

As mentioned above under the caption Revenue Recognition, we defer a portion of the revenue and cost of goods sold related to current period shipments while recognizing revenue and cost of goods sold from shipments in prior periods.

Interest Expense

Interest expense for the fiscal year ended June 30, 2008 was $9.4 million compared with $4.8 million in the fiscal year ended June 30, 2007, representing an increase of $4.6 million. The increase in interest expense primarily relates to recognition of the non-cash discounts attributable to the Series F Notes and Preferred Stock (see Note 9 to the Consolidated Financial Statements for additional information).

Other income (expense), net

Other income (expense), net, includes interest income, gain (loss) on the disposal of assets and miscellaneous income. Other income was $0.1 million for the fiscal year ended June 30, 2008, a decrease of $0.3 million from income of $0.4 million for the fiscal year ended June 30, 2007. The decrease in other income for fiscal 2008 over the same period in fiscal 2007 was due entirely to decreased interest income.

Income Tax Expense

While we incurred net losses in 2008 and 2007, we recorded a deferred tax provision associated with the goodwill created with the Vertical Networks and Comdial acquisitions. The effective tax rate utilized for the provision was 40.0%.

Year Ended June 30, 2007 Compared to Year Ended June 30, 2006

Revenue

Our revenues were $79.1 million for the fiscal year ended June 30, 2007 compared to revenues of $55.5 million for the fiscal year ended June 30, 2006. Total revenues increased $23.6 million, or 42.5%, for fiscal 2007 compared to fiscal 2006. The increase in revenue was primarily due to the acquisitions of Comdial on September 28, 2005 and Vodavi on December 1, 2006. The acquisition of the Vodavi product lines drove approximately 95% of the increase in revenue. Our reported revenue includes shipping and handling charges and is recorded net of reserves for sales returns, discounts and customer incentive programs.

We distribute our products internationally. International product revenue was 3% and 2% of total net revenue for fiscal years 2007 and 2006, respectively. Our international revenue continued to increase at the same pace as its underlying domestic business, and as we continue to focus on and strengthen our distribution efforts in international geographic regions, we expect that our international component will continue to grow in importance to our overall revenue.

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Cost of Goods Sold and Gross Margin

Costs of goods sold (“COGS”) includes expenses associated with finished goods purchased from outsourced manufacturers, warranty expense, freight expense, royalty payments, and inventory obsolescence expense. COGS increased by approximately $16.7 million, or 65.3%, to $42.4 million for the fiscal year ended June 30, 2007 compared with $25.6 million for the fiscal year ended June 30, 2006. The increase in COGS from fiscal 2006 to fiscal 2007 was primarily attributable to sales of the Vodavi product lines subsequent to the acquisition in fiscal 2007, as hardware is a significant component of the cost.

Gross profit declined from 53.8% of net revenue to 46.5% of net revenue in 2007. The decrease was attributable to the increased sales of hardware based products, including the Vodavi product lines which have a lower margin than our InstantOffice and Comdial product lines.

Operating Expenses

Our operating expenses were $48.0 million for the fiscal year ended June 30, 2007, an increase of $2.2 million or 4.8%, from $45.8 million for the fiscal year ended June 30, 2006. The increase in operating expenses is primarily related to the acquisition of Vodavi. As part of this acquisition, we acquired two additional office locations, one of which includes a warehouse, and significant infrastructure to maintain these operations.

Marketing and selling expenses. Total marketing and selling expenses decreased $0.3 million, or 1.7%, to $16.7 million for the fiscal year ended June 30, 2007 compared with the fiscal year ended June 30, 2006 expenses of $17.0 million. As a percentage of revenues, marketing and selling expenses were 21.1% for fiscal 2007 and 30.5% for fiscal 2006. The decrease in marketing and selling expenses from fiscal 2006 to fiscal 2007 was primarily attributable to consolidating the customer support functions to achieve economies of scale and to reduced participation in trade shows.

Research and product development expenses. Total research and product development expenses increased $2.1 million, or 17.9%, to $13.6 million for the fiscal year ended June 30, 2007 compared with the fiscal year ended June 30, 2006 expenses of $11.6 million. As a percentage of revenues, research and product development expenses were 17.2% for fiscal 2007 and 20.8% for fiscal 2006. The increase in product development expenses from the levels for fiscal 2006 to the levels for fiscal 2007 was due to the additional personnel and related costs for ongoing research and product development efforts related to the next generation product lines.

General and administrative expenses (“G&A”). Total G&A expenses decreased $0.3 million, or 2.0%, to $15.9 million for the fiscal year ended June 30, 2007 compared with the fiscal year ended June 30, 2006 expenses of $16.2 million. As a percentage of revenues, G&A expenses were 20.0% for fiscal 2007 and 29.1% for fiscal 2006. The decrease in G&A expenses from fiscal 2006 to fiscal 2007 was primarily attributable to lower accruals of liquidated damages (see below) offset by increased G&A costs as a result of the Vodavi acquisition.

G&A expense also includes liquidated damages that we are accruing related to certain equity financings. Total liquidated damages recorded for the fiscal year ended June 30, 2007 was $1.0 million, representing a decrease of $1.1 million or 50%, compared with $2.2 million accrued for the fiscal year ended June 30, 2006.

Amortization of intangible assets. Amortization of the intangible assets acquired in the acquisitions of Vertical Networks, Comdial and Vodavi was $1.9 million for the fiscal year ended June 30, 2007 compared with $1.1 million for the same period in 2006 representing an increase of $0.8 million, or 73.7%. This increase was attributable primarily to the addition of the intangible assets acquired in the Vodavi acquisition.

Operating Loss

For the fiscal year ended June 30, 2007, our operating loss decreased $4.6 million, or 29.1%, to ($11.3) million on revenue of $79.1 million, from an operating loss of ($15.9 million) on revenue of $55.5 million for the fiscal year ended June 30, 2006. As discussed above, the factors primarily affecting this decrease in operating loss were increased gross profit as a result of the Vodavi acquisition partially offset by an increase in operating expenses.

Included in the operating loss are non-cash compensation expense related to restricted stock and stock option grants of $5.1 million in 2007 compared with $4.0 million in 2006 and depreciation and amortization (for other than the acquired intangibles) expense of $1.5 million compared with $1.5 million in 2006.

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As mentioned above under the caption Revenue Recognition, we defer a portion of the revenue and cost of goods sold related to current period shipments while recognizing revenue and cost of goods sold from shipments in prior periods.

Interest Expense

Interest expense for the fiscal year ended June 30, 2007 was $4.8 million compared with $0.7 million in the fiscal year ended June 30, 2006, representing an increase of $4.2 million. The increase in interest expense relates to debt instruments incurred in order to finance the Vodavi acquisition.

Gain on Settlement of Litigation

Gain on settlement of litigation for the fiscal year ended June 30, 2007 was $0 compared with $1.2 million in the fiscal year ended June 30, 2006. The fiscal year 2006 gain relates to settlement of litigation with the former shareholders of Vertical Networks, Inc. regarding certain license agreements and earnout provisions in the acquisition agreement.

Other income (expense), net

Other income (expense), net, includes interest income, gain (loss) on the disposal of assets and miscellaneous income. Other income was $0.4 million for the fiscal year ended June 30, 2007, an increase of $0.4 million from income of $4,000 for the fiscal year ended June 30, 2006. The increase in other income for fiscal 2007 over the same period in fiscal 2006 was due entirely to increased interest income.

Income Tax Expense

While we incurred net losses in 2007 and 2006, we recorded a deferred tax provision associated with the goodwill created with the Vertical Networks and Comdial acquisitions offset by a reduction in the deferred tax liability related to the Vodavi acquisition as a result of the amortization of the intangible assets. The effective tax rate utilized for the provision was 40.0%.

Liquidity and Capital Resources

Financial Condition, Liquidity And Capital Resources (in thousands)

	Positions at
	June 30, 2008		June 30, 2007		Change
Cash and cash equivalents	$	3,695	$	8,019	$	(4,324	)
Working capital (excl. restricted cash)		233		4,841		(4,608	)
Cash used in operating activities		9,794		8,914		880
Cash used in investing activities		1,397		24,704		(23,307	)
Cash provided by financing activities		7,003		36,948		(29,945	)

Working capital, consisting of total current assets minus current liabilities, was $0.2 million at June 30, 2008, compared to working capital of $4.8 million at June 30, 2007, representing a decrease of ($4.6) million. The decrease in working capital is primarily attributable to the $4.3 million decrease in cash.

As of June 30, 2008, our cash and cash equivalents were approximately $3.7 million, a decrease of $(4.3) million from the balance at June 30, 2007. Net cash flows used in operating activities were $9.8 million in fiscal year 2008, an increase of $0.9 million from the net cash flows used in operating activities of $8.9 million in fiscal 2007.

Net cash flows used in investing activities were $1.4 million in fiscal 2008, a decrease of $23.3 million from the net cash flows used in investing activities of $24.7 million in fiscal 2007. The change is primarily attributable to the difference in cash provided by the Series E financing which was used to acquire Vodavi in fiscal 2007 compared with the cash provided by the Series F financing which was used to fund operations in fiscal 2008.

Net cash flows provided by financing activities were $7.0 million in fiscal 2008, a decrease of $29.9 million from the net cash flows provided by financing activities of $36.9 million in fiscal 2007. This decrease was primarily attributable to the $27.0 million in cash provided by the Series E financing in fiscal 2007 versus the $7.8 million in cash provided by the Series F financing (See Note 9 to the Consolidated Financial Statements).

We have incurred losses and negative or minimal positive cash flows from operations in every fiscal period since 1996 and have an accumulated deficit, including non-cash equity charges, of $121.5 million as of June 30, 2008. Our management expects that operating losses will continue in the near future. In August 2008, we closed an additional $2.5 million in debt financing with one of

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our lenders (see Note 15 to the Consolidated Financial Statements). On September 30, 2008, we entered into an amendment to the Loan Agreement with Silicon Valley Bank, pursuant to which the maturity date of the loan was changed to August 21, 2009 (see Note 8 to the Consolidated Financial Statements). On October 6, 2008, MC Venture Partners, as holder of a majority of the Series D Preferred Stock, notified us that they agreed to not make the election to require redemption of the Series D Preferred Stock on or before October 1, 2009 (see Note 9 to the Consolidated Financial Statements). As a result, we anticipate that we will meet our forecasted cash requirements for the next twelve months. A change in circumstance, such as a reduction in the demand for our products, could necessitate that we seek additional debt or equity capital or take actions to reduce our operating costs to levels that can be supported by our available cash. Such additional financings may not be available on terms acceptable to us, or at all, and may significantly affect our stockholders, including for example, by substantially diluting their ownership interest.

Supplementary Financial Data

Unaudited Quarterly Results

The following tables present selected unaudited quarterly operating results for the Company’s four quarters ended June 30, 2008 and June 30, 2007 (in thousands). The Company believes that all necessary adjustments have been made to present fairly the related quarterly results, except per share data.

Fiscal 2008	First Quarter			Second Quarter			Third Quarter			Fourth Quarter			Total
Net revenue	$	19,706		$	18,711		$	16,100		$	18,077		$	72,594
Gross profit		8,978			8,655			7,780			8,382			33,795
Operating loss		(4,326	)		(4,779	)		(5,325	)		(3,796	)		(18,226	)
Net loss		(4,945	)		(6,136	)		(6,136	)		(11,320	)		(28,537	)
Loss applicable to common shares		(5,288	)		(6,522	)		(6,629	)		(12,129	)		(30,568	)
Basic and diluted net loss per common share	$	(0.10	)	$	(0.13	)	$	(0.13	)	$	(0.23	)	$	(0.58	)
Fiscal 2007	First Quarter			Second Quarter			Third Quarter			Fourth Quarter			Total
Net revenue	$	15,870		$	18,080		$	22,683		$	22,515		$	79,148
Gross profit		8,116			8,657			10,458			9,555			36,786
Operating loss		(2,988	)		(2,348	)		(2,356	)		(3,565	)		(11,257	)
Net loss		(3,332	)		(3,664	)		(4,173	)		(4,850	)		(16,019	)
Loss applicable to common shares		(3,497	)		(3,866	)		(4,386	)		(5,124	)		(16,873	)
Basic and diluted net loss per common share	$	(0.07	)	$	(0.08	)	$	(0.09	)	$	(0.10	)	$	(0.35	)

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Reference is made to the consolidated financial statements, the reports thereon and the notes thereto commencing at page 43 of this Report, which are incorporated herein by reference.

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

None.

ITEM 9A(T). CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported within the required time periods and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.

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As required by Rule 13a-15 under the Exchange Act, we have completed an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness and the design and operation of our disclosure controls and procedures as of June 30, 2008. Based upon this evaluation, our management, including the Chief Executive Officer and the Chief Financial Officer, has concluded that our disclosure controls and procedures were effective as of June 30, 2008.

Management’s Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and the Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control over Financial Reporting – Guidance for Smaller Public Companies issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under this framework, our management concluded that our internal control over financial reporting was effective as of June 30, 2008.

This report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

Changes in Internal Controls. Subsequent to the date of their evaluation, there have not been any significant changes in our internal controls or in other factors that could significantly affect these controls.

Limitations on Effectiveness of Controls and Procedures. Our management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls 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. These inherent limitations include, but are not limited to, the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The following table sets forth certain information regarding our directors and executive officers:

Name	Age	Position
William Y. Tauscher	58	Chief Executive Officer, President and Chairman of the Board
Richard N. Anderson	52	Executive Vice President and General Manager
Kenneth M. Clinebell	47	Chief Financial Officer, Secretary and Treasurer
Peter H. Bailey	36	Senior Vice President
Scott K. Pickett	46	Chief Technology Officer
Michael P. Downey (1)(2)(3)	61	Director
John W. Watkins (1)	47	Director
Francis E. Girard (1)(2)(3)	68	Director
Matthew J. Rubins	40	Director
R. Randy Stolworthy (2)	44	Director
Jong Dae An	47	Director

(1) Member of the Compensation Committee

(2) Member of the Audit Committee

(3) Member of the Nominating Committee

William Y. Tauscher has served as Chairman of our board of directors since February 2004 and as our Chief Executive Officer since September 2004. Mr. Tauscher has served as the managing member of The Tauscher Group since 1999, which invests and assists in the management of enterprises in various industries. Before founding The Tauscher Group, Mr. Tauscher served as chairman and CEO of Vanstar Corporation (formerly ComputerLand Corporation) until 1999, having led the group that acquired ComputerLand in 1987. He currently serves on several boards of directors, including Safeway Corporation, a $30 billion NYSE listed company, and holds controlling investments in a number of successful private companies.

Richard N. Anderson joined the Company in January 2005 as Executive Vice President and General Manager. Prior to joining Vertical, he was the Executive Vice President and General Manager of CFM Corporation, a leading integrated manufacturer of home products. He was with CFM Corporation from October 2003 until January 2005. Previously, Mr. Anderson was CEO of Temtex Industries, Inc. from July 2002 until its purchase by CFM Corporation in October 2003. Mr. Anderson also served in various executive roles, including Chief Operating Officer of KnowledgePlanet from September 2000 until July 2002, and held Senior Vice President positions in sales and marketing for Inacom and Vanstar Corporations.

Kenneth M. Clinebell joined the Company in September 2005 as Senior Vice President of Finance and Operations. Mr. Clinebell was appointed Interim Chief Financial Officer, Interim Treasurer and Interim Secretary on January 10, 2006 and was appointed Chief Financial Officer, Treasurer and Secretary on June 20, 2006. Mr. Clinebell was formerly Senior Vice President, Chief Financial Officer, Chief Operating Officer, Treasurer and Secretary of Comdial Corporation (“Comdial”) prior to Comdial’s acquisition by the Company in September 2005. Mr. Clinebell joined Comdial in November 2002. Prior to joining Comdial, Mr. Clinebell held various positions at Vicorp, Inc., currently a multi-national software development company. Mr. Clinebell joined Vicorp, Inc. in 1994 as a member of the senior executive team.

Peter H. Bailey joined the Company in September 2004 as Senior Vice President of Business Development and Product Marketing. Prior to joining the Company, Mr. Bailey led the next-generation networking banking practice for ThinkEquity Partners LLC, a San Francisco based Investment Banking Firm, and advised the Company on its acquisition of Vertical Networks and simultaneous private placement equity financing. Mr. Bailey joined ThinkEquity Partners in July 2003 when the banking practice of Pacific Crest Securities merged with ThinkEquity Partners. Mr. Bailey joined Pacific Crest in July 2002. Prior to Pacific Crest, he was responsible for Corporate Development at Carrier1 International S.A., a pan-European alternative telecom services provider, where he was responsible for mergers and acquisitions, corporate investment and financial restructuring initiatives from January 2000 through May 2002. Prior to Carrier1, Mr. Bailey held various roles including at a New York-based publishing/digital media start-up Convergence Media, which he co-founded. Prior to Convergence, Mr. Bailey was with Salomon Brothers Inc. in New York in the investment banking division.

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Scott K. Pickett joined the Company as Chief Technology Officer in September 2004 as a result of our acquisition of Vertical Networks, a company he helped to co-found in 1996. Prior to co-founding Vertical Networks, Mr. Pickett served as Director of Development for National Semiconductor’s LAN division, where he led development of several industry-first systems and networking products, including multimedia product solutions (802.9), multiprotocol VoIP gateway, integrated communications platform, and the PCMCIA Ethernet card. Prior to National Semiconductor, he held positions with Fairchild Semiconductor and General Electric.

Michael P. Downey has served on our Board since February 1997. From March 2000 until June 2000, Mr. Downey served as our interim President and Chief Executive Officer. Mr. Downey currently is a private investor and executive consultant. From 1995 until 1997, Mr. Downey served as Executive Vice President and Chief Financial Officer of Nellcor Puritan Bennett, also referred to as NPB, a medical manufacturing company. Mr. Downey served as Vice President and Chief Financial Officer of NPB from 1989 until 1995 and in other capacities for NPB from 1986 until 1989. Prior to his employment by NPB, Mr. Downey was Vice President of Finance for Shugart Corporation, a manufacturer and distributor of computer disk drives, and he had several years experience in accounting management positions with General Motors Corporation. Mr. Downey is a member of the board of directors of Emulex Corporation, a NYSE listed company that designs and manufactures software- and hardware-based network access products. Mr. Downey served on the board of directors of First Consulting Group, Inc., a consulting integration and management company for the healthcare and pharmaceutical industries that is listed on The Nasdaq National Stock Market, until it was acquired by Computer Sciences Corporation in January of 2008. Mr. Downey served on the board of directors of Adeza Biomedical, a company that designs, manufactures and markets health products, which was listed on The Nasdaq Stock Market until it was acquired by Cytec Corporation in May of 2007.

John W. Watkins has served on our Board since October 2005, when he was appointed to fill the remaining term of Mr. John P. Ward. Prior to joining M/C Venture Partners in 2004, Mr. Watkins co-founded Telegraph Hill Communication Partners, a private equity firm focused in the media, communication services and information technology industries, and was with the firm from January 2001 to June 2003. From 1989 to 2001 he was a member of J.P. Morgan Capital, where he led the firm’s private equity investment effort in communications and media-related industries and served on the Investment Committee and board of directors. Prior to joining J.P. Morgan Capital, Mr. Watkins was an Associate in J.P. Morgan’s Corporate Finance group and an Investment Banking Analyst at E.F. Hutton and Company.

Francis E. Girard has served on our Board since October 1998. Mr. Girard currently serves as senior advisor to Comverse Network Systems, a manufacturer of computer and telecommunications systems and a subsidiary of Comverse Technologies, Inc. He also served as Vice Chairman of Comverse Technologies, Inc. from 2001 to 2004 and served as Chief Executive Officer from 1998 until January 2001. From 1996 to 1998, Mr. Girard served as President and Chief Executive Officer and as a director of Boston Technology, Inc., a provider of communications and information processing systems. Previously, Mr. Girard has also served as Vice President of Sales, Marketing and Support of NEC Information Systems, Inc.

Matthew J. Rubins has served on the Board since September 2004. Mr. Rubins has been a general partner of M/C Venture Partners, a private equity firm, since 1997. Prior to joining M/C Venture Partners, he was an Assistant Vice President with Deutsche Morgan Grenfell Technology Group. Previously, Mr. Rubins was a financial analyst and then Associate in the media and telecommunications groups at Donaldson, Lufkin & Jenrette.

R. Randy Stolworthy has served on our Board since September 2004. Mr. Stolworthy has been a Managing Member of RRS & Company, a real estate investment and development company since 1992. Prior to RRS & Company, Mr. Stolworthy was President and CEO of NZ Corporation and CEO of Bridge Financial Corporation, a subsidiary of NZ Corporation. Previously, he co-founded Voicelink Data, which merged with Digital Systems International in 1991. Prior to Voicelink Data Services, Mr. Stolworthy was a general partner and manager of the Seattle office for FBS Venture Capital Company. Mr. Stolworthy is also a co-manager of the managing partner of Pathfinder Ventures.

Jong Dae An served as a director of Vodavi from August 2004 until its acquisition by Vertical in December 2006, at which time he was appointed to our board of directors. Mr. An has served as a group leader of the export business within the Network Division of LG Electronics Inc. where his career began in 1986. During most of this tenure with LGN, Mr. An managed the export of telecommunications equipment, establishing considerable market share in North America and Europe through relationships with leading distributors and world-class telecom service providers. Mr. An received a Master of Business Administration degree from the Helsinki School of Economy.

Board of Directors

Classified Board. Our board of directors is divided into three classes with one class of directors elected annually for a term of three years. Each class serves staggered three-year terms as follows:

• The Class I directors are Michael P. Downey, Francis E. Girard and Jong Dae An. The Class I directors serve until the annual meeting of the shareholders for the fiscal year ending June 30, 2008;

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• The Class II directors are William Y. Tauscher and R. Randy Stolworthy. The Class II directors serve until the annual meeting of the shareholders for the fiscal year ending June 30, 2010; and

• The Class III directors are John W. Watkins and Matthew J. Rubins. The Class III directors serve until the annual meeting of the shareholders for the fiscal year ending June 30, 2009.

