Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995

Some of the information in this Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as "may," "will," "expect," "anticipate," "believe," "estimate," "continue" and similar words. You should read statements that contain these words carefully because they: (1) discuss our future expectations; (2) contain projections of our future operating results or financial condition; or (3) state other "forward-looking" information. However, we may not be able to predict future events accurately. The risk factors listed in our Annual Report on Form 10-K for the year ended December 31, 2011, as well as any cautionary language in this Form 10-Q, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. You should be aware that the occurrence of any of the events described in these risk factors and elsewhere in this Form 10-Q could materially and adversely affect our business. Further, there can be no assurance as to the timing of possible transactions with respect to our patent portfolio or whether such transactions will be completed.

Summary of Operations. We have been a supplier of signal processing and digital communications technology for imaging and telecommunications applications since the early 1990s. Presently, our business operations are focused along three product lines: i) biometrics and imaging; ii) DSL service assurance; and iii) patent management.

Biometrics & Imaging. Our biometrics products consist of software and services used in biometric systems, and our imaging products consist of software used primarily in medical imaging applications. Biometrics systems are used in applications such as law enforcement, border control, national defense, secure credentialing, access control and background checks. We typically sell our biometrics software and services to: i) systems integrators that incorporate our software products into biometrics systems that they are developing on behalf of their customers; ii) OEMs that incorporate our products into their biometrics hardware and software solutions; and iii) directly to government agencies that are deploying biometrics systems. Our imaging software is primarily sold to OEMs and systems integrators that incorporate our software into their medical and imaging products.

DSL Service Assurance. Our DSL service assurance products consist of DSL software and hardware products that are used by telephone companies to improve the quality of their DSL service offerings. We sell our DSL service assurance software products through OEMs and directly to telephone companies. Our DSL service assurance hardware products are typically sold to OEMs that incorporate our modules into their automated testhead and handheld test equipment. Our OEM customers sell their equipment to telephone companies.

In January 2012, our Board of Directors approved the shutdown of our DSL service assurance hardware product line. We will continue to build and ship DSL service assurance hardware products to fulfill customer orders that were received as of the date of the shutdown notice. DSL hardware revenue and expenses will continue in 2012 until we complete the shutdown, which currently we anticipate will be in the third quarter of 2012.

We estimate that exiting this product line will produce a modest amount of operating income in the first nine months of 2012. DSL hardware operating income consisted of revenue from final hardware shipments less the following direct costs: i) cost of goods sold, ii) engineering and sales expenses to support final product shipments, and iii) one-time costs related to the shutdown, the majority of which were severance and employee-related costs. Shutdown costs of $101,000 and $282,000 were included in expenses for the three and six month periods ended June 30, 2012, respectively.

Revenue and expenses directly attributable to the DSL service assurance hardware product line were (in 000s):

                                     Three Months Ended          Six Months Ended
                                          June 30,                   June 30,
                                     2012           2011         2012         2011

 Hardware revenue                  $   1,255      $  1,603     $  2,084     $  3,353
 Direct expenses                       1,005         1,656        1,835        3,545
   Income (loss) from operations   $     250      ($    53 )   $    249     ($   192 )

Notwithstanding our decision to exit the DSL service assurance hardware business, we remain committed to developing our LDP software product and growing our DSL service assurance software business. There are essentially no technological or market dependencies between our DSL service assurance hardware and software product lines.

Patent Management. As we previously disclosed, our board of directors has been considering strategic options with respect to the monetization of a significant portion of our patent portfolio.

On June 21, 2012, we closed an agreement to sell patents pertaining to wireless technology for $75 million. Net proceeds from that transaction after transaction costs were $71.2 million and were included in the "Gain on sale of patent assets" line of our statement of comprehensive income for the three and six months ended June 30, 2012.

We intend to continue to pursue patent monetization alternatives for certain other patents remaining in our patent portfolio. We are unable to predict the size or the timing of any future potential transactions involving such patents or whether such transactions will be completed.

Prior to November 2009, we were also a supplier of DSL silicon intellectual property to the semiconductor industry. We continue to receive royalties from two customers that use our DSL silicon IP in their DSL chipsets.