Board Structure. Our Board must consist of (1) the Chief Executive Officer of the Company, serving as a Class II director (currently William Y. Tauscher); (2) one member serving as a Class II director designated by the written consent of (a) Special Situations Fund III, L.P. and its affiliates (collectively, “SSF”), so long as SSF continues to beneficially own at least 50% of the shares of Common Stock acquired by SSF upon the conversion of the shares of Series B Preferred Stock held by it, pursuant to the terms of the 2004 Consent or (b) in the event that SSF is not entitled to appoint a director, the majority-in-interest of the shares of Common Stock held by the Series B and Series C Investors that were acquired by them upon the conversion, pursuant to the terms of the 2004 Consent, of the shares of Series B Preferred Stock and Series C Preferred Stock held by them, acting as a single class; (3) two members who will serve as Class III directors designated in writing by M/C Venture Partners (currently John W. Watkins and Matthew J. Rubins); and (4) two Industry Directors who will serve as Class I directors designated by the mutual agreement of M/C Venture Partners and the Board (currently Michael P. Downey and Francis E. Girard). Currently, SSF does not have a sitting delegate on the Board.

Audit Committee. The audit committee consists of Michael P. Downey, Francis E. Girard, and R. Randy Stolworthy, all of whom have been determined by our Board to be independent under the criteria set forth under applicable securities laws and NASDAQ standards. Mr. Downey serves as the chair of this committee and as the audit committee financial expert. Mr. Downey is an “audit committee financial expert,” as defined by the rules and regulations of both the Securities and Exchange Commission (the “Commission”) and NASDAQ. The audit committee has oversight responsibility for the integrity of our financial reporting process and systems of internal controls regarding finance, accounting and legal compliance. The audit committee monitors the independence and performance of our registered independent accountants and internal auditing department. The audit committee also provides an avenue of communication among the registered independent accountants, management, our internal auditing department and our Board. Our audit committee has the authority to conduct investigations appropriate to fulfill its responsibilities, and has the ability to retain, at our expense, special legal, accounting or other consultants or experts it deems necessary in the performance of its duties.

Compensation Committee. The compensation committee consists of Michael P. Downey, Francis E. Girard, and John W. Watkins. Mr. Girard serves as the chair of this committee. Messrs. Downey and Girard have been determined by our board to be independent under the criteria set forth under applicable securities laws and NASDAQ standards. The compensation committee recommends the compensation of our Chief Executive Officer to our board of directors. The compensation committee also reviews and approves the design, administration and effectiveness of compensation programs for other key executive officers, including salary, bonus, other perquisites and option grants under our stock incentive plans.

Nominating Committee. The nominating committee consists of Michael P. Downey and Francis E. Girard, each of whom has been determined by our board to be independent under the criteria set forth under applicable securities laws and NASDAQ standards. Mr. Downey serves as the chair of this committee. The nominating committee identifies qualified individuals to become members of the board of directors and oversees the evaluation of our board of directors and management.

Section 16 Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires our directors, executive officers and holders of more than 10% of our common stock to file with the SEC initial reports of ownership and reports of changes in ownership of our common stock and other equity securities. Officers, directors and greater than 10% stockholders are required by the SEC regulations to furnish us with copies of all Section 16(a) reports they file. To our knowledge, based solely on a review of the copies of such reports and written representations that no other reports were required, we believe that all filing requirements applicable to our officers, directors and greater than 10% stockholders were satisfied during the fiscal year ended June 30, 2008.

Code of Business Conduct and Ethics

On November 2, 2004, we approved a Code of Business Conduct and Ethics, within the meaning of Item 406(b) of Regulation S-K, which applies to our directors, officers and employees. A complete copy of the Code of Business Conduct and Ethics can be obtained upon request, without charge, by submitting a request in writing to Vertical Communications, Inc., Ten Canal Park, Suite 602, Cambridge, MA 02141.

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Involvement in Certain Legal Proceedings

The Company’s Executive Vice President and General Manager, Richard N. Anderson, served as Vice Chief Executive Officer of Temtex Industries, Inc. from July 2002 until October 2003. That company filed for Chapter 11 Bankruptcy Protection on May 2, 2003.

The Company’s Chief Financial Officer, Treasurer and Secretary, Kenneth M. Clinebell, served as Chief Financial Officer, Chief Operating Officer, Treasurer and Secretary of Comdial Corporation from November 2002 through September 2005. Comdial Corporation filed for Chapter 11 Bankruptcy Protection on May 24, 2005.

ITEM 11. EXECUTIVE COMPENSATION.

COMPENSATION DISCUSSION AND ANALYSIS

Overview

The executive officers include the Chief Executive Officer (“CEO”), the Executive Vice President and General Manager, the Chief Financial Officer, the Chief Technology Officer and the Senior Vice President of Business Development and Product Management. The Board of Directors has delegated to the Compensation Committee the authority for administering the compensation program for executive officers. In addition to Mr. Downey and Mr. Girard, Mr. Watkins serves as a member of the Compensation Committee. In this Compensation Discussion and Analysis, unless the context otherwise requires, the terms “we,” “our” and “the Committee” refer to the Compensation Committee.

The Committee reviews and approves all executive officers’ compensation, including:

• Base salary;

• Annual incentive compensation;

• Long-term incentive compensation;

• Employment agreements;

• Severance arrangements

• Change-in-control agreements; and

• Any special or supplemental benefits.

The Committee reviews and approves corporate goals and objectives used in determining the compensation of the CEO, evaluates the CEO’s performance in light of those goals and objectives and makes recommendations to the Board regarding the CEO’s compensation based on this evaluation. In determining the long-term incentive component of the CEO’s compensation, the Committee considers the value of similar incentive awards to CEOs at comparable companies and the awards given to the CEO in past years. The Committee also reviews and approves changes, amendments or modifications to base salary, incentive compensation, equity awards or other long-term compensation of executive officers. The Committee also approves the annual and long-term incentive programs.

The Committee has authority to engage a compensation consultant to both assist it in carrying out its responsibilities in this respect and to conduct periodic reviews of the total compensation program for executive officers. During 2007, the Committee used the services of Grant Thornton, LLP, independent compensation and benefit consultants, for competitive data and advice regarding executive compensation.

Executive Compensation Philosophy and Objectives

Compensation Philosophy. The objectives of our executive compensation policies are:

• to attract, retain and reward executive officers who contribute to our Company’s success;

• to align the financial interests of executive officers with the performance of our Company;

• to strengthen the relationship between executive pay and stockholder value;

• to motivate executive officers to achieve our Company’s business objectives; and

• to reward individual performance.

In general, the Committee considers, among other things, the following:

• The level of compensation paid to executive officers in companies similarly situated in size and products. To ensure that pay is competitive, the Compensation Committee, from time to time, compares our Company’s executive compensation packages with those offered by other companies in the same or similar industries. Compensation surveys used by our Company include the companies comprising the software and telecommunications industry;

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• The individual performance of each executive officer. Individual performance includes meeting performance objectives, demonstration of knowledge, skills and teamwork and acceptance of our Company core values;

• Corporate performance. Corporate performance is evaluated by factors such as performance relative to competitors, performance relative to business conditions and progress in meeting our Company’s objectives and goals; and

• The responsibility and authority of each position relative to other positions within our Company.

Base Salary

Base salaries are established for each executive officer at levels that are intended to be competitive with comparable positions at other software and telecommunications industry companies of similar size or products. Our Company seeks to pay salaries to executive officers that are commensurate with their qualifications, duties and responsibilities and that are competitive in the marketplace in order to retain the highly qualified personnel that we currently have and to be able to attract highly qualified personnel in the future. In conducting annual salary reviews, the Committee considers each individual executive officer’s achievements during the prior fiscal year in meeting financial and business objectives, as well as the executive officer’s performance of individual responsibilities and our Company’s financial position and overall performance.

Performance Bonus

Executives are generally eligible to receive a performance bonus payable in cash. Performance bonuses are used to provide executive officers with financial incentives to meet performance targets of our Company and individual performance objectives. At the beginning of each fiscal year, the Committee establishes a targeted bonus for each executive and establishes the individual performance objectives for the executive to achieve the bonus. These bonuses are targeted between 0 % and 50% of the executive officer’s base salary, for the applicable period. Before a bonus becomes payable, the predetermined objectives must have been achieved. Individual bonuses might increase if our Company exceeds its established objectives. The individual performance objectives for executives other than the Chief Executive Officer are proposed by management and reviewed and approved by the Committee. Individual performance objectives for the Chief Executive Officer are determined by the Committee and reviewed and approved by the Board of Directors (other than the Chief Executive Officer).

During 2007, the Committee approved incentive performance bonuses for certain executive officers. Such bonuses are intended as an incentive for the executive officers to meet performance targets of our Company and in recognition of the value of the contributions made by these executives during the past year and the overall performance of the Company during that time. The Company performance targets include specific revenue and operational cash flow thresholds that must be achieved before the bonuses will be earned. The Committee approved performance bonuses effective January 1, 2007 for the following executive officers: Mr. Tauscher, 50% of base salary and Messrs. Anderson, Clinebell, Pickett and Bailey, 40% of base salary. No executive officer incentive performance bonuses were paid in fiscal 2008.

Executive Personal Benefits

We believe that executives generally should not be treated differently than other employees when it comes to personal benefits and therefore, we have limited executive personal benefits. During 2008, these personal benefits for the Named Executive Officers (as defined below) were generally limited to life insurance coverage and matching contributions by the Company with respect to the Company-sponsored 401(k) Savings Plan.

Stock Option and Restricted Stock Awards

The Committee believes that equity ownership by executive officers provides incentives to build stockholder value and aligns the interests of executive officers with the stockholders. The Committee typically awards stock options subject to four-year vesting upon hiring an executive officer. After the initial grant, the Committee considers awarding additional options and restricted stock, usually on an annual basis. Option awards and restricted stock awards are generally granted at the market price for our common stock at the time of grant. In determining the size of stock option and restricted stock grants, the Committee considers the level and responsibility of the executive officer, the contribution that the executive officer is expected to make to our Company and comparable equity compensation offered by other software and telecommunications industry companies.

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Compensation Committee Interlocks and Insider Participation

Michael P. Downey served as our interim President and Chief Executive Officer from March 2000 until June 2000. Mr. Girard has never been an officer or employee of the Company or any of its subsidiaries. None of our executive officers is a director or member of the compensation committee (or other committee serving an equivalent function) of any other entity, whose executive officers served as a director or member of our board of directors.

Compensation Committee Report

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management, and based on the committee’s review and discussions with management, has recommended to the full Board of Directors that the Compensation Discussion and Analysis be included in our Annual Report on Form 10-K for the year end June 30, 2008.

The Compensation Committee

Michael P. Downey Francis E. Girard John W. Watkins

Summary Compensation Table

The following Summary Compensation Table contains information concerning annual and long-term compensation provided to each person who served as Company’s Chief Executive Officer during the fiscal year ended June 30, 2008, each person who served as principal financial officer during the fiscal year ended June 30, 2008 and each of the three next most highly compensated executive officers of the Company.

Name and Principal Position	Year	Salary ($)	Bonus ($)		Restricted Stock Awards ($) (6)	Option Awards ($) (6)	All Other Compensation ($) (7)	Total ($)
William Y Tauscher Chief Executive Officer (1)	2007	353,410	—		107,589	1,578,554	388	2,039,941
William Y Tauscher Chief Executive Officer (1)	2008	360,000	—		—	—	424	360,424
Richard N. Anderson Executive Vice President and General Manager (2)	2007	294,608	—		53,795	278,876	6,007	633,286
Richard N. Anderson Executive Vice President and General Manager (2)	2008	300,000	—		—	—	8,158	308,158
Kenneth M. Clinebell Chief Financial Officer (3)	2007	267,492	96,154	(8)	40,346	132,021	6,639	542,652
Kenneth M. Clinebell Chief Financial Officer (3)	2008	250,000	—		—	—	8,139	258,139
Scott K. Pickett Chief Technology Officer (4)	2007	245,569	—		40,346	346,323	4,164	636,402
Scott K. Pickett Chief Technology Officer (4)	2008	250,000	—		—	—	6,717	256,717
Peter H. Bailey Senior Vice President (5)	2007	233,549	—		40,346	346,323	5,702	625,920
Peter H. Bailey Senior Vice President (5)	2008	250,000	—		—	—	8,098	258,098

(1) Mr. Tauscher began serving as our Chief Executive Officer on September 28, 2004 and as our President on November 16, 2004.

(2) Mr. Anderson joined the Company as our Executive Vice President and General Manager in January 2005.

(3) Mr. Clinebell joined the Company as our Senior Vice President of Finance and Operations in September 2005 and was appointed Chief Financial Officer, Treasurer and Secretary in June 2006.

(3) Mr. Anderson joined the Company as our Executive Vice President and General Manager in January 2005.

(4) Mr. Pickett joined the Company as our Chief Technology Officer in September 2004.

(5) Mr. Bailey joined the Company in September 2004 as our Senior Vice President of Business Development and Product Management.

(6) Dollar values represent the compensation costs of restricted stock and options for financial reporting purposes for fiscal year 2007 under FAS 123(R), rather than an amount paid to or realized by the named executive officer. The FAS 123(R) value as of the grant date is spread over the number of months of service required for the grants to become non-forfeitable. There can be no assurance that the FAS 123(R) amounts will ever be realized by the named executive officers.

(7) All other compensation consists of life insurance premiums and matching contributions by the Company with respect to the Company-sponsored 401(k) Savings.

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(8) The bonus amounts paid to Mr. Clinebell in fiscal 2007 result from agreements entered into when the Company acquired the operations of Comdial Corporation in 2005, including amounts that would have been payable to Mr. Clinebell at the time of the acquisition under Comdial’s Key Employee Retention Plan.

Outstanding Equity Awards At Fiscal Year-End

The following table sets forth information relating to the outstanding equity awards held by our Named Executive Officers as of June 30, 2008.

	Option Awards				Restricted Stock Awards
Name	Number of Securities Underlying Unexercised Options (#) Exercisable	Number of Securities Underlying Unexercised Options (#) Unexercisable	Option Exercise Price ($)	Option Expiration Date (1)	Number of Shares That Have Not Vested (#)	Market Value of Shares That Have Not Vested ($) (2)
William Y Tauscher Chief Executive Officer	77,500 5,833 500,000 1,687,500 583,333	0 0 0 112,500 1,166,667	2.55 2.55 2.58 0.97 0.85	02/20/2014 02/20/2014 03/26/2014 09/28/2014 02/19/2017	1,750,000	140,000
Richard N. Anderson Executive Vice President and General Manager	364,167 105,417 291,667	95,833 124,583 583,333	1.81 0.48 0.85	04/13/2015 08/17/2016 02/19/2017	875,000	70,000
Kenneth M. Clinebell Chief Financial Officer	258,750 218,750	201,250 437,500	0.89 0.85	03/07/2016 02/19/2017	656,250	52,500
Peter H. Bailey Senior Vice President	431,250 218,750	28,750 437,500	0.97 0.85	09/28/2014 02/19/2017	656,250	52,500
Scott K. Pickett Chief Technology Officer	431,250 218,750	28,750 437,500	0.97 0.85	09/28/2014 02/19/2017	656,250	52,500

(1) All outstanding awards are pursuant to option grants with 10 year terms and vesting over four years.

(2) All outstanding awards are pursuant to restricted stock grants with cliff vesting after four years and one month. The market value of the unvested shares is determined by multiplying the number of shares by $0.08, the closing market price of our Common Stock at June 30, 2008.

Potential Payments Upon Termination or Change in Control

Richard N. Anderson. We have a severance agreement with Richard N. Anderson, Executive Vice President and General Manager, which provides that should Mr. Anderson’s employment be terminated by the Company, other than for cause as defined in the agreement, Mr. Anderson will be entitled to severance pay equal to six months of his annual base salary in effect at the time of the termination.

Kenneth M. Clinebell. We have an employment agreement with Kenneth M. Clinebell, Chief Financial Officer, Treasurer and Secretary, which is an annual agreement that can be renewed for additional consecutive periods of one year upon the consent of both Mr. Clinebell and the Company. The agreement specifies Mr. Clinebell’s annual base salary and bonus compensation and also provides that should Mr. Clinebell’s employment be terminated by the Company other than for cause as defined in the agreement or at the option of the executive, Mr. Clinebell will be entitled to severance pay equal to six months of the annual base salary plus bonus, as defined in the agreement. In the event of a termination of the agreement under a change of control, Mr. Clinebell will be eligible for severance pay equal to twelve months of the annual base salary in effect at the time of the change of control.

Peter H. Bailey. We have a severance agreement with Peter H. Bailey, Senior Vice President of Business Development and Product Management, which provides that should Mr. Bailey’s employment be terminated by the Company, other than for cause as defined in the agreement, Mr. Bailey will be entitled to severance pay equal to six months of his annual base salary in effect at the time of the termination.

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Scott K. Pickett. We have a severance agreement with Scott K. Pickett, Chief Technology Officer, which provides that should Mr. Pickett’s employment be terminated by the Company, other than for cause as defined in the agreement, Mr. Pickett will be entitled to severance pay equal to six months of his annual base salary in effect at the time of the termination.

Compensation of Directors

Effective January 1, 2007, certain directors of the Company receive annual retainers of up to $40,000 (previously $16,000) plus $1,000 per board meeting attended and $700 per committee meeting attended ($400 for telephonic board or committee meetings). Directors also receive reimbursement for reasonable out-of-pocket expenses in connection with travel to and attendance at board and committee meetings, and other corporate business. Directors are eligible to receive awards under our 2004 Stock Incentive Plan, however, the plan does not provide for the automatic grant of stock options to our non-employee directors. We expect that from time to time, at our discretion, we will grant equity awards to our non-employee directors under the 2004 Stock Incentive Plan under such terms consistent with the plan as we deem appropriate at the time of those grants. Directors who are employees of the Company do not receive compensation for service on the board or committees of the board other than their compensation as employees.

The following table sets forth amounts paid by the Company to directors in connection with their services to the Company in fiscal 2008.

Name	Fees Earned or Paid in Cash ($)	Option Awards ($) (6)	Total ($)
William Y. Tauscher (1)	—	—	—
Michael P. Downey (2)	49,200	24,535	73,735
Francis E. Girard (3)	49,200	24,535	73,735
John W. Watkins (4)	—	—	—
Matthew J. Rubins	—	—	—
R. Randy Stolworthy (5)	12,000	—	12,000
Jong Dae An	—	—	—

(1) Mr. Tauscher is an employee of the company and as such, receives no compensation as a director other than his employee compensation.

(2) Mr. Downey is an independent director and serves as Chairman of the Audit Committee and as a member of the Compensation Committee.

(3) Mr. Girard is an independent director and serves as Chairman of the Compensation Committee and as a member of the Audit Committee.

(4) Mr. Watkins serves as a member of the Compensation Committee.

(5) Mr. Stolworthy serves as a member of the Audit Committee.

(6) Dollar values represent the compensation costs of stock options for financial reporting purposes for fiscal year 2007 under FAS 123(R), rather than an amount paid to or realized by the named directors. The FAS 123(R) value as of the grant date for the stock option grants is spread over the number of months of service required for the grant to become non-forfeitable. There can be no assurance that the FAS 123(R) amounts will ever be realized by the named directors.

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

The following table sets forth information as of August 31, 2008, except as otherwise noted, with respect to the beneficial ownership of our Common Stock by:

• each person known to own beneficially more than five percent of our outstanding common stock;

• each of our directors;

• each Named Executive Officer; and

• all executive officers and directors as a group.

Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission (the “SEC”) and includes voting and investment power with respect to the securities. Unless otherwise indicated below and except to the extent authority is shared by spouses under applicable law, to our knowledge, the persons named in the table have sole voting and investment power with respect to all shares of Common Stock shown as beneficially owned by them. The number of shares of Common Stock used to calculate the percentage ownership of each listed person includes the shares of Common Stock underlying options, warrants and other convertible securities held by such persons that are exercisable within 60 days of August 31, 2008. Unless otherwise indicated, the address of each of our employees, officers and directors is c/o Vertical Communications, Inc., Ten Canal Park, Suite 602, Cambridge, Massachusetts 02141.

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	Shares Beneficially Owned
	Number		Percent (1)
Named Directors and Executive Officers
William Y. Tauscher	52,165,094	(2)	50.7	%
Richard N. Anderson	1,766,668	(3)	3.3	%
Kenneth M. Clinebell	1,226,771	(4)	2.3	%
Peter H. Bailey	8,834,365	(5)	14.6	%
Scott K. Pickett	2,360,780	(6)	4.4	%
Michael P. Downey	129,766	(7)	*
John W. Watkins	162,453,476	(8)	84.7	%
Francis E. Girard	75,999	(9)	*
Matthew J. Rubins	162,453,476	(10)	84.7	%
R. Randy Stolworthy	108,523,005	(11)	69.1	%
All directors and executive officers as a group (11 persons)	337,535,925		94.2	%
5% Stockholders
M/C Venture Partners 75 State Street, Suite 2500 Boston, MA 02109	162,453,476	(12)	84.7	%
LG-Nortel Co., Ltd. GS tower 679 Yoksam-dong Kangnam-gu, Seoul, Korea	74,396,227	(13)	58.7	%
Austin W. Marxe and David M. Greenhouse c/o Special Situations Funds 153 East 53rd Street New York, NY 10022	48,340,200	(14)	54.3	%
Pathfinder Ventures 21 East 6th Street, Suite 706 Tempe, AZ 85281	108,517,689	(15)	69.1	%

* Less than 1%

(1) The percentages reported in this column are based on 52,377,252 shares of common stock issued and outstanding as of August 31, 2008.

(2) Consists of 1,750,000 restricted shares of common stock subject to vesting contingencies, 3,000,000 shares of common stock issuable upon exercise of options exercisable within 60 days of August 31, 2008, 20,471,698 shares issuable upon exercise of warrants held, 943,396 shares issuable upon conversion of the Series E Preferred Stock and 26,000,000 shares issuable upon conversion of the Series F Preferred Stock.

(3) Consists of 875,000 restricted shares of common stock subject to vesting contingencies and 891,668 shares of common stock issuable upon exercise of options exercisable within 60 days of August 31, 2008.

(4) Consists of 656,250 restricted shares of common stock subject to vesting contingencies and 570,521 shares of common stock issuable upon exercise of options exercisable within 60 days of August 31, 2008.

(5) Consists of 656,250 restricted shares of common stock subject to vesting contingencies, 743,021 shares of common stock issuable upon exercise of options exercisable within 60 days of August 31, 2008, 3,471,698 shares issuable upon exercise of warrants held, 943,396 shares issuable upon conversion of the Series E Preferred Stock and 3,020,000 shares issuable upon conversion of the Series F Preferred Stock.

(6) Consists of 656,250 restricted shares of common stock subject to vesting contingencies, 743,021 shares of common stock issuable upon exercise of options exercisable within 60 days of August 31, 2008, 447,170 shares issuable upon exercise of warrants held, 94,340 shares issuable upon conversion of the Series E Preferred Stock and 420,000 shares issuable upon exercise of the Series F Preferred Stock.

(7) Consists of 55,600 shares of common stock owned by Mr. Downey and 74,166 shares issuable upon exercise of options exercisable within 60 days of August 31, 2008.

(8) Consists of: (a) 21,760,545 shares of common stock owned, 57,939,556 shares issuable upon exercise of warrants held, 7,330,860 shares issuable upon conversion of the Series D Preferred Stock, 17,805,660 shares issuable upon conversion of the

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Series E Preferred Stock and 48,500,000 shares issuable upon conversion of the Series F Preferred Stock owned by M/C Venture Partners V, L.P., of which Mr. Watkins is a Manager of M/C VP V, LLC, the sole general partner of M/C Venture Partners V, L.P., (b) 502,038 owned, 1,076,039 shares issuable upon exercise of warrants held, 137,243 shares issuable upon conversion of the Series D Preferred Stock, 332,075 shares issuable upon conversion of the Series E Preferred Stock and 900,000 shares issuable upon conversion of the Series F Preferred Stock owned by M/C Venture Investors, LLC, of which Mr. Watkins is a Manager, and (c) 792,046 shares of common stock owned, 2,366,843 shares issuable upon exercise of warrants held, 300,382 shares issuable upon conversion of the Series D Preferred Stock, 730,189 shares issuable upon conversion of the Series E Preferred Stock and 1,980,000 shares issuable upon conversion of the Series F Preferred Stock owned by Chestnut Venture Partners, L.P. of which, Mr. Watkins is a General Partner of Chestnut Street Partners, Inc., the General Partner of Chestnut Venture Partners, L.P.

(9) Consists of 9,333 shares of common stock owned by Mr. Girard and 66,666 shares of common stock issuable upon exercise of options exercisable within 60 days of August 31, 2008.

(10) Consists of: (a) 21,760,545 shares of common stock owned, 57,939,556 shares issuable upon exercise of warrants held, 7,330,860 shares issuable upon conversion of the Series D Preferred Stock, 17,805,660 shares issuable upon conversion of the Series E Preferred Stock and 48,500,000 shares issuable upon conversion of the Series F Preferred Stock owned by M/C Venture Partners V, L.P., of which Mr. Rubins is a Manager of M/C VP V, LLC, the sole general partner of M/C Venture Partners V, L.P., (b) 502,038 owned, 1,076,039 shares issuable upon exercise of warrants held, 137,243 shares issuable upon conversion of the Series D Preferred Stock, 332,075 shares issuable upon conversion of the Series E Preferred Stock and 900,000 shares issuable upon conversion of the Series F Preferred Stock owned by M/C Venture Investors, LLC, of which Mr. Rubins is a Manager, and (c) 792,046 shares of common stock owned, 2,366,843 shares issuable upon exercise of warrants held, 300,382 shares issuable upon conversion of the Series D Preferred Stock, 730,189 shares issuable upon conversion of the Series E Preferred Stock and 1,980,000 shares issuable upon conversion of the Series F Preferred Stock owned by Chestnut Venture Partners, L.P. of which, Mr. Rubins is a General Partner of Chestnut Street Partners, Inc., the General Partner of Chestnut Venture Partners, L.P.

(11) Consists of (a) 878,272 shares of common stock owned, 323,302 shares issuable upon exercise of warrants held, and 1,294,747 shares issuable upon conversion of the Series D Preferred Stock owned by Pathfinder Ventures III, L.L.C., of which Mr. Stolworthy is a co-manager of the managing member, (b) 2,922,500 shares of common stock owned and 1,400,000 shares issuable upon exercise of warrants held by Pathfinder Ventures II, L.L.C., of which Mr. Stolworthy is a co-manager of the managing member, (c) 20,000 shares of common stock owned by Pathfinder Ventures, LLC, of which Mr. Stolworthy is the managing member, (d) 13,679,245 shares issuable upon conversion of the Series E Preferred Stock, 41,160,000 shares issuable upon conversion of the Series F Stock and 46,839,623 shares issuable upon exercise of warrants held by Pathfinder Ventures IV, L.L.C., of which Mr. Stolworthy is a co-manager of the managing member, (e) 5,266 shares of common stock owned by Mr. Stolworthy, and (e) 50 shares of common stock owned by Mr. Stolworthy’s children.

(12) Consists of the shares described in footnote 8 above.

(13) Consists of 12,264,151 shares of common stock issuable upon conversion of the Series E Preferred Stock, 28,000,000 shares issuable upon conversion of the Series F Preferred Stock and 34,132,076 shares issuable upon exercise of warrants held.

(14) Consists of (a) 6,454,166 shares of common stock owned, 763,171 shares issuable upon exercise of warrants held, 188,679 shares issuable upon conversion of the Series E Preferred Stock and 440,000 shares issuable upon exercise of the Series F Preferred Stock owned by Special Situations Fund III, L.P.; (b) 2,049,228 shares of common stock owned, 3,004,255 shares issuable upon exercise of warrants held, 801,887 shares issuable upon conversion of the Series E Preferred Stock and 2,560,000 shares issuable upon conversion of the Series F Preferred Stock owned by Special Situations Cayman Fund, L.P.; (c) 2,000,303 shares of common stock owned, 2,964,802 shares issuable upon exercise of warrants held, 801,887 shares issuable upon conversion of the Series E Preferred Stock and 2,520,000 shares issuable upon conversion of the Series F Preferred Stock owned by Special Situations Private Equity Fund, L.P.; (d) 191,925 shares of common stock owned, 310,361 shares issuable upon exercise of warrants held, 94,340 shares issuable upon conversion of the Series E Preferred Stock and 260,000 shares issuable upon conversion of the Series F Preferred Stock owned by Special Situations Technology Fund, L.P; (e) 1,053,936 shares of common stock owned, 1,651,178 shares issuable upon exercise of warrants held, 471,698 shares issuable upon conversion of the Series E Preferred Stock owned and 1,400,000 shares issuable upon conversion of the Series F Preferred Stock by Special Situations Technology Fund II, L.P. and (f) 8,537,332 shares issuable upon exercise of warrants held, 2,358,491 shares issuable upon conversion of the Series E Preferred Stock and 7,460,000 shares issuable upon conversion of the Series F Preferred Stock owned by Special Situations Fund III, QP, L.P. MGP Advisors Limited is the general partner of Special Situations Fund III, L.P. AWM Investment Company, Inc. is the general partner of MGP Advisors Limited and the general partner of and investment adviser to the Special Situations Cayman Fund, L.P. SST Advisers, L.L.C. is the general partner of and investment adviser to the Special Situations Technology Fund, L.P. and the Special Situations Technology Fund II, L.P. MG Advisers, L.L.C. is the general partner of and investment adviser to the Special Situations Private Equity Fund, L.P. Austin W. Marxe and David M. Greenhouse are the principal owners of MGP Advisors Limited, SST Advisers, L.L.C., AWM Investment Company, Inc. and MG Advisers, L.L.C. and are principally responsible for the selection, acquisition and disposition of the portfolio securities by each investment adviser on behalf of its fund.

(15) Consists of (a) 878,272 shares of common stock owned, 323,302 shares issuable upon exercise of warrants held, and 1,294,747 shares issuable upon conversion of the Series D Preferred Stock owned by Pathfinder Ventures III, L.L.C., of which Mr. Stolworthy is a co-manager of the managing member, (b) 2,922,500 shares of common stock owned and 1,400,000 shares

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issuable upon exercise of warrants held by Pathfinder Ventures II, L.L.C., of which Mr. Stolworthy is a co-manager of the managing member, (c) 20,000 shares of common stock owned by Pathfinder Ventures, LLC, of which Mr. Stolworthy is the managing member and (d) 13,679,245 shares issuable upon conversion of the Series E Preferred Stock, 41,160,000 shares issuable upon conversion of the Series F Stock and 46,839,623 shares issuable upon exercise of warrants held by Pathfinder Ventures IV, L.L.C., of which Mr. Stolworthy is a co-manager of the managing member.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

2008 Equity Financing

During, March, April and May, 2008, the Company entered into a securities purchase agreement (the “SPA”) with certain investors pursuant to which the Company agreed to (1) the issuance and sale of subordinated convertible promissory notes (the “Notes”) and (2) upon conversion of the Notes, the issuance of a to-be-established series of the Company’s preferred stock (the “Series F Preferred Stock”) and warrants (the “Series F Warrants”) to purchase shares of the Company’s common stock.

Under the SPA, the Company received aggregate proceeds of $7,867,064 from the investors in exchange for the issuance and sale of the Notes. The Notes accrued interest at the rate of 15% annually.

On May 19, 2008, the Notes automatically converted into shares of Series F Preferred Stock. The Notes converted into Series F Preferred Stock at a rate of one share per $1,000 of outstanding principal and accrued interest of $168,708 (rounded to the nearest share).

The Company issued a total of 8,036 shares of Series F Preferred Stock.

The material terms of the Series F Preferred Stock are as follows:

1. With regard to the powers, designations, preferences and rights, the Series F Preferred Stock is substantially similar to the Series E Preferred Stock and ranks equally with respect to the payment of dividends, redemption and rights upon liquidation, dissolution or sale of the Company.

2. In connection with the automatic conversion of the Notes into Series F Preferred Stock, the Company issued warrants to purchase common shares at an exercise price of $0.01 per share. The number of shares for which the warrants are exercisable is calculated as the original principal amount of the Note divided by $0.05 (the conversion price of the Series F Preferred Stock into common stock).

The Series F Preferred Stock is convertible into 160,741,280 shares of Common Stock and the Series F Warrants are convertible into 157,341,280 shares of Common Stock.

A material relationship exists between certain of the Series F investors and the Company. Specifically, each of M/C Venture Partners V, L.P. and its affiliates, Special Situations Fund III, L.P. and its affiliates , Pathfinder Ventures IV, L.L.C. and its affiliates and William Y. Tauscher, the Company’s Chief Executive Officer, President and Chairman of the Board, own shares of the Company’s common stock. LG-Nortel Co., Ltd. is the primary supplier of the products sold in the Vodavi business. Additionally, Peter Bailey, through West Laurelhurst LLC, and Scott Pickett are Series F Investors and executive officers of the Company. Mr. Bailey is a Senior Vice President of the Company and Mr. Pickett is the Company’s Chief Technology Officer.

LG-Nortel Co. Ltd. Relationship

LG-Nortel Co. Ltd. (“LGN”) owns approximately 18% of the Company’s outstanding Series E and Series F Preferred Stock at June 30, 2008 and has a designated member on the Company’s board of directors. The Company purchased approximately $15.4 million of key telephone systems, commercial grade telephones, and voice mail products from LGN and an affiliate of LGN during fiscal 2008. The Company owed LGN and its affiliate a total of $3.6 million for product purchases at June 30, 2008. The Company’s payment terms with LGN and its affiliate are 90 days after shipment, except for shipments of single line telephones, which are 30 days after shipment. Current balances are non-interest bearing.

The Company conducts joint development activities with LGN for the design and development of hardware incorporated into some of the Company’s existing and planned telephone systems and commercial grade telephones. Generally, LGN contributes the ongoing research and development costs for the product hardware and produces the finished goods developed under the alliance, and the Company obtains the right to sell such products throughout North America and the Caribbean.

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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

Independent Auditors’ Fees

The following table summarizes the fees of Vitale Caturano & Company Ltd., our independent registered public accounting firm, billed to us for each of the last two fiscal years for audit services and billed to us in each of the last two fiscal years for other services:

Fee Category	2008		2007
Audit Fees(1)	$	242,488	$	291,910
Audit-Related Fees(2)	$	74,390	$	22,045
Total Fees	$	316,878	$	313,955

(1) Audit fees consist of fees for the audit of our financial statements, the review of the interim financial statements included in our quarterly reports on Form 10-Q, and other professional services provided in connection with statutory and regulatory filings or engagements.

(2) Audit-related fees consist of fees for assurance and related services that are reasonably related to the performance of the audit and the review of our financial statements and which are not reported under “Audit Fees”. These services relate to employee benefit audits, internal control reviews, attest services that are not required by statute or regulation and consultations concerning tax compliance, financial accounting and reporting standards.

None of the audit-related fees billed in 2008 or 2007 related to services provided under the de minimis exception to the audit committee pre-approval requirements.

Pre-Approval Policies and Procedures

The Audit Committee has adopted policies and procedures relating to the approval of all audit and non-audit services that are to be performed by the Company’s independent auditors. This policy generally provides that the Company will not engage its independent auditors to render audit or non-audit services unless the service is specifically approved in advance by the Audit Committee or the engagement is entered into pursuant to one of the pre-approval procedures described below.

From time to time, the Audit Committee may pre-approve specified types of services that are expected to be provided to the Company by its independent auditors during the next 12 months. Any such pre-approval is detailed as to the particular service or type of services to be provided and is also generally subject to a maximum dollar amount. All accounting work for the year ended June 30, 2008 was pre-approved by the audit committee in accordance with its stated pre-approval policies.

The Audit Committee has also delegated to the chairman of the Audit Committee the authority to approve any audit or non-audit services to be provided to the Company by its independent auditors. Any approval of services by a member of the Audit Committee pursuant to this delegated authority is reported on at the next meeting of the Audit Committee.

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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Financial Statements and Financial Statement Schedules

(1) Financial Statements are listed in the Index to Consolidated Financial Statements on page F-1 of this report.

(2) Financial Statement Schedules: All schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements and notes thereto.

(b) Exhibits

2.1	Agreement and Plan of Merger dated as of October 18, 2006, by and among Vertical Communications, Inc, Vertical Acquisition Sub Inc. and Vodavi Technology, Inc. (Incorporated by reference to Exhibit 2.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
3.1	Certificate of Incorporation of Vertical Communications, Inc., as amended (Incorporated by reference to Exhibit 2.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on September 10, 2003).
3.2	Bylaws of Vertical Communications, Inc. (Incorporated by reference to Exhibit 2.1 to Vertical Communication, Inc.’s Quarterly Report on Form 10-Q filed with the Commission on November 14, 2001).
3.3	Form of Proposed Amended and Restated Certificate of Incorporation of Vertical Communication, Inc. (Incorporated by reference to Annex C to Vertical Communication, Inc.’s Definitive Proxy Statement on Schedule 14A filed with the Commission on March 10, 2006).
3.4	Certificate of Powers, Designation, Preferences and Rights of the Series D Convertible Preferred Stock of Vertical Communications, Inc, dated, February 9, 2006 (Incorporated by reference to Exhibit 2.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on February 9, 2006).
3.5	Form of Certificate of Powers, Designations, Preferences and Rights of the Series E Convertible Preferred Stock of Vertical Communications, Inc. (Incorporated by reference to Exhibit 3.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
3.6	Certificate of Powers, Designations, Preferences and Rights of the Series E Convertible Preferred Stock of Vertical Communications, Inc. (Incorporated by reference to Exhibit 3.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on December 4, 2006).
3.7	Certificate of Powers, Designations, Preferences and Rights of the Series F Convertible Preferred Stock of Vertical Communications, Inc. (filed herewith).
4.1	Specimen Certificate representing shares of Artisoft, Inc.’s Common Stock, $0.01 par value per share (Incorporated by reference to Exhibit 99.4 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on September 10, 2003).
4.2	Registration Rights Agreement dated August 8, 2001 by and among Artisoft and the Investors set forth therein (Incorporated by reference to Exhibit 99.2 to Vertical Communication, Inc.’s Registration Statement on Form S-3 (File No. 333-71014) filed with the Commission on October 5, 2001).
4.2.1	Amendment No. 1 dated September 28, 2004 to Registration Rights Agreement originally dated August 8, 2001 by and among Artisoft and the Investors set forth therein (Incorporated by reference to Exhibit 4.2.1 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 13, 2005).
4.3	Form of Warrant issued to the Investors party to the agreements filed as Exhibit 10.12 hereto (Incorporated by reference to Exhibit 99.3 to Vertical Communication, Inc.’s Registration Statement on Form S-3 (File No. 333-71014) filed with the Commission on October 5, 2001).

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4.4	Registration Rights Agreement dated September 27, 2002 by and among Artisoft and the Investors set forth therein (Incorporated by reference to Exhibit 10.17 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 20, 2002).
4.5	Registration Rights Agreement dated September 10, 2003 by and among Artisoft and the Investors set forth therein (Incorporated by reference to Exhibit 99.15 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on September 10, 2003).
4.5.1	Amendment No. 1 dated September 28, 2005 to Registration Rights Agreement originally dated September 10, 2003 by and among Artisoft and the Investors set forth therein (Incorporated by reference to Exhibit 4.5.1 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 13, 2005).
4.6	Form of Warrant issued to the Investors party to the agreements filed as Exhibits 10.16 and 10.17 hereto (Incorporated by reference to Exhibit 99.16 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on September 10, 2003).
4.7	Form of Warrant to purchase shares of the Company’s Common Stock, dated September 28, 2005, issued by Artisoft, Inc. with schedule of warrant holders attached therein (Incorporated by reference to Exhibit 4.7 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 13, 2005).
4.8	Voting Agreement, dated September 28, 2005, by and among Artisoft, Inc. and the Investors set forth therein with schedule of stockholders to Voting Agreement attached therein (Incorporated by reference to Exhibit 4.8 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 13, 2005).
4.9	Form of Warrant to purchase shares of the Company’s Common Stock, dated as of February 9, 2006, issued by Artisoft, Inc. with schedule of warrant holders attached therein (Incorporated by reference to Exhibit 4.9 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 16, 2006).
4.10	Form of Amendment No. 1 to Voting Agreement, dated as of February 9, 2006, by and between Artisoft, Inc. and the Investors set forth therein with schedule of Investors attached therein (Incorporated by reference to Exhibit 4.10 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 16, 2006).
4.11	Voting Agreement, dated as of February 9, 2006, by and between Artisoft, Inc. and the Investors set forth therein with schedule of Investors attached therein (Incorporated by reference to Exhibit 4.11 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 16, 2006)..
4.12	Voting Agreement dated as of October 18, 2006 by and among Vertical Communications, Inc., LG-Nortel Co. Ltd and Vodavi Technology, Inc. (Incorporated by reference to Exhibit 4.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
4.13	Voting Agreement dated as of October 18, 2006 by and between Vertical Communications, Inc. and certain stockholders of Vodavi Technology, Inc. . (Incorporated by reference to Exhibit 4.2 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
4.14	Form of Tranche I Warrant to purchase shares of the Company’s Common Stock, to be issued by Vertical Communications, Inc. with schedule of warrant holders attached therein . (Incorporated by reference to Exhibit 4.3 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
4.15	Form of Tranche II Warrant to purchase shares of the Company’s Common Stock to be issued by Vertical Communications, Inc. with schedule of warrant holders attached therein . (Incorporated by reference to Exhibit 4.3 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006)..
4.16	Form of Warrant to purchase shares of the Company’s Common Stock, to be issued by Vertical Communications, Inc. to NEIPF, L.P. (Incorporated by reference to Exhibit 4.4 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006)..
4.17	Form of Additional Warrant to purchase shares of the Company’s Common Stock, to be issued by Vertical Communications, Inc. to NEIPF, L.P. (Incorporated by reference to Exhibit 4.7 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).