Summary of Financial Results

Net income for the three months ended June 30, 2012 was $54.9 million, or $2.49 per diluted share, which compares to a net loss of $267,000, or $0.01 per diluted share, for the three months ended June 30, 2011. Income from operations for the three months ended June 30, 2012 was $445,000, which compares to a loss from operations of $283,000 for the three months ended June 30, 2011.

Net income for the six months ended June 30, 2012 was $56.0 million, or $2.60 per diluted share, which compares to net income of $323,000, or $0.02 per diluted share, for the six months ended June 30, 2011. Income from operations for the six months ended June 30, 2012 was $1.5 million, which compares to $290,000 for the six months ended June 30, 2011.

Higher net income in three and six month periods ended June 30, 2012 versus the corresponding periods in 2011 was primarily a result of the $71.2 million gain on the sale of patent assets. To a lesser degree, higher net income in 2012 was also driven by higher income from operations. Improved operating income in 2012 was primarily a result of: i) a greater proportion of software revenue in product sales, which is more profitable than hardware revenue; ii) lower expenses in our DSL service assurance engineering organization; and iii) lower CEO related expenses because our former CEO, who resigned on April 1, 2011, was replaced with existing members of senior management.

Results of Operations

Product Sales. Product sales consist primarily of revenue from the sale of hardware and software products. Hardware products consist primarily of DSL service assurance modules. Software products consist of software products, including maintenance contracts, for biometrics, medical imaging, and DSL service assurance applications.

Product sales were $4.0 million in three month periods ended June 30, 2011 and June 30, 2012. As a percentage of total revenue, product sales increased from 68% in the second quarter of 2011 to 75% in the current year quarter. Unchanged product sales were primarily due to a $0.4 million increase in revenue from the sale of biometrics and imaging software, which was offset by a $0.3 million decrease in revenue from the sale of DSL service assurance hardware and a $0.1 million decrease in revenue from the sale of DSL service assurance software.

Product sales decreased 5% from $9.1 million in the six months ended June 30, 2011 to $8.6 million in the same six month period in 2012. As a percentage of total revenue, product sales increased from 74% in the first six months of 2011 to 77% in the corresponding period of 2012. The dollar decrease in product sales was primarily due to a $1.3 million decrease in revenue from the sale of DSL service assurance hardware and a $0.6 million decrease in revenue from the sale of DSL service assurance software. The decrease in revenue from the sale of DSL service assurance hardware and software was partially offset by a $1.4 million increase in revenue from the sale of biometrics and imaging software.

Increases in revenue from the sale of biometrics and imaging software in the three and six month periods ended June 30, 2012 versus the corresponding periods in 2011 was primarily due to several larger-sized license transactions that were a result of our customers purchasing licenses for their customers' biometrics projects.

Decreases in revenue from the sale of DSL service assurance hardware in the three and six month periods ended June 30, 2012 versus the corresponding periods in 2011 was primarily due to our Board of Director's decision in January 2012 to shutdown this product line. Revenue attributable to the DSL service assurance hardware product line was $1.3 million and $1.6 million in the three months ended June 30, 2012 and 2011, respectively; and $2.1 million and $3.4 million in the six months ended June 30, 2012 and 2011, respectively. We will continue to build and ship DSL service assurance hardware products until we fulfill last time buy customer orders. We currently anticipate that we will conclude DSL hardware shipments during the third quarter of 2012. We expect that revenue from the sale of DSL service assurance hardware products will be insignificant after the quarter ended September 30, 2012.

Decreases in revenue from the sale of DSL service assurance software in the three and six month periods ended June 30, 2012 were primarily due to a larger sale of our LDP software in 2011 from which we recognized revenue in the three and six month periods of 2011. There was no revenue recognized from LDP sales of this magnitude in the three and six month periods of 2012.

Services. Services primarily consist of engineering service fees related to: i) our biometrics and imaging product line; ii) our DSL service assurance product line; and iii) a legacy DSL silicon contract.

Services decreased 50% from $1.4 million in the three months ended June 30, 2011 to $0.7 million in the same three month period in 2012. As a percentage of total revenue, services decreased from 23% in the second quarter of 2011 to 13% in the current year quarter.