36

4.18	Form of Warrant to purchase shares of the Company’s Common Stock, to be issued by Vertical Communications, Inc. with schedule of warrant holders attached therein . (Incorporated by reference to Exhibit 4.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on March 18, 2008).
10.1	1994 Stock Incentive Plan . (Incorporated by reference to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on February 10, 1995)
10.2	OEM/Reseller Agreement, dated January 18, 2000, between Artisoft, Inc., and Toshiba America Information Systems, Inc. (Incorporated by reference to Exhibit 10.11 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 28, 2001).
10.3	Second Addendum to OEM/Reseller Agreement dated January 18, 2000 by and between Artisoft and the Telecommunication Systems Division of Toshiba America Information Systems, Inc. (Incorporated by reference to Exhibit 99.6 to Amendment No. 2 Vertical Communication, Inc.’s Registration Statement on Form S-3 (File No. 333-100756) filed with the Commission on February 10, 2003).
10.4	Patent License Agreement between Lucent Technologies GRL Corporation and Artisoft effective as of June 30, 2002 (Incorporated by reference to Exhibit 99.5 to Amendment No. 1 Vertical Communications, Inc.’s Registration Statement on Form S-3 (File No. 333-100756) filed with the Commission on December 20, 2002).
10.5	Agreement dated December 16, 2003 among Artisoft, Inc. and the Investors set forth therein (including the form of warrant) (Incorporated by reference to Exhibit 99.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on December 19, 2003).
10.7	Asset Purchase Agreement, dated as of September 23, 2004, between Artisoft, Inc. and Vertical Networks Incorporated (Incorporated by reference to Exhibit 2.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on September 29, 2004).
10.8	2004 Stock Incentive Plan, as amended (Incorporated by reference to Exhibit 21.1 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 13, 2004).
10.9	Stock Purchase Agreement dated September 28, 2004 among Artisoft and the Investors set forth therein Incorporated (Incorporated by reference to Exhibit 10.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 4, 2004).
10.9.1	Amendment No. 1 dated September 28, 2005 to Stock Purchase Agreement, originally dated September 28, 2004, by and among Artisoft, Inc. and the Investors set forth therein (Incorporated by reference to Exhibit 10.17.1 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 13, 2005).
10.10	Consent, Waiver and Amendment dated September 25, 2004 among Artisoft and the shareholders of Artisoft set forth therein (Incorporated by reference to Exhibit 10.2 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 4, 2004).
10.11	Sublease, dated January 7, 2000, by and between Vertical Networks, Inc. and MMC Networks, Inc. (Incorporated by reference to Exhibit 10.1 to Vertical Communication, Inc.’s Quarterly Report on Form 10-Q filed with the Commission on January 25, 2005).
10.12	Software Purchase Agreement, dated August 20, 2004 by and between Vertical Networks Inc. and CVS Pharmacy Inc. (Incorporated by reference to Exhibit 10.2 to Vertical Communication, Inc.’s Quarterly Report on Form 10-Q filed with the Commission on January 25, 2005).
10.13	Asset Purchase Agreement, dated as of September 1, 2005, between Comdial Corporation and Vertical Communications Acquisition Corp (Incorporated by reference to Exhibit 2.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on September 1, 2005).
10.14	Lease dated August 31, 2005, by and between Artisoft, Inc. and One Memorial Drive Sublease, LLC for One Memorial Drive, Cambridge, Massachusetts 02142 Corp (Incorporated by reference to Exhibit 10.22 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).

37

10.15	Lease dated June 6, 2005, by and between Artisoft, Inc. and SRI Mission Towers II LLC for Suite 400, 3979 Freedom Circle Drive, Santa Clara, California (Incorporated by reference to Exhibit 10.23 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.16	Secured Subordinated Promissory Note, dated September 28, 2005, issued by Artisoft, Inc. to Comdial Corporation therein (Incorporated by reference to Exhibit 10.24 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.17	Security Agreement, dated September 28, 2005, by and among Comdial Corporation, Artisoft, Inc. and Vertical Communications Acquisition Corp (Incorporated by reference to Exhibit 10.25 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.16	Stock Purchase Agreement, dated September 28, 2005, by and among Artisoft, Inc. and certain Investors set forth therein (Incorporated by reference to Exhibit 10.26 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.17	Consent, Waiver and Release Agreement, dated September 28, 2005, by and among the Artisoft, Inc. and the Investors set forth therein (Incorporated by reference to Exhibit 10.27 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.18	Loan and Security Agreement, dated September 28, 2005, by and between Artisoft, Inc. and Silicon Valley Bank (Incorporated by reference to Exhibit 10.28 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.18.1	Loan Modification Agreement, dated December 21, 2005 by and between Artisoft, Inc. and Silicon Valley Bank (Incorporated by reference to Exhibit 10.28.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on December 27, 2005).
10.19	Subordination Agreement, dated September 28, 2005, by and among Artisoft, Inc., Comdial Corporation and Silicon Valley Bank (Incorporated by reference to Exhibit 10.29 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.20	Intellectual Property Security Agreement, dated September 28, 2005, by and between Artisoft, Inc. and Silicon Valley Bank (Incorporated by reference to Exhibit 10.30 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.21	Form of Agreement dated September 28, 2005, by and between Artisoft, Inc. and certain holders of options to purchase shares of Artisoft, Inc.’s common stock with schedule of option holders (Incorporated by reference to Exhibit 10.31 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.22	Lease Agreement, dated September 28, 2005, by and between DMB Sarasota I, L.P., as Landlord and Vertical Communications Acquisition Corp., as Tenant for Fruitville Business Park, Sarasota, Florida (Incorporated by reference to Exhibit 10.32 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.23	Intellectual Property Security Agreement, dated September 28, 2005, by and between Vertical Communications Acquisition Corp. and Silicon Valley Bank (Incorporated by reference to Exhibit 10.25 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on September 1, 2005).
10.24	Securities Purchase Agreement, dated as of February 9, 2006, by and among Artisoft, Inc. and the Investors set forth therein (Incorporated by reference to Exhibit 10.34 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 16, 2006).
10.25	Consent and Waiver Agreement, dated as of February 9 2006, by and among Artisoft, Inc. and the stockholders set forth therein (Incorporated by reference to Exhibit 10.35 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 16, 2006).
10.26	Consent Agreement, dated as of February 9, 2006, by and between Artisoft, Inc. and Vertical Communications Acquisition Corp. and Silicon Valley Bank (Incorporated by reference to Exhibit 10.36 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 16, 2006).

38

10.27	Employment Agreement, dated June 20, 2006, between Vertical Communication, Inc and Kenneth Clinebell was filed as exhibit 10.33 on Vertical Communication, Inc.’s Current Report on Form 8-K dated June 23, 2006 and is incorporated herein by reference (Incorporated by reference to Exhibit 10.37 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 16, 2006).
10.28	Letter of Modification of Compensation Plan, dated June 20, 2006, from Vertical Communication, Inc to Dick Anderson (Incorporated by reference to Exhibit 10.34 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on June 23, 2006)
10.29	Letter of Modification of Compensation Plan, dated June 20, 2006, from Vertical Communication, Inc to Scott Pickett Anderson (Incorporated by reference to Exhibit 10.35 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on June 23, 2006).
10.30	Letter of Modification of Compensation Plan, dated June 20, 2006, from Vertical Communication, Inc to Peter Bailey Anderson (Incorporated by reference to Exhibit 10.36 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on June 23, 2006).
10.31	Settlement Agreement and Mutual Release dated as of May 24, 2006, by and between Consolidated IP Holdings, Inc., formerly known as Vertical Networks, Inc. and Vertical Communications, Inc. formerly known as Artisoft, Inc. (Incorporated by reference to Exhibit 10.41 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 16, 2006).
10.32	Patent License Agreement, dated as of May 24, 2006, by and between Vertical Communications, Inc. and Converged Data Solutions LLC (Incorporated by reference to Exhibit 10.42 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 16, 2006).
10.33	Memorandum of Understanding dated as of October 18, 2006 by and between Vertical Communications, Inc and LG-Nortel Co. Ltd. (Incorporated by reference to Exhibit 10.1 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
10.34	Securities Purchase Agreement dated as of October 18, 2006 by and between Vertical Communications, Inc. and certain investors (Incorporated by reference to Exhibit 10.2 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
10.35	Credit Agreement dated as of October 18, 2006, by and among Vertical Communications, Inc., Columbia Partners, L.L.C. Investment Management and NEIPF, L.P. (Incorporated by reference to Exhibit 10.3 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
10.36	Form of Senior Secured Promissory Note (Initial Bridge Note) issued by Vertical Communications, Inc. to NEIPF, L.P. as filed (Incorporated by reference to Exhibit 10.4 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
10.37	Security Agreement dated as of October 18, 2006, by and among Vertical Communications, Inc., Vertical Communications Acquisition Corp., Columbia Partners, L.L.C. Investment Management, and NEIPF, L.P. (Incorporated by reference to Exhibit 10.5 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
10.38	Intellectual Property Security Agreement dated as of October 18, 2006, by and among Vertical Communications, Inc., Vertical Communications Acquisition Corp., Columbia Partners, L.L.C. Investment Management, and NEIPF, L.P. (Incorporated by reference to Exhibit 10.6 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
10.39	Pledge Agreement dated as of October 18, 2006, by and among Vertical Communications, Inc., Columbia Partners, L.L.C. Investment Management, and NEIPF, L.P. (Incorporated by reference to Exhibit 10.7 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on October 19, 2006).
10.40	Form of Funding Commitment Letter dated October 12, 2006 (Incorporated by reference to Exhibit 11.1 to Vertical Communication, Inc.’s Quarterly Report on Form 10-Q filed with the Commission on November 14, 2006).

39

10.41	Form of Senior Secured Promissory Note (Term Note) issued by Vertical Communications, Inc. to NEIPF, L.P. (Incorporated by reference to Exhibit 10.9 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on December 4, 2006).
10.42	Joinder Agreement dated December 1, 2006 by and between Vodavi Technology, Inc. and NEIPF, L.P. (Incorporated by reference to Exhibit 10.10 to Vertical Communication, Inc.’s Current Report on Form 8-K filed with the Commission on December 4, 2006).
10.43	Loan and Security Agreement, dated May 25, 2007, by and between Vertical Communications, Inc., Vertical Communications Acquisition Corp., Vodavi Technology, Inc. and Vodavi Communications Systems, Inc. and Silicon Valley Bank (Incorporated by reference to Exhibit 10.44 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 15, 2007).
10.44	Joinder Agreement dated May 25, 2007, by and between Vodavi Communications Systems, Inc., Columbia Partners, L.L.C. Investment Management and NEIPF, L.P. (Incorporated by reference to Exhibit 10.45 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 15, 2007).
10.45	Subordination and Intercreditor Agreement, dated May 25, 2007 by and between NEIPF, L.P., Columbia Partners, L.L.C. Investment Management and Silicon Valley Bank (Incorporated by reference to Exhibit 10.46 to Vertical Communication, Inc.’s Annual Report on Form 10-K filed with the Commission on October 15, 2007).
10.46	Loan Modification Agreement, dated October 15, 2007 by and between Vertical Communications Inc., Vertical Communications Acquisition Corp., Vodavi Technology, Inc. and Vodavi Communications Systems, Inc. and Silicon Valley Bank (filed herewith).
10.47	Amendment to Credit Agreement dated as of October 15, 2007, by and among Vertical Communications, Inc., Columbia Partners, L.L.C. Investment Management and NEIPF, L.P. (filed herewith).
10.48	Securities Purchase Agreement dated as of March 17, 2008, by and among the Vertical Communications, Inc. and certain investors (Incorporated by reference to Exhibit 10.1 to Vertical Communications, Inc.’s Current Report on Form 8-K filed with the Commission on March 18, 2008).
10.49	Consent and Waiver Agreement, dated as of March 17, 2008 by and among Vertical Communications, Inc. and the stockholders set forth therein (Incorporated by reference to Exhibit 10.2 to Vertical Communications, Inc.’s Current Report on Form 8-K filed with the Commission on March 18, 2008).
10.50	Form of Subordinated Promissory Note issued by Vertical Communications, Inc. to certain investors (Incorporated by reference to Exhibit 10.3 to Vertical Communications, Inc.’s Current Report on Form 8-K filed with the Commission on March 18, 2008).
10.52	Second Loan Modification Agreement, dated March 17, 2008 by and between Vertical Communications Inc., Vertical Communications Acquisition Corp., Vodavi Technology, Inc. and Vodavi Communications Systems, Inc. and Silicon Valley Bank (Incorporated by reference to Exhibit 10.5 to Vertical Communications, Inc.’s Current Report on Form 8-K filed with the Commission on March 18, 2008).
10.53	Second Amendment to Credit Agreement dated as of March 17, 2008 by and among Vertical Communications, Inc., Columbia Partners, L.L.C. Investment Management and NEIPF, L.P. (Incorporated by reference to Exhibit 10.4 to Vertical Communications, Inc.’s Current Report on Form 8-K filed with the Commission on March 18, 2008).
10.54	Joinder Agreement, dated as of April 16, 2008 by and between Vertical Communications, Inc. and certain investors (Incorporated by reference to Exhibit 10.1 to Vertical Communications, Inc.’s Current Report on Form 8-K filed with the Commission on May 2, 2008).
10.55	Consent and Waiver Agreement, dated as of April 16, 2008 by and between Vertical Communications, Inc. and the Additional Investors (Incorporated by reference to Exhibit 10.1 to Vertical Communications, Inc.’s Current Report on Form 8-K filed with the Commission on May 2, 2008).

40

21.1	Subsidiaries of Vertical Communications.
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934
32.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

+ Confidential materials omitted and filed separately with the Commission.

41

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

Date: October 9, 2008

Vertical Communications, Inc
By:	/s/ William Y. Tauscher
	William Y. Tauscher
	Chairman and Chief Executive Officer

Pursuant to the requirements of the Securities Act of 1933, as amended, this report statement has been signed by the following persons in the capacities indicated and on the dates indicated.

Signature	Title	Date
/S/ WILLIAM Y. TAUSCHER	Chairman, President and Chief Executive Officer (Principal Executive Officer)	October 9, 2008
WILLIAM Y. TAUSCHER
/S/ Kenneth M. Clinebell	Chief Financial Officer (Principal Financial and Accounting Officer)	October 9, 2008
Kenneth M. Clinebell
/S/ Michael P. Downey	Director	October 9, 2008
Michael P. Downey
/S/ John W. Watkins	Director	October 9, 2008
John W. Watkins
/S/ FRANCIS E. GIRARD	Director	October 9, 2008
FRANCIS E. GIRARD
/S/ MATTHEW J. RUBINS	Director	October 9, 2008
MATTHEW J. RUBINS
/S/ JONG DAE AN	Director	October 9, 2008
JONG DAE AN
/S/ R. RANDY STOLWORTHY	Director	October 9, 2008
R. RANDY STOLWORTHY

42

VERTICAL COMMUNICATIONS, INC.

Index to Consolidated Financial Statements

	Page Reference Form 10-K
Report of Independent Registered Public Accounting Firm – Vitale Caturano & Company, Ltd.	44
Consolidated Balance Sheets as of June 30, 2008 and 2007	45
Consolidated Statements of Operations for the years ended June 30, 2008, 2007 and 2006	46
Consolidated Statements of Convertible Redeemable Preferred Stock, Shareholders’ Equity and Comprehensive Loss for the years ended June 30, 2008, 2007 and 2006	47
Consolidated Statements of Cash Flows for the years ended June 30, 2008, 2007 and 2006	49
Notes to Consolidated Financial Statements	51

43

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of

Vertical Communications, Inc.

We have audited the accompanying consolidated balance sheets of Vertical Communications, Inc. as of June 30, 2008 and 2007 and the related statements of operations, convertible redeemable preferred stock, shareholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended June 30, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal controls over financial reporting. Our audits included consideration of internal controls over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal controls over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Vertical Communications, Inc. as of June 30, 2008 and 2007 and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 2008 in conformity with accounting principles generally accepted in the United States of America.

VITALE, CATURANO & COMPANY, LTD.

October 8, 2008

Boston, Massachusetts

44

VERTICAL COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

	June 30, 2008			June 30, 2007
ASSETS
Current assets:
Cash and cash equivalents	$	3,695		$	8,019
Trade receivables, net of allowances of $237 and $354, respectively		12,081			13,678
Inventories, net		13,893			12,818
Prepaid expenses		1,396			1,745
Deferred costs		4,105			4,437
Total current assets		35,170			40,697
Property and equipment		8,368			6,848
Less accumulated depreciation and amortization		(5,971	)		(4,603	)
Net property and equipment		2,397			2,245
Goodwill		35,363			40,336
Intangible assets, net of accumulated amortization		13,452			16,265
Deferred costs, net of current portion		—			3,291
Other assets		309			471
Total assets	$	86,691		$	103,305
LIABILITIES, CONVERTIBLE REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,920		$	6,238
Accrued liabilities		10,665			10,049
Trade accounts payable to a stockholder		3,551			2,419
Deferred revenue		9,854			10,294
Customer deposits		175			175
Current portion of long term debt		5,772			6,681
Total current liabilities		34,937			35,856
Deferred revenue, net of current portion		71			6,043
Deferred tax liability		2,264			5,761
Long term debt, net of current portion		17,734			16,014
Total liabilities		55,006			63,674
Series D convertible, redeemable preferred stock, $1.00 par value, 5,000 shares authorized, 4,291 issued and outstanding at June 30, 2008 and 5,000 issued and outstanding at June 30, 2007. (liquidation preference of $5,860 including dividends)		2,894			1,238
Series E convertible, redeemable preferred stock, $1.00 par value, 33,000 shares authorized, 27,400 shares issued and outstanding at June 30, 2008 and 2007. (liquidation preference of $31,739 including dividends)		6			—
Series F convertible, redeemable preferred stock, $1.00 par value, 8,500 shares authorized, 8,036 shares issued and outstanding at June 30, 2008. (liquidation preference of $8,175 including dividends)		5,353			—
Shareholders’ equity:
Preferred stock, $1.00 par value, authorized 30,000,000 shares		—			—
Common stock, $.01 par value per share. Authorized 750,000,000 shares; 52,377,272 issued and outstanding shares at June 30, 2008 and 52,084,483 at June 30, 2007		524			521
Accumulated other comprehensive loss		(65	)		(52	)
Additional paid-in capital		143,365			129,793
Accumulated deficit		(119,966	)		(91,429	)
Deferred Toshiba equity cost		(426	)		(440	)
Total shareholders’ equity		23,432			38,393
Total Liabilities, Convertible Redeemable Preferred Stock and Shareholders’ Equity	$	86,691		$	103,305

45

VERTICAL COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

	Years Ended June 30,
	2008			2007			2006
Net revenue	$	72,594		$	79,148		$	55,535
Cost of goods sold		38,799			42,362			25,632
Gross profit		33,795			36,786			29,903
Operating expenses:
Sales and marketing		19,292			16,668			16,962
Product development		15,985			13,618			11,552
General and administrative		14,307			15,857			16,182
Amortization of intangible assets		2,437			1,900			1,094
Total operating expenses		52,021			48,043			45,790
Loss from operations		(18,226	)		(11,257	)		(15,887	)
Interest expense, net		(9,376	)		(4,841	)		(690	)
Gain on settlement of litigation		—			—			1,200
Other income, net		97			428			4
Loss before provision for income taxes		(27,505	)		(15,670	)		(15,373	)
Provision for income taxes		1,032			349			626
Net loss		(28,537	)		(16,019	)		(15,999	)
Series D preferred stock accretion and dividends		(1,886	)		(854	)		(324	)
Series E preferred stock accretion and dividends		(6	)		—			—
Series F preferred stock accretion and dividends		(139	)		—			—
Net loss applicable to common shareholders	$	(30,568	)	$	(16,873	)	$	(16,323	)
Net loss applicable to common shareholders per share—basic and diluted	$	(0.58	)	$	(0.35	)	$	(0.38	)
Weighted average common shares outstanding—basic and diluted		52,333			48,813			43,311

46

VERTICAL COMMUNICATIONS, INC. AND SUBSIDIARIES

STATEMENT OF CONVERTIBLE REDEEMABLE PREFERRED STOCK, SHAREHOLDERS’ EQUITY & COMPREHENSIVE LOSS

(in thousands, except share and per share amounts)

	Preferred Stock D					Preferred Stock E				Preferred Stock F			Common Stock
	Shares		$1 Par Value per Share			Shares	$1 Par Value per Share			Shares	$1 Par Value per Share		Shares		$.01 Par Value per Share
Balance at June 30, 2005	—		$	—		—	$	—		—	$	—	36,612,765		$	366
Common stock issued	—			—		—		—		—		—	11,329,785			113
Exercise of common stock options	—			—		—		—		—		—	83,178			1
Exercise of common stock Warrants	—			—		—		—		—		—	1,207,973			12
Retirement of treasury Stock	—			—		—		—		—		—	(2,216,783	)		(22	)
Issuance of Series D preferred stock and warrants, net of expenses	5,000			3,890		—		—		—		—	—			—
Beneficial conversion feature attributable to Series D preferred stock	—			(659	)	—		—		—		—	—			—
Series D dividends & accretion	—			324		—		—		—		—	—			—
Amortization of deferred Toshiba equity costs	—			—		—		—		—		—	—			—
Reclass of deferred Compensation	—			—		—		—		—		—	—			—
Foreign currency translation adjustment	—			—		—		—		—		—	—			—
Stock-based compensation	—			—				—		—		—	—			—
Net Loss	—			—		—		—		—		—	—			—
Comprehensive Loss	—			—		—		—		—		—	—			—
Balance at June 30, 2006	5,000		$	3,555			$			—	$	—	47,016,918		$	470
Exercise of common stock warrants	—			—		—		—		—		—	473,815			5
Issuance of restricted stock	—			—		—		—		—		—	4,593,750			46
Issuance of Series D anti-dilution warrants	—			(363	)	—		—		—		—	—			—
Beneficial conversion feature attributable to Series D anti-dilution	—			(2,807	)	—		—		—		—	—			—
Series D dividends and Accretion	—			854		—		—		—		—	—			—
Issuance of Series E preferred stock & warrants, net of costs	—			—		27,400		15,564		—		—	—			—
Beneficial conversion feature attributable to Series E preferred stock	—			—		—		(15,564	)	—		—	—			—
Issuance of Columbia warrant
Amortization of deferred Toshiba equity costs	—			—		—		—		—		—	—			—
Foreign currency translation adjustment	—			—		—		—		—		—	—			—
Stock-based compensation	—			—		—		—		—		—	—			—
Net Loss	—			—		—		—		—		—	—			—
Comprehensive Loss	—			—		—		—		—			—			—
Balance at June 30, 2007	5,000		$	1,238		27,400	$	—		—	$	—	52,084,483		$	521
Exercise of common stock options	—			—		—		—		—		—	78,968			1
Issuance of Series D anti-dilution warrants	—			(61	)	—		—		—		—	—			—
Conversion of Series D shares	(79	)		(169	)	—		—		—		—	213,821			2
Series D dividends and accretion	—			1,886		—		—		—		—	—			—
Series E transaction costs	—			—		—		—		—		—	—			—
Series E dividends and accretion	—			—		—		6		—		—	—			—
Issuance of Series F preferred stock & warrants, net of costs	—			—		—		—		8,036		5,214	—			—
Series F dividends & accretion	—			—		—		—		—		139	—			—
Amortization of deferred Toshiba equity costs	—			—		—		—		—		—	—			—
Foreign currency translation adjustment	—			—		—		—		—		—	—			—
Stock-based compensation	—			—		—		—		—		—	—			—
Net Loss	—			—		—		—		—		—	—			—
Comprehensive Loss	—			—		—		—		—			—			—
Balance at June 30, 2008	4,921		$	2,894		27,400	$	6		8,036	$	5,353	52,377,272		$	524

47

VERTICAL COMMUNICATIONS, INC. AND SUBSIDIARIES

STATEMENT OF CONVERTIBLE REDEEMABLE PREFERRED STOCK, SHAREHOLDERS’ EQUITY & COMPREHENSIVE LOSS

(in thousands, except share and per share amounts)

	Accumulated Other Comprehensive Income			Additional Paid in Capital			Accumulated Deficit			Deferred Compensation			Deferred Toshiba Equity Costs			Treasury Stock			Net Stockholders’ Equity			Comprehensive Loss
Balance at June 30, 2005	$	4		$	151,842		$	(59,411	)	$	(8,243	)	$	(644	)	$	(69,680	)	$	14,234
Common stock issued		—			12,658			—			—			—			—			12,771		—
Exercise of common stock options		—			99			—			—			—			—			100		—
Exercise of common stock warrants		—			1,363			—			—			—			—			1,375		—
Retirement of treasury stock		—			(69,658	)		—			—			—			69,680			—		—
Issuance of Series D preferred stock and warrants, net of expenses		—			951			—			—			—			—			951		—
Beneficial conversion feature attributable to Series D preferred stock		—			659			—			—			—			—			659		—
Series D dividends and accretion		—			(324	)		—			—			—			—			(324	)	—
Amortization of deferred Toshiba equity costs		—			—			—			—			134			—			134		—
Reclass of deferred compensation		—			(8,243	)		—			8,243			—			—			—		—
Foreign currency translation adjustment		(19	)		—			—			—			—			—			(19	)	(19	)
Stock-based compensation		—			4,042			—			—			—			—			4,042		—
Net Loss		—			—			(15,999	)		—			—			—			(15,999	)	(15,999	)
Comprehensive Loss		—			—			—			—			—			—			—		(16,018	)
Balance at June 30, 2006	$	(15	)	$	93,389		$	(75,410	)	$	—		$	(510	)	$	—		$	17,924
Exercise of common stock warrants		—			—			—			—			—			—			5		—
Issuance of restricted stock		—			238			—			—			—			—			284		—
Issuance of Series D anti-dilution warrant		—			363			—			—			—			—			363		—
Beneficial conversion feature attributable to Series D anti-dilution		—			2,807			—			—			—			—			2,807		—
Series D dividends and accretion		—			(854	)		—			—			—			—			(854	)	—
Issuance of Series E preferred stock & warrants, net of costs		—			11,401			—			—			—			—			11,401		—
Beneficial conversion feature attributable to Series E preferred stock		—			15,564			—			—			—			—			15,564		—
Issuance of Columbia warrant		—			2,114			—			—			—			—			2,114
Amortization of deferred Toshiba equity costs		—			—			—			—			70			—			70		—
Foreign currency translation adjustment		(37	)		—			—			—			—			—			(37	)	(37	)
Stock-based compensation		—			4,771			—			—			—			—			4,771		—
Net Loss		—			—			(16,019	)		—			—			—			(16,019	)	(16,019	)
Comprehensive Loss		—			—			—			—			—			—			—		(16,056	)
Balance at June 30, 2007	$	(52	)	$	129,793		$	(91,429	)	$	—		$	(440	)	$	—		$	38,393
Exercise of common stock options		—			60			—			—			—			—			61		—
Issuance of Series D anti-dilution warrants		—			61			—			—			—			—			61
Conversion of Series D shares		—			167			—			—			—			—			169
Series D dividends and accretion		—			(1,886	)		—			—			—			—			(1,886	)
Series E transaction costs		—			(42	)		—			—			—			—			(42	)
Series E dividends and accretion		—			(6	)		—			—			—			—			(6	)
Issuance of Series F preferred stock & warrants, net of costs		—			9,098			—			—			—			—			9,098
Series F dividends & accretion		—			(139	)		—			—			—			—			(139	)
Amortization of deferred Toshiba equity costs		—			—			—			—			14			—			14
Foreign currency translation adjustment		(13	)		—			—			—			—			—			(13	)	(13	)
Stock-based compensation		—			6,259			—			—			—			—			6,259
Net Loss		—			—			(28,537	)		—			—			—			(28,537	)	(28,537	)
Comprehensive Loss		—			—			—			—			—			—			—		(28,550	)
Balance at June 30, 2008	$	(65	)	$	143,365		$	(119,966	)	$	—		$	(426	)	$	—		$	23,432

48

VERTICAL COMMUNICATIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Years Ended June 30,
	2008			2007			2006
Cash flows from operating activities:
Net loss	$	(28,537	)	$	(16,019	)	$	(15,999	)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization		4,201			3,722			2,920
Amortization of deferred Toshiba equity costs		14			70			134
Non-cash interest		6,770			2,431			—
Non-cash compensation		6,259			5,055			4,042
Deferred tax provision		1,032			349			626
Non-cash changes in accounts receivable allowances		176			69			(101	)
Changes in assets and liabilities:
Trade receivables		1,471			(517	)		(1,364	)
Inventories		(1,075	)		(76	)		155
Prepaid expenses		349			3,429			232
Deferred costs		3,623			3,169			(916	)
Other assets		(170	)		(140	)		18
Accounts payable		(186	)		(2,723	)		(384	)
Accrued liabilities		2,691			(1,466	)		2,397
Deferred revenue		(6,412	)		(6,267	)		2,180
Net cash used in operating activities		(9,794	)		(8,914	)		(6,060	)
Cash flows from investing activities:
Cash used for acquisitions, net of cash acquired		—			(24,665	)		(19,249	)
Purchases of property and equipment		(1,520	)		(428	)		(964	)
Increase (decrease) in restricted cash		—			389			(95	)
Net cash used in investing activities		(1,520	)		(24,704	)		(20,308	)
Cash flows from financing activities:
Payment of capital lease obligations		(13	)		(22	)		(16	)
(Payment of)/proceeds from SVB term note		—			(2,000	)		2,000
Payment of Comdial note		—			(2,575	)		—
Net change in SVB revolver facility		(899	)		135			6,534
Proceeds from issuance of Columbia debt, net of issuance costs		—			14,440			—
Proceeds from issuance of common stock, net of issuance costs		61			5			12,871
Proceeds from issuance of preferred stock and warrants, net of issuance costs		—			26,965			4,841
Proceeds from issuance of convertible notes payable		7,854			—			—
Net cash provided by financing activities		7,003			36,948			26,230
Effect of foreign currency exchange rates		(13	)		(37	)		(16	)
Net increase (decrease) increase in cash and cash equivalents		(4,324	)		3,293			(154	)
Cash and cash equivalents at beginning of period		8,019			4,726			4,880
Cash and cash equivalents at end of period	$	3,695		$	8,019		$	4,726
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest	$	687		$	920		$	501
Cash paid for taxes	$	—		$	—		$	—
Conversion of preferred stock to common	$	169		$	—		$	—
Conversion of notes payable and accrued interest into Series F preferred stock	$	8,036		$	—		$	—
Non cash dividend and accretion on preferred stock	$	2,031		$	854		$	324

49

On September 28, 2005 the Company acquired the assets of Comdial Corporation and on December 1, 2006 the Company acquired the assets of Vodavi Technology, Inc. as follows (see Note 3):

	Vodavi			Comdial
Accounts receivable		2,721			3,158
Inventory		6,671			4,540
Other current assets		2,319			2,248
Property and equipment		1,058			1,285
Other assets		12			150
Intangible assets		11,950			4,300
Goodwill		9,475			9,190
Cash used in acquisitions, net of cash acquired		(24,665	)		(19,249	)
		14,514			5,622
Note payable to Comdial Corporation		—			(2,500	)
Liabilities assumed	$	9,541		$	3,122

50

VERTICAL COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization

Vertical Communications, Inc. (formerly Artisoft, Inc) (the “Company”, “we”, “our”, “us” or the “Registrant”), develops, markets and sells business phone systems, software, hardware and associated services. We sell our products through distributors, resellers and system integrators such as AT&T, Fujitsu, IBM, and Graybar, and we engage in alliances with those parties and other technology vendors to assist us in selling and marketing our products. Most of our end user customers rely upon resellers or systems integrators to implement our products, and these resellers and systems integrators can significantly influence our customers’ purchasing decisions. We market and sell our products in the United States, Europe and Latin America. We also have distributor relationships in Africa, Asia, Australia and the Middle East.

Acquisition of Vertical Networks Inc.

On September 28, 2004, we completed the acquisition of substantially all of the assets, other than patents and patent rights, of Vertical Networks Inc. (“Vertical Networks”), pursuant to the terms of an asset purchase agreement entered into on September 23, 2004. Vertical Networks was a leading provider of distributed IP-PBX software and communications solutions to large enterprises. We also received a patent license for the use of all of Vertical Networks’ patents and patent applications other than Vertical Networks’ rights under specified patents that do not relate to the business we purchased. In addition, we assumed specific liabilities of Vertical Networks. The operational results of this acquisition have been included in all periods since September 28, 2004, the date that the acquisition was consummated.

Acquisition of the Assets of Comdial Corporation

On September 28, 2005, pursuant to approval of the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”), we, through our subsidiary Vertical Communications Acquisitions Corporation acquired certain assets and assumed certain liabilities of Comdial Corporation (“Comdial” and the “Comdial Acquisition”). Comdial was a manufacturer and distributor of telephone systems targeted to small to midsize businesses, branch or regional offices of large organizations, national retailers, government agencies, and education campuses. The operational results of this acquisition have been included in all periods since September 28, 2005, the date that the Comdial Acquisition was consummated.

Acquisition of Vodavi Technology, Inc.

On December 1, 2006, we completed the acquisition of all of the outstanding securities of Vodavi Technology, Inc. (“Vodavi”) pursuant to an Agreement and Plan of Merger dated as of October 18, 2006 (the “Merger Agreement”), by and among the Company, Vodavi and Vertical Acquisition Sub Inc., a Delaware corporation and wholly-owned subsidiary of the Company (“MergerSub”). MergerSub was merged with and into Vodavi with Vodavi continuing its corporate existence as a wholly-owned subsidiary of the Company. Vodavi was a provider of traditional and next-generation business telecommunications solutions, targeted to small and medium-sized business, primarily in the United States. The aggregate consideration paid by the Company to the stockholders of Vodavi was approximately $31.1 million in cash. In addition, the Company incurred approximately $0.5 million in transaction costs related to the merger. The operational results of this acquisition are included in all periods since December 1, 2006, the date that the merger was consummated.

2. Summary of Significant Accounting Policies

Consolidation - The consolidated financial statements include the accounts of Vertical and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Asset Valuation - Asset valuation includes assessing the recorded value of certain assets, including accounts and notes receivable, inventories, goodwill and other intangible assets. We use a variety of factors to assess valuation, depending upon the asset. Accounts and notes receivable are evaluated based upon the credit-worthiness of our customers, our historical experience, and the age of the receivable. The recoverability of inventories is based upon the types and levels of inventory held, forecasted demand, and pricing. Should current market and economic conditions deteriorate, our actual recovery could be less than our estimate. Our intangible assets, are evaluated using established valuation models based upon the expected period the asset will be utilized, forecasted cash flows, changes in technology and customer demand. Our goodwill resulting from our acquisitions of Vertical Networks, Comdial and Vodavi is evaluated annually to determine if impairment has occurred since the acquisitions.

Use of Estimates - The Company’s preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities during the reported periods. Actual results could differ from those estimates.

51

Cash Equivalents - The Company considers all highly liquid securities with original maturities of three months or less to be cash equivalents.

Concentrations - For the years ended June 30, 2008, 2007 and 2006, sales to Graybar accounted for 16%, 16% and 12%, respectively, of total net revenues. At June 30, 2008 and 2007 one customer accounted for approximately 16% and 26%, respectively, of the Company’s outstanding gross trade receivables. The loss of any of the major systems integrators, distributors, resellers or OEMs, or their failure to pay the Company for products purchased from the Company, could have an adverse effect on the Company’s operating results.

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash deposits in bank accounts. Deposits in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) of $100,000 are exposed to loss in the event of nonperformance by the institution. The Company has had cash deposits in excess of the FDIC insurance coverage.

Related Party Transactions - LG-Nortel Co. Ltd. (LGN) owns approximately 18% of the Company’s outstanding Series E and Series F Preferred Stock at June 30, 2008 and owned approximately 24% of the Company’s outstanding Series E Preferred Stock at June 30, 2007 and has a designated member on the Company’s board of directors. The Company purchased approximately $15.4 million and $7.2 million of key telephone systems, commercial grade telephones, and voice mail products from LGN and an affiliate of LGN during fiscal 2008 and 2007, respectively. The Company owed LGN and its affiliate a total of $3.6 million and $2.4 million for product purchases at June 30, 2008 and 2007, respectively. The Company’s payment terms with LGN and its affiliate are 90 days after shipment, except for shipments of single line telephones, which are 30 days after shipment. Current balances are non-interest bearing.

The Company conducts joint development activities with LGN for the design and development of hardware incorporated into some of the Company’s existing and planned telephone systems and commercial grade telephones. Generally, LGN contributes the ongoing research and development costs for the product hardware and produces the finished goods developed under the alliance, and the Company obtains the right to sell such products throughout North America and the Caribbean.

Accounts Receivable - Accounts receivable are recorded at the invoiced amount. Credit is granted to customers without requiring collateral. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. Management regularly analyzes accounts receivable including current aging, historical write-off experience, customer concentrations, customer creditworthiness, and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Bad debts are written off against the allowance when identified. If the assumptions that are used to determine the allowance for doubtful accounts change, the Company may have to provide for a greater level of expense in the future periods or reverse amounts provided in prior periods.

The Company’s allowance for doubtful accounts activity, for the fiscal years ended June 30, 2008, 2007 and 2006 was as follows (in thousands):

	Balance at Beginning of Year	Acquired With Vodavi (2007) and Comdial (2006)	Additions	Usage/ Adjustments		Balance at End of Year
Allowance for Doubtful Accounts:
Year Ended June 30, 2008	354	—	39	(156	)	237
Year Ended June 20, 2007	322	144	69	(181	)	354
Year Ended June 30, 2006	423	128	136	(365	)	322

Inventories - We measure our inventories at lower of cost or market on a first in, first out (FIFO) basis. We also provide allowances for excess and obsolete inventory equal to the difference between the cost of our inventory and the estimated market value based upon assumptions about product life cycles, product demand and market conditions. If actual product life cycles, product demand or market conditions are less favorable than those projected by management, additional inventory allowances or write-downs may be required.

Property and Equipment - Property and equipment are stated at cost less accumulated depreciation and amortization. Expenditures that materially increase values or capacities or extend useful lives of property and equipment are capitalized. Routine maintenance, repairs, and renewal costs are expensed as incurred. Gains or losses from the sale or retirement of property and equipment are recorded in current operations and the related book value of the property is removed from property and equipment accounts and the related accumulated depreciation and amortization accounts.

52

Estimated useful lives are generally two to seven years. Depreciation and amortization are calculated over the estimated useful lives of the respective assets using the straight-line method. Leasehold improvement amortization is computed using the straight-line method over the shorter of the lease term or the estimated useful life of the related assets.

Other Assets - Other assets are stated at cost and principally consist of deferred financing costs related to our debt.

Goodwill - Goodwill represents the cost in excess of the estimated fair values of assets and liabilities acquired. Under Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, goodwill is subject to at least an annual assessment for impairment by applying a fair value-based test. The Company’s goodwill arose from the acquisitions of Vertical Networks, Comdial and Vodavi and is tested annually for potential impairment. Although the Vertical Networks, Comdial and Vodavi goodwill was deemed to not be impaired when it was tested in fiscal year 2008, there can be no assurances that subsequent reviews will not result in material impairment charges. A considerable amount of judgment is required in calculating this impairment analysis, principally in determining discount rates, financial forecasts and allocation methodology. Unanticipated changes in market conditions could have a material impact on our projected cash flows. Differences in actual cash flows as compared to the projected discounted cash flows could require the Company to record an impairment loss.

Intangible Assets - The value of intangible assets we acquired as part of the acquisitions of Vertical Networks, Comdial and Vodavi was based upon the fair value of those assets on the acquisition date and are being amortized on a straight line basis over their estimated useful lives ranging from one to ten years. Three amortizable intangible assets were identified—existing technology, existing customer relationships and trade names and trademarks.

Impairment of Long-Lived Assets - Long-lived assets, such as property, equipment, and finite-lived intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset or asset group to estimated future undiscounted net cash flows of the related asset or group of assets over their remaining lives. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment charge is recognized for the amount by which the carrying amount exceeds the estimated fair value of the asset. Impairment of long-lived assets is assessed at the lowest levels for which there are identifiable cash flows that are independent of other groups of assets. The impairment of long-lived assets requires judgments and estimates. If circumstances change, such estimates could also change.

Income Taxes - The Company has not recognized any current income tax expense in any period presented due to the Company’s net losses. However, in fiscal years 2008, 2007 and 2006, the Company recorded a deferred tax provision and corresponding liability arising from the timing differences associated with amortizing goodwill for income tax purposes over a 15 year life.

Foreign Currency Translation - The functional currency of the Company’s foreign operations (Germany) is the local currency. As a result, assets and liabilities are translated at period-end exchange rates and revenues and expenses are translated at the average exchange rates. Adjustments resulting from translation of such financial statements are classified in accumulated other comprehensive loss. Foreign currency gains and losses arising from transactions denominated in currencies other than the functional currency were included in operations in each year presented but were not significant.

Comprehensive Income - SFAS No. 130 Reporting Comprehensive Income requires the reporting of comprehensive income in addition to net income from operations. Comprehensive income is a more inclusive reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. To date, the Company’s comprehensive income items include net loss and foreign translation adjustments. Comprehensive income has been included in the Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Loss for all periods.

Warranty Costs - The Company accrues for warranty costs based on estimated warranty return rates and estimated costs to repair. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty returns, and repair cost. The Company reviews the adequacy of its recorded warranty accrual on a quarterly basis.

The Company’s warranty reserve activity for the fiscal years ended June 30, 2008, 2007 and 2006 was as follows (in thousands):

	Balance at Beginning of Year	Acquired With Vodavi (2007) and Comdial (2006)	Additions / Reductions		Adjustments		Balance at End of Year
Warranty reserves:
Year Ended June 30, 2008	693	—	(119	)	—		574
Year Ended June 20, 2007	738	89	68		(202	)	693
Year Ended June 30, 2006	109	585	62		(18	)	738

53

Revenue Recognition - The Company recognizes revenue for the sale of its Wave, InstantOffice and TeleVantage products pursuant to Statement of Position (“SOP”) 97-2, Software Revenue Recognition, and SOP 98-9, Software Revenue Recognition With Respect to Certain Transactions. For revenue generated by the sale of Comdial and Vodavi products, where the Company has determined that the software is incidental, the Company follows Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition. Generally, the Company recognizes revenue when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when persuasive evidence of an arrangement exists, the product has been shipped or the services have been provided to the customer, the sales price is fixed or determinable and collectability is reasonably assured. The Company reduces revenue for estimated customer returns, rotations and sales rebates when such amounts are estimable. When not estimable, the Company defers revenue until the product is sold to the end customer or the customer’s rights expire. As part of its Televantage product sales price, the Company provides telephone support, which is generally utilized by the customer shortly after the sale. The cost of the phone support is not significant but is accrued in the financial statement. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue.

The Company defers revenue on shipments to Toshiba until the product is resold by Toshiba to its customers. The deferral of revenue is due to the Company’s inability to reasonably estimate potential future stock rotations resulting from future product releases and their effect on future revenue as Toshiba purchases the TeleVantage software and license keys in bulk amounts and maintains an inventory for future sales to customers. For all other TeleVantage license sales, assuming that all other revenue recognition criteria have been met, revenue is recognized at the time of delivery of the software to the customer.

Revenue from delivered elements of one-time charge licensed software is recognized at the inception of the license term using the residual method, provided we have vendor-specific objective evidence (“VSOE”) of the fair value of each undelivered element. Revenue is deferred for the fair value of the undelivered elements based upon the price of these elements when sold separately. Revenue is also deferred for the entire arrangement if VSOE does not exist for each undelivered contract element. Examples of undelivered elements in which the timing of delivery is uncertain include contractual elements that give customers rights to any future upgrades at no additional charge or future maintenance that is provided within the overall price. The revenue that is deferred for any contract element is recognized when all of the revenue recognition criteria have been met for that element. Revenue for annual software subscriptions is recognized ratably over the length of the software subscription. Certain contracts for the sale of telephone systems acquired with Vertical Networks in September 2004 were determined to be bundled with software subscriptions with lengths of up to five years from the date of acquisition. The revenue and cost of sales of the systems under these contracts have been deferred and will be amortized ratably over the length of the associated software subscription, as the Company does not have VSOE for these subscription agreements.

Revenue from time and material service contracts is recognized as the services are provided. Revenue from fixed price, long-term service or development contracts is recognized over the contract term, using a proportional performance model, based on the percentage of services that are provided during the period compared with the total estimated services to be provided over the entire contract. Losses on fixed price contracts are recognized during the period in which the loss first becomes apparent. Revenue from this type of service contracts was immaterial for each of the years ended June 30, 2008, 2007 and 2006.