Services decreased 38% from $2.2 million in the first six months of 2011 to $1.4 million in the same six month period in 2012. As a percentage of total revenue, services decreased from 18% in the first six months of 2011 to 12% in the corresponding period of 2012.

For the three and six month periods, the dollar decrease in services was primarily due to decreases in revenue from the sale of biometrics engineering services. While we are attempting to grow our biometrics services business, we were engaged in fewer larger projects in the first half of 2012 compared to the first half of 2011. Notwithstanding our intentions to grow this business, we are unable to predict whether services revenue will trend upward or downward in future periods as we continue to develop this business.

Royalties. Royalties consist of royalty payments we receive under legacy DSL silicon contracts. We receive royalties from DSL silicon customers for the right to incorporate our silicon IP in their DSL chipsets.

Royalties increased 15% from $541,000 in the three months ended June 30, 2011 to $625,000 in the same three month period in 2012. As a percentage of total revenue, royalties increased from 9% in the second quarter of 2011 to 12% in the current year quarter.

Royalties increased 12% from $1.0 million in the first six months of 2011 to $1.1 million in the same six month period in 2012. As a percentage of total revenue, royalties increased from 8% in the first six months of 2011 to 10% in the corresponding period of 2012.

For the three and six month periods, the dollar increase in royalties was primarily due to higher DSL royalties reported to us by one of our licensees, which was partially offset by lower royalties from our other licensee.

Our royalty revenue currently comes predominantly from DSL chipset sales by Ikanos Communications, Inc. ("Ikanos") and Lantiq Deutschland GmbH ("Lantiq"). The sale of our DSL silicon IP assets in November 2009 did not alter the royalty obligations of Ikanos or Lantiq, which we expect to continue per the existing agreements with those parties. We remain uncertain as to whether these licensees will be able to maintain their market shares and chipset prices in the face of intense competition, and whether our relationships with them will contribute meaningful royalties to us in the future. Accordingly, we are unable to predict whether royalties reported by our licensees will trend upward or downward in future periods.

Cost of Product Sales. Since the cost of software product sales is minimal, cost of product sales consists primarily of the cost of hardware product sales.

Cost of product sales decreased 24% from $1.1 million in the three months ended June 30, 2011 to $0.8 million in the same three month period in 2012. As a percentage of product sales, cost of product sales decreased from 27% in the second quarter of 2011 to 20% in the current year quarter, which means that product gross margins increased from 73% to 80%.

Cost of product sales decreased 44% from $2.3 in the six months ended June 30, 2011 to $1.3 million in the same six month period in 2012. As a percentage of product sales, cost of product sales decreased from 25% in the first six months of 2011 to 15% in the corresponding period of 2012, which means that product gross margins increased from 75% to 85%.

For the three and six month periods, the decrease in cost of product sales was primarily due to lower revenue from DSL service assurance hardware products as a result of our decision to shut down the DSL service assurance hardware product line in January 2012. The increase in product gross margins in the three and six month periods is primarily due to a higher proportion of software revenue in the product sales mix.

Cost of Services. Cost of services consists of engineering costs to complete customer engineering projects. Such costs primarily include: i) engineering salaries, stock-based compensation, fringe benefits, and facilities; and ii) engineering consultants and contractors.

Cost of services decreased 20% from $450,000 in the three months ended June 30, 2011 to $361,000 in the same three month period in 2012. Cost of services as a percentage of services increased from 33% in the second quarter of 2011 to 53% in the current quarter, which means that gross margins on services decreased from 67% to 47%.

Cost of services decreased 11% from $807,000 in the six months ended June 30, 2011 to $717,000 in the same six month period of 2012. Cost of services as a percentage of services increased from 37% in the first six months of 2011 to 52% in the corresponding period of 2012, which means that gross margins on services decreased from 63% to 48%.

For the three and six month periods, the dollar decrease in cost of services was primarily due to a decrease in biometrics engineering services as described in the Services section above. The decrease in gross margins on services was primarily due to the mix of engineering service projects. The profitability of service revenue is affected by the size and profitability of individual customer projects that comprise service revenue in any particular quarter.