Advertising - The Company expenses advertising costs as incurred. Advertising expenses for the years ended June 30, 2008, 2007 and 2006 were $278,000, $250,000 and $83,000 respectively.

Research and Product Development Costs - All costs associated with internal engineering and product development activities are expensed as incurred. Development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. After technological feasibility is established and until the products are available for sale, software development costs are capitalized and amortized over the greater of the amount computed using: (a) the ratio that current gross revenue for the product bears to the total of current and anticipated future gross revenue for that product or (b) the straight line method over the estimated economic life of the product including the period being reported on. The amortization period has been determined as the life of the product, which is generally two years. The amortization of capitalized development costs was $0 in 2008, $0 in 2007 and $37,000 in 2006.

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Computation of Net Loss Per Share - Net loss per share-basic is based upon the weighted average number of common shares outstanding. Net loss per diluted share is based upon the weighted average number of common and common equivalent shares outstanding assuming dilution. Common equivalent shares, consisting of the common shares underlying outstanding stock options, warrants and convertible preferred stock are included in the per share calculations where the effect of their inclusion would be dilutive.

A reconciliation of basic weighted average common shares with weighted average shares assuming dilution is as follows (in thousands):

	Year Ended June 30
	2008	2007	2006
Weighted average shares, excluding shares in Treasury—basic	52,333	48,813	43,311
Net effect of dilutive potential common shares outstanding based on the treasury stock method using the average market price	—	—	—
Weighted average common shares assuming dilution	52,333	48,813	43,311
Anti-dilutive potential common shares excluded from the computation above	433,405	108,768	10,251

Stock Based Compensation

On July 1, 2005, the Company adopted the provisions of FASB Statement No. 123 (revised 2004) Accounting for Stock-Based Compensation (SFAS No. 123R) and elected to use the modified prospective transition method as permitted under SFAS 123R. Under SFAS 123R, compensation cost recognized includes compensation cost for all share-based payments, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. In computing stock based compensation, we apply an estimated forfeiture rate based on actual forfeitures in our recent history. The fair value of options granted was calculated using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Year ended June
	2008	2007	2006
Expected Dividend Yield	0%	0%	0%
Volatility Factor	117 to 135%	117 to 120%	113 to 115%
Risk free Interest Rate	2.67 to 4.41%	4.87 to 4.95%	3.95% to 5.03%
Expected Life (years)	6.0	6.0	6.0

The risk-free interest rate is based upon the U. S. Treasury securities yield. The term of the options grant is derived from historical data. The expected volatility is based upon the historical volatility of the Company’s common stock over the expected life of the option. The Company recognizes expense using the straight-line attribution method for both pre- and post-adoption grants. The amount of option expense recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company currently expects, based on analysis of its historical forfeitures, a forfeiture rate of approximately 3%.

On October 20, 1994, the Company’s shareholders approved the Company’s 1994 Stock Incentive Plan (the “1994 Plan”). The 1994 Plan provides for the grant of Incentive Stock Options, Nonqualified Stock Options, Stock Appreciation Rights (Tandem and Free-standing), Restricted Stock, Deferred Stock, Performance Units and Performance Shares to officers, key employees, non-employee directors and certain consultants of the Company. This Plan was replaced by the 2004 Stock Incentive Plan (the “2004 Plan”) that was approved by the Company’s shareholders on March 15, 2004. At June 30, 2008, the maximum number of shares that can be granted under the 2004 Plan is 80,000,000.

On March 29, 2005, the SEC issued SAB 107 which expresses the view of the SEC regarding the interaction between SFAS No. 123R and certain SEC rules and regulations concerning the valuation of share-based payment arrangements for public companies. In particular, SAB 107 provides guidance related to share-based payment transactions with non-employees, the transition from nonpublic to public entity status, valuation methods (including assumptions such as expected volatility and expected term), the

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accounting for certain redeemable financial instrument issues under shares-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS No. 123R in an interim period, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to adoption of SFAS No. 123R, and disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS No. 123R. The Company has accounted for its stock option grants in compliance with SAB 107.

Segmentation of Financial Results - The Company’s primary operating decision makers evaluate the Company’s financial performance using consolidated financial information. Accordingly, the Company presents its financial results as a single segment related to the sale of its telecommunication solutions.

Fair Value of Financial Instruments - The carrying amounts of cash and cash equivalents, trade receivables, accounts payable, notes payable and accrued liabilities approximate fair value because of the short maturity of these instruments.

3. Acquisitions

Vertical Networks, Inc.

On September 28, 2004, we acquired substantially all of the assets, other than patents and patent rights and most of the liabilities, of Vertical Networks. Vertical Networks was a leading provider of distributed IP-PBX software and communications solutions to large enterprises. We also received a patent license for the use of all of Vertical Networks’ patents and patent applications other than Vertical Networks’ rights under specified patents that do not relate to the business we purchased. In addition, we assumed specific liabilities of Vertical Networks.

The purchase price for Vertical Networks consisted of: $12.5 million in cash, paid at closing, with an additional $1.0 million held in escrow to secure Vertical Networks’ indemnification obligations to us, $1.0 million in transaction costs, the assumption of most liabilities of Vertical Networks and an earnout provision of up to $5.5 million. The earnout obligation is equal to the first $5.5 million of non-refundable software license revenues collected by us from CVS Pharmacy, Inc. (“CVS”) in connection with a specific contract which provided CVS with software to be used in connection with, among other things, a rapid prescription refill project that CVS is implementing. In May, 2006 we entered into a settlement agreement with Consolidated IP Holdings, Inc. formerly known as Vertical Networks, Inc. (“CIPH”) which, among other provisions, reduced the maximum earnout to $4.3 million. We have accrued $2.8 million of the earn-out provision to date which has been included in the purchase price table below. The balance of the potential earn-out, $1.8 million has been excluded. As of June 30, 2006, we released the entire balance of the escrow to Vertical Networks which is included in the purchase price table below. The remaining contingent payments will be recorded as a component of the purchase price if and when the related contingencies are resolved.

The following table represents the allocation of the purchase price for our acquisition of Vertical Networks over the fair value of the assets acquired and liabilities assumed at the date of acquisition (in millions):

	Fair Values
Cash	$	0.3
Accounts receivable net		3.8
Inventory, net		1.3
Other current assets		0.3
Property and equipment		0.4
Other Assets		0.1
Intangible assets		4.3
Goodwill		16.7
Accounts payable		(4.8	)
Accrued expenses		(2.3	)
Other current liabilities		(0.3	)
Deferred revenue		(2.6	)
Total Purchase Price	$	17.2

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The values of current assets and liabilities were based upon their historical costs in the hands of the seller, Vertical Networks, on the date of acquisition due to their short-term nature. Property and equipment was also estimated based upon its historical cost as there was no appreciated real estate and the historical costs of the office equipment, furniture and machinery closely approximated fair value. The estimated value of deferred revenue was based upon the guidance in EITF 01-03, Accounting in a Business Combination for Deferred Revenue of an Acquiree, and was calculated as the estimated cost for us to fulfill the contractual obligations acquired under various customer contracts plus a fair value profit margin. Of the seller’s recorded deferred revenue of $6.6 million, we determined that only $2.6 million met the standard set by EITF 01-03 as representing assumed legal obligations; the balance of the deferred revenue, representing mostly customer payments with no remaining obligations, was not recorded by us. The excess purchase price was allocated to goodwill based upon the following factors: the value acquired in the form of additional scale and economies of scale resulting from the size of the combined entity, and the value of the assembled workforce, especially the engineering and sales talent personnel who have continued as part of the acquired operation. The benefits of added scale and the economics resulting therefrom was a primary reason for the acquisition, along with the talents of the acquired personnel and the ability to leverage existing, owned technology over the acquired products.

The following are the identifiable intangible assets acquired and the respective periods over which the assets will be amortized on a straight-line basis (in millions):

	Amount		Life (In Years)
Customer relationships	$	3.5	5
Existing technology		0.8	5
	$	4.3

The amounts assigned to identifiable intangible assets acquired was based on their respective fair values determined as of the acquisition date. The excess of the purchase price over the tangible and identifiable intangible assets was recorded as goodwill and amounted to approximately $16.7 million.

Comdial Corporation

On September 28, 2005, we completed the acquisition of substantially all of the assets of Comdial (the “Comdial Assets”) from Comdial, pursuant to the terms of an asset purchase agreement entered into on September 1, 2005.

The Comdial Assets include all of Comdial’s intellectual property, fixed assets, equipment, inventories, accounts receivable, rights under contracts and leases, cash and other current assets.

In exchange for the acquired assets, we (i) delivered $14.5 million in cash, (ii) executed an 8% secured promissory note in the aggregate principal amount of $2.5 million to Comdial which matured on the first anniversary of the closing date, (iii) repaid $1.7 million of debtor-in-possession financing incurred to fund operations of Comdial prior to the closing, (iv) repaid an amended and restated note dated May 25, 2005, issued by Comdial to Dialcom Acquisition, LLC, in the principal amount of $1.9 million and (v) paid $0.4 million and assumed $0.2 million of Comdial’s remaining obligations under a key employee retention plan with Comdial’s employees, as approved by an order of the Bankruptcy Court. In addition, we incurred approximately $0.8 million in transaction costs related to the acquisition.

We also assumed certain liabilities of Comdial such as post petition ordinary course trade payables outstanding as of the acquisition date, certain employee related obligations, and certain customer related obligations and liabilities related to certain assumed executory contracts. In addition, we assumed pre-petition and post petition obligations under remaining unfulfilled purchase orders outstanding as of the closing date. The amount of the liabilities and purchase obligations we assumed as of September 28, 2005 was approximately $8.9 million, which included $6.0 million in open purchase order obligations that have been excluded from the table below.

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The following table represents the allocation of the purchase price for our acquisition of Comdial over the fair value of the assets acquired and liabilities assumed at the date of acquisition (in millions):

	Fair Values
Cash	$	0.2
Accounts Receivable, net		3.2
Inventory, net		4.5
Other Current Assets		2.2
Property and Equipment		1.3
Intangible assets		4.3
Goodwill		9.2
Accounts Payable		(0.2	)
Accrued Expenses		(1.0	)
Other Current Liabilities		(1.7	)
Net assets acquired	$	22.0

The values of current assets and liabilities were based upon their historical costs on the date of acquisition due to their short-term nature. Property and equipment was also valued based upon its historical cost as there was no appreciated real estate and the historical costs of the office equipment, furniture and machinery most closely approximated fair value.

The following are the identifiable intangible assets acquired and the respective periods over which the assets will be amortized on a straight-line basis (in millions):

	Amount		Life (In Years)
Trade names/Trademarks	$	0.2	1
Customer relationships		3.3	10
Existing technology		0.8	5
	$	4.3

The amounts assigned to identifiable intangible assets acquired was based on their respective fair values determined as of the acquisition date. The excess of the purchase price over the tangible and identifiable intangible assets was recorded as goodwill and amounted to approximately $9.2 million.

Vodavi Technology, Inc.

On December 1, 2006, we completed the acquisition of all of the outstanding securities of Vodavi pursuant to the Merger Agreement by and among the Company, Vodavi and MergerSub wherein MergerSub was merged with and into Vodavi, with Vodavi continuing its corporate existence as a wholly-owned subsidiary of the Company.

Pursuant to the Merger Agreement, each issued and outstanding share of common stock of Vodavi was converted into the right to receive $7.50 in cash, without interest, on the terms specified in the Merger Agreement. Immediately prior to the effective time of the Merger, all outstanding options to purchase shares of Vodavi capital stock, whether vested or not vested, were exercised pursuant to a cashless exercise procedure and all equity incentive plans administered by Vodavi were terminated. The aggregate consideration paid by the Company to the stockholders of Vodavi was approximately $31.1 million in cash. In addition, the Company incurred approximately $0.5 million in transaction costs related to the merger.

The Company obtained the Merger Consideration (a) through the sale of 27,400 shares of its newly designated Series E convertible preferred stock, par value $1.00 per share, at a purchase price of $1,000 per share to certain investors pursuant to a Securities Purchase Agreement, as amended and restated (the “Series E Securities Purchase Agreement”), and (b) by entering into a Credit Agreement (the “Credit Agreement”) dated as of October 18, 2006, by and among the Company, Vertical Communications Acquisition Corp., a Delaware corporation (“VCAC”), Columbia Partners, L.L.C. Investment Management (“Investment Manager”), and NEIPF, L.P. (“Lender”), pursuant to which the Company issued (i) a senior secured promissory note payable to Lender in the principal amount of $10.0 million; and (ii) a senior secured promissory note payable to Lender in the principal amount of $15.0 million.

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The following table represents the estimated allocation of the purchase price for our acquisition of Vodavi over the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition (in millions).

	Fair Values
Cash	$	6.9
Accounts Receivable, net		2.8
Inventory, net		6.6
Other Current Assets		2.3
Property and Equipment		1.1
Intangible Assets		12.0
Goodwill		9.4
Total assets acquired		41.1
Accounts Payable		(6.5	)
Accrued Expenses		(3.1	)
Total liabilities assumed		(9.6	)
Total purchase price	$	31.5

The estimated values of current assets, excluding inventory, and liabilities were based upon their historical costs on the date of acquisition due to their short-term nature. Inventory was valued at estimated selling prices less the sum of (i) the cost of disposal and (ii) a reasonable profit allowance for the selling effort. Property and equipment was also estimated based upon its historical cost as there was no appreciated real estate and the historical costs of the office equipment, furniture and machinery most closely approximated fair value. The identified intangible assets were valued at their fair value as of the acquisition date. The residual purchase price was recorded as goodwill.

The following are the identifiable intangible assets acquired and the respective periods over which the assets will be amortized on a straight-line basis (in millions):

	AMOUNT		LIFE (In Years)
Trade names/Trademarks	$	0.7	4
Customer relationships		10.5	9
Customer relationships - other		0.6	8
Existing technology		0.2	4
	$	12.0

The amounts assigned to identifiable intangible assets acquired was based on their respective fair values determined as of the acquisition date using a discounted cash flow analysis and relief from royalty methodology. The excess of the purchase price over the tangible and identifiable intangible assets was recorded as goodwill and amounted to approximately $9.4 million.

4. Inventories

Inventories, net, at June 30, 2008 and 2007 consist of the following (in thousands):

	June 30,
	2008		2007
Raw Materials	$	838	$	465
Finished Goods		13,055		12,353
	$	13,893	$	12,818

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5. Property and Equipment

Property and equipment at June 30, 2008 and 2007 consist of the following (in thousands):

	June 30,
	2008			2007
Furniture and Fixtures	$	995		$	936
Computers, software and other equipment		6,007			5,553
Leasehold improvements		1,366			359
		8,368			6,848
Accumulated depreciation and amortization		(5,971	)		(4,603	)
	$	2,397		$	2,245

Depreciation and amortization expense for the years ended June 30, 2008, 2007 and 2006 was approximately $1.3 million, $1.5 million and $1.5 million, respectively.

6. Intangible Assets

Intangible assets related to the acquisitions of Vertical Networks, Comdial and Vodavi as of June 30, 2008 and 2007 consisted of the following (in thousands):

	June 30, 2008			June 30, 2007			Life in Years
Acquired technology-Vertical Networks	$	800		$	800		5
Acquired customers relationships-Vertical Networks		3,500			3,500		5
Trade names/trademarks-Comdial		200			200		1
Acquired customer relationships-Comdial		3,300			3,300		10
Acquired technology- Comdial		800			800		5
Trade names-Vodavi		690			690		4
Customer relationships-Vodavi		10,440			10,440		9
Customer relationships, other-Vodavi		600			600		8
Existing technology-Vodavi		220			220		4
		20,550			20,550
Accumulated amortization		(7,098	)		(4,285	)
	$	13,452		$	16,265

Amortization expense for the years ended June 30, 2008, 2007 and 2006 was approximately $2.8 million, $2.3 million and $1.4 million respectively, of which $372,000, $352,000 and $287,000, respectively, was included in cost of sales. The estimated aggregate amortization expense for the fiscal years ending June 30, 2009, 2010, 2011, 2012 and 2013 is $2.8 million, $2.2 million, $1.7 million, $1.7 million and $1.6 million, respectively.

7. Accrued Liabilities

Accrued liabilities at June 30, 2008 and 2007 consist of the following (in thousands):

	June 30,
	2008		2007
Compensation and benefits	$	2,586	$	2,446
Payroll, sales, property and other taxes		260		235
Marketing and sales incentives		837		868
Professional fees		228		426
Interest		78		110
Warranty		574		693
Earn-out obligation		257		257
Royalties		1,476		813
Registration settlement fees		2,550		2,550
Other		1,819		1,651
	$	10,665	$	10,049

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8. Debt

Debt Related to Comdial Acquisition

We financed a portion of the purchase price for the Comdial assets (the “2005 Debt Financing”) by entering into a loan agreement with Silicon Valley Bank (“SVB”) on September 28, 2005 (the “SVB Loan Agreement”). The SVB Loan Agreement terms provided the Company with a revolving line of credit in an amount not to exceed $7.0 million (the “Revolving Loan”), as well as a $2.0 million term loan (the “Term Loan”). The Revolving Loan initially matured on September 27, 2006. On September 27, 2006, the Company entered into a Third Loan Modification Agreement with SVB under which the maturity date of the Revolving Loan was extended from September 27, 2006 to October 31, 2006. The Term Loan was payable in monthly principal installments of $133,333 plus interest, due beginning July 31, 2006 through and until the maturity date of September 26, 2007.

On September 28, 2005, the Company also executed a secured promissory note in the aggregate principal amount of $2.5 million (the “Comdial Note”). The Comdial Note was issued to the Comdial bankruptcy estate (the “Comdial Estate”) in connection with the acquisition of the Comdial assets. The Comdial Note was subject to interest at the rate of 8% per annum and initially matured on the first anniversary of the closing date. On September 28, 2006, the Company and the Comdial Estate entered into an agreement which extended the maturity date of the Comdial Note from September 28, 2006 to November 1, 2006.

On October 18, 2006, the Company issued a Senior Secured Promissory Note to NEIPF, L.P. (see “Debt Related to Vodavi Acquisition” below for additional detail). The Company used proceeds from this loan to extinguish all of the then outstanding loans with SVB and the Comdial Estate.

Debt Related to Vodavi Acquisition

On October 18, 2006, the Company entered into a Credit Agreement with Columbia Partners, LLC Investment Management (“Columbia”) and NEIPF, L.P. (“Lender”) in which the Company agreed to (a) issue a senior secured promissory note payable to Lender (the “Initial Bridge Note”) in the amount of $10.0 million, (b) issue a senior secured promissory note payable to Lender (the “Term Note” and, together with the Initial Bridge Note, the “Loans”) in the principal amount of $15.0 million; and (c) upon the issuance of the Initial Bridge Note, issue to Lender a warrant to purchase 4,500,000 shares of the Company’s common stock at an exercise price equal to $0.01 per share (the “Lender Warrant”).

The Loans are secured by substantially all of the assets of the Company including specifically all rights in the outstanding shares of capital stock of VCAC held by the Company and certain intellectual property owned by the Company.

The Initial Bridge Note was issued on October 18, 2006 in the amount of $10.0 million and bore interest at the rate of 14% per annum. The net proceeds from the Initial Bridge Note, after payment of costs of approximately $0.2 million, were utilized to retire all of the debt owed to SVB and the Comdial Estate with the remainder to supplement working capital. The Company allocated the Initial Bridge Note proceeds between the debt and the warrant based upon their relative fair values as of the issuance date, resulting in $2.1 million being allocated to the warrants. The fair value of the warrants was determined using the Black-Scholes option pricing model with the following assumptions: no dividend yield; weighted average risk free rate of 4.42%; volatility of 115% and a contractual life of 7 years. The proceeds attributable to the warrant were recorded as a discount on the debt which will be accreted, with the deferred issuance costs and cash interest, over the term of the Initial Bridge Note using the effective interest method. On May 25, 2007, the Company entered into a Loan and Security Agreement with Silicon Valley Bank (see below). At this time, the Company satisfied all amounts owed under the Initial Bridge Note and this note was extinguished. The Company fully accreted the debt discount and fully amortized the deferred issuance costs in conjunction with the repayment of the Initial Bridge Note.

The Term Note was issued on December 1, 2006 in the amount of $15.0 million. A portion of the interest equal to .05% of the outstanding principal amount is payable quarterly in arrears. The Company is also obligated to pay the Lender a premium equal to the amount required to provide the Lender with a rate of return of 13.5% per annum upon any payment or prepayment of any amount of the Term Note. This premium is subject to increase to 15.5% for any period in which an event of default, as defined in the agreement, occurs and continues. The principal amount of the Term Note and any unpaid interest, including the payment premium, is payable in full on October 17, 2009. Cash interest, the premium and deferred issuance costs of $0.3 million will be accreted over the life of term note using the effective interest method.

The Credit Agreement initially contained certain financial covenants related to minimum revenue, minimum EBITDA and cash availability. On October 15, 2007, the Company entered into an amendment to the Credit Agreement effective as of September 30, 2007, and on March 17, 2008, the Company entered into a second amendment to the Credit Agreement effective as of December 31, 2007, to modify the financial covenants. Pursuant to the second amendment of the Credit Agreement, the Company must (a) maintain cash, cash equivalents or available borrowing capacity of specified amounts ranging from $4.0 million to $5.0 million as of

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the last day of each calendar month; (b) beginning with the trailing three month period ended March 31, 2008 and for each quarter thereafter, maintain specified minimum EBITDA; and (c) beginning with the trailing three month period ended March 31, 2008, maintain specified minimum revenue. As of June 30, 2008, the Company is in compliance with the financial covenants of the amended Credit Agreement.

Silicon Valley Bank

On May 25, 2007, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with SVB providing for a line of credit of up to $10.0 million (the “Line of Credit”).

The Line of Credit originally matured and the principal balance thereof was payable in full, on May 24, 2009. On September 30, 2008, the Company entered into an amendment to the Loan Agreement, pursuant to which the maturity date was extended to August 21, 2009. Borrowing availability under the Line of Credit is based on the existence of stipulated percentages of the Company’s eligible accounts receivable and inventory and is also subject to an additional $2,000,000 collateral reserve requirement established by SVB. Amounts borrowed under the Line of Credit bear interest at a per annum rate equal to the bank’s prime rate, plus 2% per year (7% at June 30, 2008).

The Company’s obligations under the Loan Agreement are secured by all of the Company’s inventory, equipment, payment intangibles, letter-of-credit rights, supporting obligations, accounts, and general intangibles, including, without limitation, all of the Company’s intellectual property, deposit accounts, and all money, and all property now or at anytime in the future in SVB’s possession, and all proceeds, all products and all books and records related to such collateral.

The Loan Agreement initially contained certain financial covenants related to minimum revenue, minimum EBITDA and cash availability. On October 15, 2007, the Company entered into an amendment to the Credit Agreement effective as of September 30, 2007, which modified the financial covenants. At December 31, 2007, the Company was not in compliance with the amended financial covenants related to minimum revenue and EBITDA. On March 17, 2008, the Company entered into a second amendment to the Loan Agreement effective as of December 31, 2007, which modified the financial covenants. Pursuant to the second amendment of the Loan Agreement, the Company must (a) maintain cash, cash equivalents or available borrowing capacity of specified amounts ranging from $4.0 million to $5.0 million as of the last day of each calendar month; (b) beginning with the trailing three month period ended March 31, 2008 and for each quarter thereafter, maintain specified minimum EBITDA; and (c) beginning with the trailing three month period ended March 31, 2008, maintain specified minimum revenue. As of June 30, 2008, the Company is in compliance with the financial covenants of the amended Loan Agreement.

The aggregate contractual maturities of debt for the years ended June 30 are (in thousands):

2009	$	5,772
2010	$	17,734
	$	23,506

9. Convertible Redeemable Preferred Stock

Series D Preferred Stock

On February 9, 2006, the Company completed the sale (the “Series D Financing”) of 5,000 shares of its Series D Convertible Preferred Stock, par value $1.00 per share (the “Series D Preferred Stock”) and warrants to purchase an aggregate of 1,041,667 shares (the “Series D Warrants”) of the Company’s common stock pursuant to a Securities Purchase Agreement (the “2006 Securities Purchase Agreement”) between the Company and certain investors (the “Series D Investors”). The aggregate proceeds to the Company from the Series D Financing was $5.0 million. The Series D Preferred Stock accrues dividends at a rate of $80 per year and is subject to anti-dilution adjustments in the event the Company issues additional shares of common stock for consideration that is less than the conversion price of the Series D Preferred Stock. Beginning February 9, 2009, the Series D Preferred Stock may be redeemed at a price equal to the Original Issue Price, plus unpaid dividends provided that the holders of a majority of the outstanding shares consent to the redemption. In addition to the shares of Series D Preferred Stock, the Company issued warrants to purchase an aggregate of up to 1,041,667 shares of common stock at a per share exercise price of $0.01. On October 6, 2008, MC Venture Partners, as holder of a majority of the Series D Preferred Stock, notified the Company that they agreed to not make the election the require redemption of the Series D Preferred Stock on or before October 1, 2009.

Obligation to Register Shares

Pursuant to the 2006 Securities Purchase Agreement, we agreed to register the shares of common stock issuable upon conversion of the Series D Preferred Stock and upon exercise of the Series D Warrants (collectively, the “Issued Shares”) for resale by the Series D Investors under the Securities Act. The Company also agreed to file with the SEC a registration statement with respect to the Issued Shares no later than March 27, 2006 (the “Filing Date”), and to use our best efforts to cause the registration

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statement to become effective on or before the date that is the earlier of (1) in the event of no review by the SEC, within five days of being informed by the SEC that the SEC has decided not to review the registration statement, but in no event later than 30 days after the Filing Date, (2) in the event of a review by the SEC, within five days of being informed by the SEC that the SEC has no further comments on such registration statement, but in no event later than 90 days after the Filing Date (the earlier of (1) and (2), the “Required Effective Date”).

The Company is currently liable for liquidated damages to each Series D Investor because the registration statement was not filed on or before March 27, 2006 (such an event, a “Filing Default”). As a result of the Filing Default, the Company must pay as liquidated damages to the Series D Investors, for each 30-day period of a default, an amount in cash equal to 1% of the aggregate purchase price paid by the Series D Investor pursuant to the 2006 Securities Purchase Agreement; provided that in no event will the aggregate amount of cash to be paid as liquidated damages exceed 9% of the aggregate purchase price paid by such Series D Investor. Through June 30, 2007, the Company has recorded the maximum damages provided for in the agreement; the Company has accrued a total of $450,000 in liquidated damages and paid $135,000 in damages as a result of the Filing Default.

Material Terms

The material terms of the Company’s Series D Preferred Stock are summarized below.

Voting. The holders of Series D Preferred Stock are entitled to vote on any matter presented at any meeting of the stockholders of the Company. Each holder of Series D Preferred Stock is entitled to cast a number votes equal to the number of whole shares of common stock into which the shares of Series D Preferred Stock are convertible as of the record date for determining stockholders entitled to vote on such matter. Currently, the issued and outstanding shares of Series D Preferred Stock would convert into an aggregate of 4,166,667 shares of common stock, which represents approximately 8.9% of the total voting power of the Company after the Capitalization Amendment

Dividends. From the date of issuance, the Series D Preferred Stock accrues dividends at a rate of $80.00 per year and compounds annually. Dividends on the Series D Preferred Stock may be declared and paid from time to time as determined by the Company’s board of directors. The Company cannot declare, pay or set aside any dividends or distributions on any other shares of capital stock of the Company unless the holders of Series D Preferred Stock first receive or simultaneously receive a dividend or distribution on each outstanding share of Series D Preferred Stock in such amounts as set forth in the Certificate of Powers, Designation, Preferences and Rights of the Series D Preferred Stock (the “Certificate of Designations”).

Liquidation. Upon liquidation, dissolution or winding up, then the holders of Series D Preferred Stock are entitled, before any distributions are made to the holders of the common stock, or any other class or series of capital stock of the Company ranking junior to the Series D Preferred Stock as to such distributions, to be paid an amount equal to $1,000 per share (the “Original Issue Price”) and any unpaid dividends thereon, subject to adjustment. For purposes of this liquidation preference, unless waived in writing by the holders of a majority of the Series D Preferred Stock (as adjusted) then outstanding, a consolidation or merger of the Company into or with another entity or the sale of all or substantially all of the Company’s assets, in each case under circumstances in which the holders of a majority in voting power of the outstanding capital stock of the Company, immediately prior to such transaction, owned less than a majority in voting power of the outstanding capital stock of the Company or its successor, would be treated as a liquidation, dissolution or winding up of the Company.

Conversion. The holders of the Series D Preferred Stock have the right, at any time and at their option, to convert each share of Series D Preferred Stock into a number of shares of the Company’s common stock determined by dividing the Original Issue Price (as adjusted) by the then-applicable per share conversion price of the Series D Preferred Stock. The conversion price is subject to adjustment in the case of any stock dividend, stock split, combination, capital reorganization, reclassification, merger or consolidation by the Company. With limited exceptions, the conversion price is also subject to adjustment in the case of an issuance of shares of the Company’s common stock, or securities exercisable for or convertible into the Company’s common stock, at a per share price less than the conversion price then in effect. In the event that this occurs, the conversion price would be reduced to equal the per share price of the newly issued securities. Initially, the conversion price of the Series D Preferred Stock is $1.20 per share.

Special Conversion. If the Company undertakes a financing involving the Company’s equity securities within 180 days of the first issuance of the Series D Preferred Stock (a “Future Financing Transaction”), the outstanding shares of the Series D Preferred Stock will automatically convert into the shares of the Company’s equity securities sold pursuant to that Future Financing Transaction (“Future Financing Securities”). The holders of the Series D Preferred Stock will, upon conversion of their Series D Preferred Stock into Future Financing Securities, be entitled to all rights granted to any other purchaser of Future Financing Securities. This right lapsed on August 8, 2006.

Anti-dilution Adjustments. In the event the Company issues additional shares of common stock (which includes certain options and convertible securities issued by the Company), except in limited circumstances, for no consideration or for consideration per share that is less than the conversion price of the Series D Preferred Stock then in effect, the conversion price of the Series D

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Preferred Stock will be reduced in accordance with the formula set forth in the Certificate of Designations. The Company’s Series E and Series F Preferred Stock financings have triggered this provision in the Series D Preferred Stock agreement, as discussed further below.

Redemption. Beginning February 9, 2009, the Series D Preferred Stock may be redeemed at a price equal to the Original Issue Price, plus all declared and unpaid dividends, provided that the holders of a majority of the issued and outstanding shares of Series D Preferred Stock consent to such redemption. Commencing 30 days after the consent, the Series D Preferred Stock must be redeemed in three equal annual installments. If the Company fails to redeem the Series D Preferred Stock in accordance with the Certificate of Designations, then interest will accrue on any unpaid amount at a rate of 1% per each 30-day period that such amounts remain unpaid.

Special Redemption. Upon notice of certain events triggering a mandatory conversion under the Certificate of Designations, a holder of Series D Preferred Stock may instead elect to have the Company redeem its shares of Series D Preferred Stock (the “Special Redemption”). Any such shares will be redeemed at a price equal to the Original Issue Price, plus all declared and unpaid dividends (the “Special Redemption Price”). If the Company fails to redeem the shares of Series D Preferred Stock pursuant to the Special Redemption, the holders of such shares will sell such shares to any persons that the Company designates and will sell such shares at the Special Redemption Price.

Series D Warrants

In addition to the shares of Series D Preferred Stock, the Company issued warrants to purchase an aggregate of up to 1,041,667 shares of common stock at a per share exercise price of $0.01. The Series D Warrants have a term of exercise expiring on February 9, 2016. The number of shares issuable upon exercise and the per share exercise price of the Series D Warrants is subject to adjustment in the case of any stock dividend, stock split, combination, capital reorganization, reclassification or merger or consolidation. Subject to limited exceptions, the number of shares of common stock for which the warrant is exercisable is also subject to adjustment in the case of an issuance of shares of common stock or securities exercisable for or convertible into common stock, at a per share price less than the per share conversion price of the Series D Preferred Stock then in effect. In the event of such an issuance, the number of shares of common stock for which the warrant is exercisable is increased in accordance with the formula set forth in the warrant. The conversion price, as defined in the warrant, is also reduced to equal the purchase price of the new issuance of common stock (or securities convertible into common stock). The Series D Warrants are exercisable at any time prior to their expiration date by delivering the warrant certificates to the Company, together with a completed election to purchase and the full payment of the exercise price or by means of a “net exercise” clause under which the Company does not receive any cash, but rather, the number of shares issued upon exercise is net of the number of shares withheld by the Company in lieu of payment of the exercise price. This net exercise right is generally limited to times when the Company is not in compliance with its obligations relating to the registration of the shares of common stock underlying the Series D Warrants for resale under the Company’s registration rights agreement with respect to those shares.

The Company allocated the proceeds between the stock and the warrants based upon their relative fair values as of the closing date, resulting in $951,000 being allocated to the warrants. The Company determined the fair value of the warrants using the Black-Scholes option pricing model with the following assumptions: no dividend yield; weighted average risk free rate of 4.54%; volatility of 115% and a contractual life of 10 years. The Company recorded the portion of the proceeds attributable to the stock as mezzanine equity pursuant to EITF Topic D-98, Classification and Measurement of Redeemable Securities after determining the guidance in FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity did not apply. The Company determined that the warrants meet the definition of a derivative instrument as defined in SFAS 133, Accounting for Derivative Instruments and Hedging Activities, but do not require derivative treatment pursuant to the scope exception in paragraph 11(a) of SFAS 133. The Company recorded the proceeds attributable to the warrants in permanent equity pursuant to guidance in EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, as the Company can settle the warrants in unregistered shares and the liquidated damages are not believed to be “uneconomic”.

The Company evaluated whether the embedded conversion feature in the stock required bifurcation and determined that the economic characteristics and risks of the embedded conversion feature in the stock were clearly and closely related to the stock and concluded that bifurcation was not required under SFAS 133. We calculated the intrinsic value of the beneficial conversion feature embedded in the stock pursuant to the guidance in EITF 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments. The beneficial conversion of $659,000 was recognized as an additional discount on the stock. The total discount on the stock resulting from the allocation of proceeds to the warrants and recording of the beneficial conversion feature will be accreted over the period through the earliest possible redemption date.

As a result of the issuance of the Lender Warrant (see Note 8) and the Series E Preferred Stock (see below), the anti-dilution adjustments in the Series D Preferred Stock and the Series D Warrants were triggered. Accordingly, on December 1, 2006, the

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Company issued 539,787 additional Series D Warrants to the Series D Investors which increased the portion of the proceeds allocable to the warrants to $1.3 million. In addition, the conversion price was adjusted to $0.79 which resulted in an increase in the value of the beneficial conversion feature to $2.8 million which was recorded as an additional discount on the stock. The additional discounts recognized as a result of these adjustments will be accreted over the period through the earliest redemption date.

As a result of the issuance of the Series F Preferred Stock (see below), the anti-dilution adjustments in the Series D Preferred Stock and the Series D Warrants were triggered. Accordingly, on May 19, 2008, the Company issued 1,164,138 additional Series D Warrants to the Series D Investors which increased the portion of the proceeds allocable to the warrants to $1.8 million. In addition, the conversion price was adjusted to $0.42 which resulted in an increase in the value of the beneficial conversion feature. Since the discounts for the Series D Warrants and beneficial conversion feature previously recorded against the Series D Preferred Stock totaled $4,939,000, the discount for the changes triggered by the Series F Preferred Stock issuance was limited to $61,000, such that the total discounts recorded on the Series D Preferred Stock financing equal the total proceeds. This additional discount will be accreted over the period through the earliest redemption date.

We will reevaluate the classification of the stock and warrants in each period to determine if reclassification is necessary. Our obligation to the Series D Preferred Stockholders, should they choose to redeem the stock at or after the redemption date is $4.9 million plus accrued but unpaid dividends of $859,953.

Series E Preferred Stock

On December 1, 2006, the Company completed the sale (the “Series E Financing”) of 27,400 shares of its Series E Convertible Preferred Stock, par value $1.00 per share (the “Series E Preferred Stock”) and warrants to purchase an aggregate of 25,849,059 shares (the “Series E Warrants”) of the Company’s common stock pursuant to the Amended and Restated Securities Purchase Agreement between the Company and certain investors (the “Series E Investors”) (the “Series E Securities Purchase Agreement”). The aggregate proceeds to the Company from the Series E Financing was $27.4 million. The Series E Preferred Stock accrues dividends at a rate of $100 per year and is subject to anti-dilution adjustments in the event the Company issues additional shares of common stock for consideration that is less than the conversion price of the Series E Preferred Stock. Beginning three years from the date of issuance, the Series E Preferred Stock may be redeemed at a price equal to the Original Issue Price, plus unpaid dividends provided that any single holder of at least thirty percent (30%) of the outstanding shares consents to the redemption. In addition to the shares of Series E Preferred Stock, the Company issued warrants to purchase an aggregate of up to 25,849,059 shares of common stock at a per share exercise price of $0.58. The Series E warrants are also subject to anti-dilution adjustments.

Obligation to Register Shares

Pursuant to the Amended and Restated Securities Purchase Agreement, we agreed to register the shares of common stock issuable upon conversion of the Series E Preferred Stock and upon exercise of the Series E Warrants (collectively, the “Issued Shares”) for resale by the Series E Investors under the Securities Act. The Company also agreed to file with the SEC a registration statement with respect to the Issued Shares no later than 210 days after the effective time of the Merger, and to use our best efforts to cause the registration statement to become effective as promptly as reasonably practicable after (1) being informed by the SEC that the SEC has decided not to review the registration statement or (2) being informed by the SEC that the SEC has no further comments on such Registration Statement.

Other Company Obligations

The Company’s negative covenants relate to obligations not to, without the prior consent of M/C Venture Partners, provided M/C Venture Partners holds 50% of the shares of Series E Preferred Stock purchased in the Series E Financing, (1) enter into a transaction involving a change in control of the Company; (2) incur indebtedness in excess of $3.0 million, subject to specified exceptions; (3) create any security with an equity component unless that security is junior to the common stock; (4) issue any equity securities; (5) transfer its intellectual property; (6) repurchase, redeem or pay dividends on any shares of capital stock (subject to limited exceptions); (7) grant stock options that are not authorized by a vote of the Board of Directors or its Compensation Committee; (8) liquidate or dissolve; (9) change the size of the Company’s Board of Directors; (10) amend the Company’s certificate of incorporation or bylaws; (11) change the nature of the Company’s business; (12) alter the voting rights of shares of the Company’s capital stock in a disparate manner; (13) take any action which would cause an adjustment to the exercise price or number of shares to be delivered under the Section 8 of the Series E Warrants; or (14) amend the Credit Agreement or the warrant issued in connection with the Credit Agreement, or take any action that would cause any increase in the number of shares for which such warrants would be exchanged.

Material Terms

The material terms of the Company’s Series E Preferred Stock are summarized below.

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Voting. The holders of Series E Preferred Stock are entitled to vote on any matter presented at any meeting of the stockholders of the Company. Each holder of Series E Preferred Stock is entitled to cast a number votes equal to the number of whole shares of common stock into which the shares of Series E Preferred Stock are convertible as of the record date for determining stockholders entitled to vote on such matter. Currently, the issued and outstanding shares of Series E Preferred Stock would convert into an aggregate of 51,698,113 shares of common stock, which represents approximately 31.8% of the total voting power of the Company on a fully diluted basis.

Dividends. From the date of issuance, the Series E Preferred Stock accrues dividends at a rate of $100.00 per year and compounds annually. Dividends on the Series E Preferred Stock may be declared and paid from time to time as determined by the Company’s board of directors. The Company cannot declare, pay or set aside any dividends or distributions on any other shares of capital stock of the Company unless the holders of Series E Preferred Stock first receive or simultaneously receive a dividend or distribution on each outstanding share of Series E Preferred Stock in such amounts as set forth in the Certificate of Powers, Designation, Preferences and Rights of the Series E Preferred Stock (the “Certificate of Designations”).

Liquidation. Upon liquidation, dissolution or winding up, the holders of Series E Preferred Stock are entitled, before any distributions are made to the holders of the common stock, or any other class or series of capital stock of the Company ranking junior to the Series E Preferred Stock as to such distributions, to be paid an amount equal to $1,000 per share (the “Original Issue Price”) and any unpaid dividends thereon, subject to adjustment. For purposes of this liquidation preference, unless waived in writing by any single holder of at least thirty percent (30%) of the outstanding Series E Preferred Stock and/or Series D Preferred Stock (as adjusted) then outstanding, a consolidation or merger of the Company into or with another entity or the sale of all or substantially all of the Company’s assets, in each case under circumstances in which the holders of a majority in voting power of the outstanding capital stock of the Company, immediately prior to such transaction, owned less than a majority in voting power of the outstanding capital stock of the Company or its successor, would be treated as a liquidation, dissolution or winding up of the Company.

Conversion. The holders of the Series E Preferred Stock have the right, at any time and at their option, to convert each share of Series E Preferred Stock into a number of shares of the Company’s common stock determined by dividing the Original Issue Price (as adjusted) by the then-applicable per share conversion price of the Series E Preferred Stock. The conversion price is subject to adjustment in the case of any stock dividend, stock split, combination, capital reorganization, reclassification, merger or consolidation by the Company. With limited exceptions, the conversion price is also subject to adjustment in the case of an issuance of shares of the Company’s common stock, or securities exercisable for or convertible into the Company’s common stock, at a per share price less than the conversion price then in effect. In the event that this occurs, the conversion price would be reduced to equal the per share price of the newly issued securities. Initially, the conversion price of the Series E Preferred Stock is $0.53 per share. Currently, the Series E Preferred Stock would convert into 51,698,113 shares of common stock.

Anti-dilution Adjustments. In the event the Company issues additional shares of common stock (which includes certain options and convertible securities issued by the Company), except in limited circumstances, for no consideration or for consideration per share that is less than the conversion price of the Series E Preferred Stock then in effect, the conversion price of the Series E Preferred Stock will be reduced to equal the per share price of the newly issued securities.

Redemption. Starting three years from the date the Series E Certificate of Designations was filed, the Series E Preferred Stock may be redeemed in three equal annual installments commencing 30 days after any single holder of at least thirty percent (30%) of the issued and outstanding shares of Series E Preferred Stock consents to such redemption. The Series E Preferred Stock may be redeemed at a price equal to the Original Issue Price, plus all declared but unpaid dividends. If the Company fails to redeem the Series E Preferred Stock in accordance with the Certificate of Designations, then interest will accrue on any unpaid amount at a rate of 1% per each 30-day period that such amounts remain unpaid.

Special Redemption. Upon notice of certain events triggering a mandatory conversion under the Series E Certificate of Designations, a holder of Series E Preferred Stock may instead elect to have the Company redeem its shares of Series E Preferred Stock (the “Special Redemption”). Any such shares will be redeemed at a price equal to the Original Issue Price, plus all declared and unpaid dividends (the “Special Redemption Price”). If the Company fails to redeem the shares of Series E Preferred Stock pursuant to the Special Redemption, the holders of such shares will sell such shares to any persons that the Company designates and will sell such shares at the Special Redemption Price.

Series E Warrants

In addition to the shares of Series E Preferred Stock, the Company issued warrants to purchase an aggregate of up to 25,849,059 shares of common stock at a per share exercise price of $0.58. The Series E Warrants have a term of exercise expiring on December 1, 2016. The number of shares issuable upon exercise and the per share exercise price of the Series E Warrants is subject to adjustment in the case of any stock dividend, stock split, combination, capital reorganization, reclassification or merger or consolidation. Subject to limited exceptions, the number of shares of common stock for which the warrant is exercisable is also subject to adjustment in the case of an issuance of shares of common stock or securities exercisable for or convertible into common stock, at a per share price less than the per share conversion price of the Series E Preferred Stock then in effect. In the event of such an issuance, the number of shares of common stock for which the warrant is exercisable is increased in accordance with the formula set forth in the

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warrant. The conversion price, as defined in the warrant, is also reduced to equal the purchase price of the new issuance of common stock (or securities convertible into common stock). The Series E Warrants are exercisable at any time prior to their expiration date by delivering the warrant certificates to the Company, together with a completed election to purchase and the full payment of the exercise price or by means of a “net exercise” clause under which the Company does not receive any cash, but rather, the number of shares issued upon exercise is net of the number of shares withheld by the Company in lieu of payment of the exercise price. This net exercise right is generally limited to times when the Company is not in compliance with its obligations relating to the registration of the shares of common stock underlying the Series E Warrants for resale under the Company’s registration rights agreement with respect to those shares.

The Company allocated the proceeds between the stock and the warrants based upon their relative fair values as of the closing date, resulting in $11.8 million being allocated to the warrants. The Company determined the fair value of the warrants using the Black-Scholes option pricing model with the following assumptions: no dividend yield; weighted average risk free rate of 4.43%; volatility of 111% and a contractual life of 10 years. The Company determined that the warrants meet the definition of a derivative instrument as defined in SFAS 133, Accounting for Derivative Instruments and Hedging Activities, but do not require derivative treatment pursuant to the scope exception in paragraph 11(a) of SFAS 133. The Company recorded the proceeds attributable to the warrants in permanent equity pursuant to guidance in EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.

The Company evaluated whether the embedded conversion feature in the stock required bifurcation and determined that the economic characteristics and risks of the embedded conversion feature in the stock were clearly and closely related to the stock and concluded that bifurcation was not required under SFAS 133. We calculated the intrinsic value of the beneficial conversion feature embedded in the stock pursuant to the guidance in EITF 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments. The beneficial conversion value, as calculated, exceeds the amount of the proceeds allocated to the stock, thus is capped at $15.6 million allocated to the Series E Preferred Stock, which is recognized as an additional discount on the stock. The Company determined that the portion of the proceeds attributable to the stock should be recorded as mezzanine equity pursuant to EITF Topic D-98, Classification and Measurement of Redeemable Securities after determining the guidance in FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity did not apply. However, since the total discount on the stock resulting from the allocation of proceeds to the warrants and recording of the beneficial conversion feature equals the face value of the Series E Preferred Stock, no initial value has been recognized in mezzanine equity for the Series E preferred stock. The total discount on the stock resulting from the allocation of proceeds to the warrants and recording of the beneficial conversion feature and the cash dividends will be accreted over the period through the earliest possible redemption date using the effective interest method. Accretion of the discount and dividends for the fiscal years ended June 30, 2007, 2008, 2009 and 2010 will be approximately $0, $7,000, $2.1 million and $33.5 million, respectively.

As a result of the issuance of the Series F Preferred Stock (see below), the anti-dilution adjustments in the Series E Preferred Stock and the Series E Warrants were triggered however, the Series E Investors waived these provisions.

We will reevaluate the classification of the stock and warrants in each period to determine if reclassification is necessary. Our obligation to the Series E Preferred Stockholders, should they choose to redeem the stock at or after the redemption date is $27.4 million plus accrued but unpaid dividends of $4.3 million.

Series F Preferred Stock

On March 17, 2008, the Company entered into a securities purchase agreement (the “SPA”) with certain investors (the “Initial Investors”) pursuant to which the Company agreed to (1) the issuance and sale of subordinated convertible promissory notes (the “Notes”) and (2) upon conversion of the Notes, the issuance of a to-be-established series of the Company’s preferred stock (the “Series F Preferred Stock”) and, if applicable, warrants to purchase shares of the Company’s common stock. Under the SPA and subsequent joinder agreements to the SPA entered into on April 16, 2008 and May 19, 2008, the Company received aggregate proceeds of $7,867,064, in exchange for the issuance and sale of the Notes. The Notes accrued interest at the rate of 15% annually and had a stated maturity of twelve months from issuance. The Notes were subordinate to the Credit Agreement and the Loan Agreement.

The Notes were automatically convertible on or before May 19, 2008 (the “Outside Date”) into shares of Series F Preferred Stock. If there was a qualifying investment, defined as an investment by LGN that (a) closes on or before the Outside Date pursuant to the SPA which LGN becomes a party to, and (c) LGN purchases a minimum of $1.0 million in principal amount of the Notes, then the Notes automatically convert into “Section 5(a)” preferred stock. If no qualifying investment occurs prior to the Outside Date, then the Notes automatically convert into “Section 5(b)” preferred stock. The Notes convert into Series F Preferred Stock at a rate of one share per $1,000 of outstanding principal and accrued interest (rounded to the nearest share). The initial conversion price of the Series F Preferred Stock to common stock is $0.05 per share.

The material terms of the Section 5(a) preferred stock were as follows:

1. With regard to the powers, designations, preferences and rights, the Section 5(a) preferred stock is substantially similar to the Series E Preferred Stock and ranks equally with respect to the payment of dividends, redemption and rights upon liquidation, dissolution or sale of the Company.

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2. In connection with the automatic conversion of the Notes into Section 5(a) preferred stock, the holders will receive warrants to purchase common shares at an exercise price of $0.01 per share. The number of shares for which the warrants are exercisable is calculated as the original principal amount of the Note divided by $0.05 (the conversion price of the Series F Preferred Stock into common stock).

The material terms of the Section 5(b) preferred stock were as follows:

1. The Section 5(b) preferred stock ranks senior to all other classes or series of capital stock with respect to the payment of dividends, redemption and rights upon liquidation, dissolution or sale of the Company.

2. The Section 5(b) preferred stock accrues a cash dividend at the rate of $120 per year per share payable before any dividend is paid on any other shares of the Company’s capital stock.

3. In the event of redemption, liquidation, dissolution or sale of the Company, the holders of the Section 5(b) preferred stock are entitled to receive an amount equal to three times the purchase price per share plus all declared and unpaid dividends.

4. Other than as noted above, the Section 5(b) preferred stock is substantially similar to the Series E Preferred Stock with regard to the powers, designations, preferences and rights. No warrants will issue upon automatic conversion of the Notes into Section 5(b) preferred stock.

Based upon the nature of the conversion feature in the note, the Company concluded that the Notes were not considered “conventional convertible debt instruments”, as this term is defined in EITF Issue No. 05-02, The Meaning of “Conventional Convertible Debt Instrument” in Issue No. 00-19. As a result, the Company bifurcated the conversion option and allocated the proceeds from the Notes between the fair value of the debt and the fair value of the conversion option on a relative fair value basis. This resulted in the Company allocating $6,289,000 to the conversion option, which was recorded as a component of additional paid in capital. The corresponding discount on the Notes was to be accreted over the life of the Notes using the effective interest rate method.

On May 19, 2008, LGN entered into a joinder agreement to the SPA to purchase $1,400,000 of Notes and the Section 5(a) conversion was triggered. The Notes and $168,708 of accrued interest converted into 8,036 Shares of Series F Preferred Stock and warrants to purchase 157,341,280 shares of the Company’s common stock at $0.01 per share (the “Series F Warrants”). Just prior to conversion the Company fully accreted the discount on the Notes resulting in $6,289,000 of non-cash interest for the year ended June 30, 2008. The Company allocated the $8,036,772 principal and interest value of the Notes, plus the $6,289,000 value of the conversion option, between the fair value of the Series F Preferred Stock and the fair value of the Series F Warrants on a relative fair value basis, resulting in $5,213,564 being allocated to the Series F Preferred stock (net of $12,798 of issuance costs) and $9,098,410 being allocated to the Series F Warrants. We determined the fair value of the warrants using the Black-Scholes option pricing model with the following assumptions: no dividend yield; weighted average risk free rate of 3.83%; volatility of 110% and a contractual life of 10 years. The Company determined that the warrants meet the definition of a derivative instrument as defined in FAS 133, Accounting for Derivative Instruments and Hedging Activities, but do not require derivative treatment pursuant to the scope exception in paragraph 11(a) of FAS 133. We recorded the proceeds attributable to the warrants in permanent equity pursuant to guidance in EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock. The Company determined that the portion of the proceeds attributable to the stock should be recorded as mezzanine equity pursuant to EITF Topic D-98, Classification and Measurement of Redeemable Securities after determining the guidance in FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity did not apply. The discount on the stock resulting from the allocation of proceeds to the warrants will be accreted over the period through the earliest possible redemption date using the effective interest method.

The Series F Preferred Stock has the same voting, dividend, liquidation, conversion, anti-dilution and redemption features as the Series E Preferred Stock (as disclosed above). The Series F Preferred stock is currently convertible into 164,620,000 shares of Common Stock. We will reevaluate the classification of the stock and warrants in each period to determine if reclassification is necessary. Our obligation to the Series F Preferred Stockholders, should they choose to redeem the stock at or after the redemption date is $8,036,000, plus accrued but unpaid dividends of $139,000.

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10. Shareholders Equity

Toshiba Stock Purchase and Warrants

In January 2000, Vertical entered into an agreement with Toshiba under which Toshiba acquired 16,666 shares of Vertical common stock at a price of $41.964 per share and was issued warrants for an additional 8,333 shares of Vertical common stock at an exercise price of $41.964 per share. The fair market value of the Vertical common stock on the date of execution of the definitive agreement was $129 per share. The difference between the issuance price and fair market value of the Vertical common stock, and the fair value of the warrants (which were valued based upon the Black-Scholes Options Pricing Model) amounted to $2.3 million. This cost of equity is being amortized as a reduction of product revenues in proportion to revenue recognized relating to the OEM and Reseller Agreement. The unamortized portion of this amount is reported as “Deferred Toshiba Equity Costs” in the shareholders equity section of the consolidated balance sheets.

Stock Incentive Plans

On October 20, 1994, the Company’s shareholders approved the Company’s 1994 Stock Incentive Plan (the “1994 Plan”). The 1994 Plan provides for the grant of Incentive Stock Options, Nonqualified Stock Options, Stock Appreciation Rights (Tandem and Free-standing), Restricted Stock, Deferred Stock, Performance Units and Performance Shares to officers, key employees, non-employee directors and certain consultants of the Company. This Plan was replaced by the 2004 Stock Incentive Plan (the “2004 Plan”) that was approved by the Company’s shareholders on March 15, 2004.

The 2004 Plan initially provided that the maximum number of options that could be granted would be 2,000,000 shares, plus the lesser of 150,000 shares of Common Stock or 1.5% of the number of shares of common stock issued and outstanding as of July 1 of each year commencing on July 1, 2004 (the “Evergreen” clause). On September 28, 2004, the 2004 Plan was amended to provide that the maximum number of options that can be granted would be increased to 8,236,255 shares and the Evergreen clause was removed from the plan so that the maximum number of shares that could be granted would no longer increase automatically each year. On April 3, 2006, the 2004 Plan was amended to provide that the maximum number of options that can be granted would be increased to 10,768,865. On February 19, 2007, the 2004 Plan was amended to provide that the maximum number of options that can be granted would be increased to 27,018,865 shares and to increase the maximum number of shares of common stock with respect to which awards may be granted to any participant under the plan to 3,500,000 shares per year. On March 7, 2008, the 2004 Plan was amended to provide that the maximum number of shares that can be granted would be increased to 80,000,000. The maximum number of shares available for grant each year shall include all previously ungranted options plus all expired and cancelled options. With the exception of options granted on September 28, 2004, stock options are generally granted at a price not less than 100% of the fair market value of the common shares at the date of grant. Generally, options become exercisable over a four-year period commencing on the date of grant and vest 25% at the first anniversary of the date of grant with the remaining 75% vesting in equal monthly increments over the remaining three years of the vesting period. No 2004 Plan options may be exercised more than ten years from the date of grant. At June 30, 2008, there were 57,145,591 remaining shares available for grant under the 2004 Plan and none were available for grant under the 1994 Plan.

Stock option activity during the last three fiscal years is as follows:

	2008				2007				2006
	Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
Outstanding at beginning of Year	19,415,983		$	0.99	8,216,803		$	1.90	7,998,090		$	2.13
Granted	1,344,500			0.90	12,759,528			0.84	2,122,750			0.92
Exercised	(78,968	)		0.75	—			—	(83,178	)		0.97
Cancelled	—			—	(507,829	)		8.13	—			—
Forfeited	2,411,955			0.87	(1,052,519	)		1.64	(1,820,859	)		1.78
Outstanding at end of year	18,269,560			1.00	19,415,983			0.99	8,216,803			1.90
Exercisable at end of year	9,095,654		$	1.15	4,066,438		$	1.45	2,975,487		$	3.14

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The following table summarizes information about the stock options outstanding at June 30, 2008:

Range of Exercise Prices		Number Outstanding at June 30, 2008	Weighted Average Exercise Price		Weighted Average Contractural Life (Years)	Number Exercisable at June 30, 2008	Weighted Average Exercise Price
$	0.08 - $0.89	12,803,837	$	0.82	8.59	4,417,749	$	0.83
$	0.97 - $1.81	4,810,990	$	1.11	6.57	4,032,073	$	1.08
$	2.30 - $3.00	617,500	$	2.57	5.72	617,500	$	2.57
$	3.96 - $4.40	10,831	$	4.26	5.01	10,831	$	4.26
$	11.70 - $12.38	7,501	$	11.92	1.99	7,501	$	11.92
$	45.00 - $52.88	6,667	$	47.95	1.97	4,167	$	47.95
$	100.50 - $129.00	3,333	$	114.75	1.59	5,833	$	114.75
		18,269,560	$	1.00	7.95	9,095,654	$	1.15

Restricted Stock

In February 2007, the Company granted restricted stock to certain key executives. This restricted stock program is a performance based plan that awards shares of common stock of the Company at the end of a four year, one month measurement period. Awards associated with this program cliff vest at the end of the measurement period subject to attainment of the defined performance measures associated with the performance of the Company’s common stock and operations.

The Company recognizes compensation expense on these awards ratably over the vesting period. The fair value of the awards was determined based on the market value of the underlying stock price at the grant date. The Company estimated a forfeiture rate of 20% based on projections related to whether the performance measures are likely to be achieved and the probability of all awards vesting. The amount of compensation expense ultimately recognized will depend on whether the performance measures are met and all of the restricted stock awards vest. The Company will assess its projections at each reporting period and, as a result, the amount of expense recorded from period to period may change.

Total stock-based compensation for both options and restricted stock awards increased loss from operations and net loss for the year ended June 30, 2008 by $6.3 million ($0.12 per basic and diluted share) As of June 30, 2008, $11.0 million of unvested stock-based compensation has not yet been recognized by the Company. The unvested stock-based compensation balance is expected to be expensed over a weighted average period of 2.5 years.

Total stock-based compensation for both options and restricted stock awards increased loss from operations and net loss for the years ended June 30, 2007 and 2006 by $5.1 million ($0.11 per basic and diluted share) and $4.0 million ($0.09 per basic and diluted share), respectively.

11. Employee Benefit Plans

The Company has a qualified 401(k) profit-sharing plan (defined contribution plan) which became effective July 1, 1991. The plan covers substantially all employees having at least 30 days of service. Participants may voluntarily contribute to the plan up to the maximum limits imposed by Internal Revenue Service regulations. The Company will match up to 50% of the participants’ annual contributions up to 3% of the participants’ compensation. Participants are immediately vested in the amount of their direct contributions and vest over a three-year period, as defined by the plan, with respect to the Company’s contribution.

The Company’s contribution to the profit-sharing plan was approximately $441,000, $364,000, and $375,000 for the fiscal years ended June 30, 2008, 2007 and 2006, respectively.

12. Income Taxes

No income tax expense (benefit) was recorded in fiscal years 2008, 2007 and 2006 as the Company incurred net losses for all periods. However, for the years ended June 30, 2008, 2007 and 2006, the Company recorded deferred tax provisions of $1.0 million, $0.3 million and $0.6 million, respectively, and a corresponding liability arising from the timing differences associated with amortizing goodwill for income tax purposes over a 15 year life. Income tax expense (benefit) differs from the amount computed by applying the combined statutory income tax rate to the loss before income taxes as follows (in thousands):

	2008		2007		2006
Computed “expected” tax benefit	(8,761	)	(6,268	)	(6,400	)
Losses not benefited	9,793		6,617		7,026
Total income tax expense, continuing operations	1,032		349		626

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The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at June 30, 2008 and 2007 are presented below (in thousands):

	June 30,
	2008		2007
Deferred tax assets:
Deferred revenue	2,328		3,444
Purchased technology	44		67
Allowances for doubtful accounts and returns	95		142
Allowances for inventory obsolescence	166		(78	)
Accrued compensation and benefits	1,326		1,077
Prepaid expenses	(22	)	18
Other accrued liabilities	1,350		1,310
Depreciation and amortization	318		577
Federal and state net operating loss and credit carryforwards	39,335		34,213
Total gross deferred tax assets	44,940		40,770
Less valuation allowance	(44,940	)	(40,770	)
Deferred tax assets	—		—
Deferred tax liabilities
Goodwill and intangibles	(2,264	)	(5,761	)
Net deferred tax liabilities	(2,264	)	(5,761	)

Total valuation allowance increased by $4.2 million and $5.1 million for the fiscal years ended June 30, 2008 and 2007, respectively. The Company has evaluated the ability to realize its deferred tax assets and based on an evaluation of all of the evidence, both objective and subjective, including the existence of operating losses in recent years, it has concluded that it is more likely than not that the deferred tax assets will not be realized.

In connection with the acquisition of Vodavi (see Note 3) a deferred income tax liability was initially established in the amount of $4.5 million to account for timing differences associated with amortizing the identified intangible assets for book purposes but not for income tax purposes. Upon completion of the Company’s analysis of its ownership changes and the impact on the availability of the Company’s deferred tax assets, we determined the deferred tax liability was not required. The reversal of this liability reduced the recorded goodwill.

The Company believes that as a result of the equity financing activity that has taken place, a change in control occurred for purposes of the Internal Revenue Code section 382, which places limitations on utilization of loss carryforwards. If a section 382 change in control had not occurred, the Company would have had $105.7 million in loss carryforwards for federal income tax purposes at June 30, 2008 and $53.6 million in loss carryforwards for state purposes at June 30, 2008. The Company expects that a substantial portion of these loss carryforwards will expire unutilized as a result of the application of section 382.

13. Commitments

Operating Leases

The Company leases office space and equipment under non-cancelable operating lease agreements expiring through fiscal 2013. These leases contain renewal options and the Company is responsible for certain executory costs, including insurance, maintenance, taxes and utilities. Total rent expense for these operating leases was approximately $2,471,000, $2,127,000, and $1,975,000 for the fiscal years ended 2008, 2007 and 2006, respectively.

The approximate minimum rental commitments under noncancelable operating leases that have remaining noncancelable lease terms in excess of one year at June 30, 2008 are as follows (in thousands):

Years Ending June 30	Future Minimum Lease Payments
2009	$	1,862
2010		1,745
2011		1,061
2012		606
2013		53
Total	$	5,327

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Royalty Agreements

Vertical licenses software from several software developers for inclusion with its products and use by its customers. These licenses are subject to royalty agreements. As of June 30, 2008 no minimum royalty obligations existed based on royalty agreements expiring within one year.

14. Contingencies, Guarantees and Indemnifications

The Company is subject to lawsuits and other claims arising in the ordinary course of its operations. In the opinion of management, based on consultation with legal counsel, the effect of such matters will not have a material adverse effect on the Company’s financial position or results of operations.

We enter into standard indemnification agreements in our ordinary course of business. Pursuant to these agreements, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our business partners or customers, in connection with any patent or any copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. Accordingly, we have no liabilities recorded for these agreements.

We warrant that our software products will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the licensed products to the customer for 90 days. We warrant that our maintenance services will be performed consistent with generally accepted industry standards through completion of the agreed upon services. Additionally, we warrant that our hardware products will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the products to the customer for periods of six months to five years. We provide for the estimated cost of hardware product warranties based on specific warranty claims and claim history. If necessary, we would provide for the estimated cost of the software and services warranties based on specific warranty claims and claim history, however, we have not incurred any significant expenses under our software or service warranties.

15. Subsequent Events

The Company filed a Form 15 with the Securities and Exchange Commission on July 29, 2008 in order to voluntarily deregister its common stock and expects that the deregistration of its shares will become effective 90 days after the filing of the Form 15. The Company is eligible to voluntarily deregister its shares as it had fewer than 300 shareholders of record as of July 29, 2008.

On August 28, 2008, the Company entered into a third amendment to the Credit Agreement, pursuant to which the principal amount of the Term Note was increased to $17.5 million resulting in $2.5 million additional proceeds, less costs, to the Company. The Company agreed to issue an additional warrant to purchase 14.5 million shares of our common stock at an exercise price of $0.01 per share to the Lender in conjunction with this increase. The Company is currently evaluating the appropriate accounting treatment for this transaction.

On September 30, 2008 the Company entered into a third amendment to the Loan Agreement, pursuant to which the maturity date of the loan was extended to August 21, 2009. On October 6, 2008, MC Venture Partners notified the Company that it, as holder of a majority of the Series D Preferred Stock, agreed not to make the election to require redemption of the Series D Preferred Stock on or before October 1, 2009.

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