Research and Development Expense. Research and development expense consists of costs for: i) engineering personnel, including salaries, stock-based compensation, fringe benefits, and facilities; ii) engineering consultants and contractors, and iii) other engineering expenses such as supplies, equipment depreciation, dues and memberships and travel. Engineering costs incurred to develop technology, products and patents related to our various product lines are classified as research and development expense. As described in the cost of services section, engineering costs incurred to provide engineering services for customer projects are classified as cost of services, and are not included in research and development expense.

The classification of total engineering costs to research and development expense and cost of services was (in 000s):

                                      Three Months Ended          Six Months Ended
                                           June 30,                   June 30,
                                       2012          2011         2012         2011

 Research and development expense   $    1,654      $ 1,809     $   3,406     $ 3,770
 Cost of services                          361          450           717         807
   Total engineering costs          $    2,015      $ 2,259     $   4,123     $ 4,577

Research and development expense decreased 9% from $1.8 million in the three months ended June 30, 2011 to $1.7 million in the same three month period in 2012. As a percentage of total revenue, research and development expense was 31% in the second quarter of 2011 and 2012.

Research and development expense decreased 10% from $3.8 million in the six months ended June 30, 2011 to $3.4 million in the same six month period in 2012. As a percentage of total revenue, research and development expense was 31% in the first six months of 2011 and 2012.

For the three and six month periods, the dollar decrease in research and development expense was primarily due to lower spending in our DSL service assurance engineering organization, which was partially offset by: i) higher spending in our biometrics and imaging engineering organization; and ii) less engineering costs classified as cost of services as set forth in the table immediately above.

Lower spending in our DSL service assurance engineering organization was driven by headcount attrition in the latter half of 2011 and our decision to exit the DSL hardware business in January 2012. Higher spending in our biometrics and imaging engineering organization was the result of headcount additions to support current projects and expected future projects. Less engineering costs were classified to cost of services because of a decrease in biometrics engineering services revenue.

Our research and development activities are focused primarily on developing biometrics and imaging software, and DSL service assurance software.

Selling and Marketing Expense. Selling and marketing expense primarily consists of costs for: i) sales and marketing personnel, including salaries, sales commissions, stock-based compensation, fringe benefits, travel, and facilities; and ii) advertising and promotion expenses.

Sales and marketing expense decreased 1% from $1.1 million for the three months ended June 30, 2011 to $1.0 million for the same three month period in 2012. As a percentage of total revenue, sales and marketing expense increased from 18% in the second quarter of 2011 to 19% in the corresponding period of 2012.

Sales and marketing expense increased 3% from $2.1 million for the six months ended June 30, 2011 to $2.2 million for the same six month period in 2012. As a percentage of total revenue, sales and marketing expense increased from 17% in the first six months of 2011 to 20% in the corresponding period of 2012.

For the three and six month periods, essentially unchanged sales and marketing expense reflected: 1) a stable sales and marketing organization; and 2) consistent levels of promotional activities. The decision to exit the DSL hardware business did not have a material impact on selling and marketing expense in the three and six month periods because the one employee involved in DSL hardware sales remained with the company as a member of the biometrics and imaging sales organization.

General and Administrative Expense. General and administrative expense consists primarily of costs for: i) officers, directors and administrative personnel, including salaries, bonuses, director compensation, stock-based compensation, fringe benefits, and facilities; ii) professional fees, including legal and audit fees; iii) public company expenses; and iv) other administrative expenses, such as insurance costs and bad debt provisions.

General and administrative expense decreased 40% from $1.8 million in the three months ended June 30, 2011 to $1.1 million in the same three month period in 2012. As a percentage of total revenue, general and administrative expense decreased from 30% in the second quarter of 2011 to 20% in the current year quarter.

General and administrative expense decreased 31% from $3.0 million in the six months ended June 30, 2011 to $2.1 million in the same six month period in 2012. As a percentage of total revenue, general and administrative expense decreased from 24% in the first six months of 2011 to 18% in the corresponding period of 2012.

For the three and six month periods, the dollar decrease in general and administrative expense was primarily due to the resignation of our former CEO on April 1, 2011. His position was filled by existing members of senior management, which obviated the need to compensate a replacement CEO. In addition, the three and six months ended June 30, 2011 included $0.6 million of severance related expenses for our former CEO.

Gain on Sale of Patent Assets. In the three months ended June 30, 2012, we recorded a $71.2 million net gain from the sale of patents pertaining to wireless technology. Gross sale proceeds of $75 million were reduced by $3.8 million of transaction costs which consisted primarily of fees from the law firm that assisted us with the sale.

We intend to continue to pursue patent monetization alternatives for certain other patents remaining in our patent portfolio. We are unable to predict the size or the timing of any future potential transactions involving such patents or whether such transactions will be completed.

Other Income. We recorded $58,000 and $85,000 of other income in the three and six month periods ended June 30, 2012, respectively. These amounts represented realized gains on the sale of high yield bond investments in both periods.

Interest Income. Interest income increased 156% from $16,000 in three months ended June 30, 2011 to $40,000 in the same three month period in 2012. Interest income increased 161% from $35,000 in the six months ended June 30, 2011 to $92,000 in the same six month period in 2012.

For the three and six month periods, the dollar increase was primarily due to interest we received from high yield bonds we purchased in the fourth quarter of 2011. We sold a portion of these bonds in late March 2012 and the remaining portion in late June 2012. At June 30, 2012, we held no high yield bonds.

Income Taxes. The gain on sale of patent assets was primarily responsible for producing $72.9 million of income before taxes in the six month period ended June 30, 2012. We used a significant portion our deferred tax assets available as of June 30, 2012 to reduce income taxes on year-to-date pre-tax earnings. Consequently, we recorded a $4.1 million income tax liability as of June 30, 2012, which consisted of $3.1 million of federal income taxes and $1.0 million of state income taxes.

A substantial portion of the deferred tax assets we utilized comprised cumulative deductions for stock options in excess of book expense. Under income tax accounting rules, that portion of tax benefits attributable to such deductions must be recorded as an adjustment to equity versus a reduction of income tax expense. In the six months ended June 30, 2012, the tax benefits from such stock-based awards were $12.7 million, which we recorded as an equity adjustment to additional paid-in capital. After the equity adjustment, we recorded $16.8 million of income tax expense in the statement of comprehensive income during the three months ended June 30, 2012. The $16.8 million income tax expense consists of the $4.1 million current income tax liability plus the $12.7 million non-cash adjustment that was recorded to equity.

We continue to record a full valuation allowance against our remaining deferred tax assets because based on all the available evidence, we continue to believe that it is more likely than not that our deferred tax assets are not currently realizable. In reaching this determination, we evaluated our three-year cumulative results as well as the impact that current economic conditions may have on our future results.

We will continue to assess the level of valuation allowance required in future periods. Should more positive than negative evidence regarding the realizability of tax assets exist at a future point in time, the valuation allowance may be reduced or eliminated altogether.

Liquidity and Capital Resources

At June 30, 2012, we had cash and cash equivalents of $101.1 million, which represented an increase of $54.5 million from December 31, 2011. The increase in cash was primarily due to: i) $71.2 million of net proceeds from the sale of patent assets; ii) $2.2 million of cash provided by operations; iii) $5.8 million of proceeds from the issuance of common stock as a result of stock option exercises; and iv) $0.9 million from the sale of investments. Increases in cash from these sources were partially offset by: i) a $25.5 million special dividend payment; ii) $59,000 of cash used to purchase capital equipment; and
iii) $36,000 of cash used to pay withholding taxes for employees who surrendered shares of common stock in connection with stock issuances.

Capital spending was primarily related to the purchase of computer hardware used principally in engineering activities.

In the six months ended June 30, 2012, we issued stock in connection with officer and employee stock grants. We allowed grantees to surrender a portion of their shares of stock in return for the Company paying their related withholding taxes. As a result of this provision, grantees surrendered 12,153 shares of common stock, and we paid approximately $36,000 of withholding taxes on their behalf.

While we cannot assure you that we will not require additional financing, or that such financing will be available to us, we believe that our cash and cash equivalents will be sufficient to fund our operations for at least the next twelve months.

Recent Accounting Pronouncements

See Note H to our Consolidated Financial Statements in Item 1.

ITEM 3: