UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

AMENDMENT NO. 1 TO

 

FORM 10-Q/A

 

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

For the quarterly period ended September 30, 2003

 

Commission File Number 000-30229

 


 

SONUS NETWORKS, INC.

(Exact name of Registrant as specified in its charter)

 

DELAWARE

 

04-3387074

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. employer identification no.)

 

250 Apollo Drive, Chelmsford, Massachusetts 01824

(Address of principal executive offices, including zip code)

 

(978) 614-8100

(Registrant’s telephone number, including area code)

 


 

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 ý  No o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý  No o

 

As of October 31, 2003, there were 244,447,808 shares of $0.001 par value per share, common stock outstanding.

 

 



 

EXPLANATORY NOTE

 

As reported in our 2003 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission (SEC) on July 28, 2004, we have restated our consolidated financial statements for the years ended December 31, 2002 and 2001 and the nine months ended September 30, 2003. We also reported in our 2003 Annual Report on Form 10-K/A that we anticipated amending our previously filed quarterly reports for each of the first three quarters of 2003. This Amendment No. 1 on Form 10-Q/A to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, filed with the SEC on November 10, 2003, is being filed for the purpose of restating our condensed consolidated financial statements and related disclosures for the three and nine months ended September 30, 2003 and 2002 under Item 1 of Part I; and restating Items 2 and 4 of Part I as well as Item 6 of Part II, consistent with the restatement-related adjustments described in our 2003 Annual Report on Form 10-K/A filed with the SEC on July 28, 2004.

 

This Amendment No. 1 on Form 10-Q/A does not reflect events occurring after the filing of the original Quarterly Report on Form 10-Q on November 10, 2003, or modify or update the disclosure presented in the original Quarterly Report on Form 10-Q, except to reflect the revisions as described above.

 

SONUS NETWORKS, INC.

AMENDMENT NO. 1 ON FORM 10-Q/A

QUARTER ENDED SEPTEMBER 30, 2003

 

TABLE OF CONTENTS

 

PART I—FINANCIAL INFORMATION

 

 

 

 

Item 1:

Financial Statements

 

 

Condensed Consolidated Balance Sheets as of September 30, 2003 (unaudited) and December 31, 2002

3

 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2003 and 2002 (unaudited)

4

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002 (unaudited)

5

 

Notes to Condensed Consolidated Financial Statements (unaudited)

6

Item 2:

Management’s Discussion and Analysis of Financial Condition and Results of Operations

28

Item 4:

Controls and Procedures

36

 

 

 

PART II—OTHER INFORMATION

 

 

 

Item 6:

Exhibits and Reports on Form 8-K

38

 

Signatures

39

 

2



 

PART I—FINANCIAL INFORMATION

 

Item 1: Financial Statements

 

SONUS NETWORKS, INC.

Condensed Consolidated Balance Sheets

(In thousands, except share data)

 

 

 

September 30,
2003

 

December 31,
2002

 

 

 

(As Restated)

 

 

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

255,059

 

$

57,278

 

Marketable securities

 

45,875

 

60,860

 

Accounts receivable, net

 

8,336

 

4,622

 

Inventory, net

 

16,422

 

10,449

 

Other current assets

 

7,487

 

3,516

 

Total current assets

 

333,179

 

136,725

 

Property and equipment, net

 

6,933

 

11,546

 

Purchased intangible assets, net

 

3,004

 

4,810

 

Other assets

 

299

 

436

 

 

 

$

343,415

 

$

153,517

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

2,909

 

$

3,625

 

Accrued expenses

 

17,470

 

16,489

 

Accrued restructuring expenses

 

845

 

2,331

 

Current portion of deferred revenue

 

72,819

 

51,728

 

Current portion of long-term liabilities

 

1,329

 

1,606

 

Total current liabilities

 

95,372

 

75,779

 

Long-term deferred revenue, less current portion.

 

12,344

 

8,024

 

Long-term liabilities, less current portion

 

1,822

 

3,293

 

Convertible subordinated note

 

10,000

 

10,000

 

Commitments and contingencies (Note 9)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.01 par value; 5,000,000 shares authorized, none issued and outstanding

 

 

 

Common stock, $0.001 par value; 600,000,000 shares authorized, 246,319,973 and 206,866,358 shares issued and 244,023,063 and 204,599,548 shares outstanding at September 30, 2003 and December 31, 2002

 

246

 

207

 

Capital in excess of par value

 

1,040,518

 

853,560

 

Accumulated deficit

 

(815,463

)

(793,426

)

Deferred compensation

 

(1,157

)

(3,659

)

Treasury stock, at cost; 2,296,910 and 2,266,810 common shares at September 30, 2003 and December 31, 2002

 

(267

)

(261

)

Total stockholders’ equity

 

223,877

 

56,421

 

 

 

$

343,415

 

$

153,517

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3



 

SONUS NETWORKS, INC.

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited and As Restated)

 

 

 

Three Months ended
September 30,

 

Nine Months ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Product

 

$

14,528

 

$

3,498

 

$

26,300

 

$

62,727

 

Service

 

7,723

 

5,660

 

20,526

 

18,714

 

Total revenues

 

22,251

 

9,158

 

46,826

 

81,441

 

Cost of revenues (1):

 

 

 

 

 

 

 

 

 

Product

 

5,382

 

5,034

 

10,816

 

28,610

 

Service

 

3,874

 

2,885

 

9,798

 

8,892

 

Write-off of inventory and purchase commitments

 

 

 

 

6,865

 

Total cost of revenues

 

9,256

 

7,919

 

20,614

 

44,367

 

Gross profit

 

12,995

 

1,239

 

26,212

 

37,074

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development (1)

 

8,036

 

9,218

 

24,245

 

35,314

 

Sales and marketing (1)

 

7,732

 

4,466

 

16,179

 

21,342

 

General and administrative (1)

 

842

 

2,932

 

4,137

 

6,711

 

Stock-based compensation

 

1,047

 

2,228

 

2,616

 

13,945

 

Amortization of purchased intangible assets

 

602

 

1,173

 

1,806

 

3,553

 

Write-off of goodwill and purchased intangible assets

 

 

10,950

 

 

10,950

 

Restructuring charges, net

 

 

1,007

 

 

6,772

 

Total operating expenses

 

18,259

 

31,974

 

48,983

 

98,587

 

Loss from operations

 

(5,264

)

(30,735

)

(22,771

)

(61,513

)

Interest expense

 

(128

)

(162

)

(406

)

(437

)

Interest income

 

396

 

465

 

1,238

 

1,569

 

Loss before income taxes

 

(4,996

)

(30,432

)

(21,939

)

(60,381

)

Provision for income taxes

 

33

 

22

 

98

 

65

 

Net loss

 

$

(5,029

)

$

(30,454

)

$

(22,037

)

$

(60,446

)

 

 

 

 

 

 

 

 

 

 

Basic and diluted net loss per share

 

$

(0.02

)

$

(0.16

)

$

(0.10

)

$

(0.32

)

 

 

 

 

 

 

 

 

 

 

Shares used in computing net loss per share (Note 3(p))

 

224,356

 

193,155

 

213,322

 

189,962

 

 


(1)                                  Excludes non-cash, stock-based compensation expense as follows:

 

Cost of revenues

 

$

13

 

$

99

 

$

35

 

$

463

 

Research and development

 

314

 

1,207

 

943

 

7,532

 

Sales and marketing

 

603

 

752

 

1,282

 

4,413

 

General and administrative

 

117

 

170

 

356

 

1,537

 

 

 

$

1,047

 

$

2,228

 

$

2,616

 

$

13,945

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4



 

SONUS NETWORKS, INC.

Condensed Consolidated Statements of Cash Flows

(In thousands, except per share data)

(Unaudited and As Restated)

 

 

 

Nine months ended
September 30,

 

 

 

2003

 

2002

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(22,037

)

$

(60,446

)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

7,659

 

12,006

 

Write-off of inventory

 

 

6,865

 

Stock-based compensation

 

2,616

 

13,945

 

Amortization of purchased intangible assets

 

1,806

 

3,553

 

Write-off of goodwill

 

 

10,950

 

Non-cash restructuring benefit

 

 

 

Changes in current assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(3,714

)

5,037

 

Inventory

 

(5,973

)

20,644

 

Other current assets

 

(3,971

)

4,261

 

Accounts payable

 

(716

)

(9,672

)

Accrued expenses

 

(989

)

(9,993

)

Deferred revenue

 

25,411

 

(32,707

)

Net cash provided by (used in) operating activities

 

93

 

(35,557

)

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(3,046

)

(2,844

)

Maturities of marketable securities

 

19,682

 

35,631

 

Purchases of marketable securities

 

(4,697

)

(22,032

)

Other assets

 

137

 

(8

)

Net cash provided by investing activities

 

12,076

 

10,747

 

Cash flows from financing activities:

 

 

 

 

 

Net proceeds from sale of common stock to public

 

182,755

 

 

Sale of common stock in connection with employee stock purchase plan

 

966

 

2,843

 

Proceeds from exercise of stock options

 

3,162

 

108

 

Additions to long-term liabilities

 

 

3,300

 

Payments of long-term liabilities

 

(1,264

)

(620

)

Repurchase of common stock

 

(6

)

(128

)

Net cash provided by financing activities

 

185,613

 

5,503

 

Net increase (decrease) in cash and cash equivalents

 

197,781

 

(19,307

)

Cash and cash equivalents, beginning of period

 

57,278

 

49,069

 

Cash and cash equivalents, end of period

 

$

255,059

 

$

29,762

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during the period for interest

 

$

288

 

$

318

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5



 

SONUS NETWORKS, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

(1) Description of Business

 

Sonus Networks, Inc. (Sonus) was incorporated on August 7, 1997 and is a leading provider of packet voice infrastructure solutions for wireline and wireless service providers. Sonus offers a new generation of carrier-class switching equipment and software that enable telecommunications service providers to deliver voice services over packet-based networks.

 

(2) Restatement of Consolidated Financial Statements

 

As reported in Sonus’ 2003 Annual Report on Form 10-K/A filed with the SEC on July 28, 2004, Sonus has restated its consolidated financial statements for the years ended December 31, 2002 and 2001 and the nine months ended September 30, 2003. Sonus also reported in its 2003 Annual Report on Form 10-K/A that it anticipated amending its previously filed quarterly reports for each of the first three quarters of 2003.  Sonus has filed this Amendment No. 1 on Form 10-Q/A to its Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, filed with the SEC on November 10, 2003, for the purpose of restating its condensed consolidated financial statements and related disclosures for the three and nine months ended September 30, 2003 and 2002. Amounts disclosed with respect to the December 31, 2002 balance sheet have previously been restated in our Form 10-K/A filed with the SEC on July 28, 2004 and are not reported as restated herein.

 

6



 

The following summarizes the effects of the restatement adjustments on various line items of Sonus’ condensed consolidated statements of operations for the three and nine months ended September 30, 2003 and 2002.

 

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended September 30, 2003

 

Nine Months Ended September 30, 2003

 

 

 

As Reported

 

Adjustments

 

As Restated

 

As Reported

 

Adjustments

 

As Restated

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

$

22,352

 

$

(7,824

)

$

14,528

 

$

48,408

 

$

(22,108

)

$

26,300

 

Service

 

6,292

 

1,431

 

7,723

 

17,611

 

2,915

 

20,526

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

28,644

 

(6,393

)

22,251

 

66,019

 

(19,193

)

46,826

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

7,237

 

(1,855

)

5,382

 

16,129

 

(5,313

)

10,816

 

Service

 

3,810

 

64

 

3,874

 

9,876

 

(78

)

9,798

 

Write-off (benefit) of inventory and purchase commitments

 

 

 

 

(735

)

735

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total cost of revenues

 

11,047

 

(1,791

)

9,256

 

25,270

 

(4,656

)

20,614

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

17,597

 

(4,602

)

12,995

 

40,749

 

(14,537

)

26,212

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

7,984

 

52

 

8,036

 

23,931

 

314

 

24,245

 

Sales and marketing

 

6,536

 

1,196

 

7,732

 

17,453

 

(1,274

)

16,179

 

General and administrative

 

999

 

(157

)

842

 

3,267

 

870

 

4,137

 

Stock-based compensation

 

866

 

181

 

1,047

 

2,499

 

117

 

2,616

 

Amortization of purchased intangible assets

 

271

 

331

 

602

 

813

 

993

 

1,806

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

16,656

 

1,603

 

18,259

 

47,963

 

1,020

 

48,983

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

941

 

(6,205

)

(5,264

)

(7,214

)

(15,557

)

(22,771

)

Interest expense

 

(128

)

 

(128

)

(406

)

 

(406

)

Interest income

 

396

 

 

396

 

1,238

 

 

1,238

 

Income (loss) before income taxes

 

1,209

 

(6,205

)

(4,996

)

(6,382

)

(15,557

)

(21,939

)

Provision for income taxes

 

 

33

 

33

 

 

98

 

98

 

Net income (loss)

 

$

1,209

 

$

(6,238

)

$

(5,029

)

$

(6,382

)

$

(15,655

)

$

(22,037

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.01

 

$

(0.03

)

$

(0.02

)

$

(0.03

)

$

(0.07

)

$

(0.10

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

$

0.01

 

$

(0.03

)

$

(0.02

)

$

(0.03

)

$

(0.07

)

$

(0.10

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares used in computing net income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

224,356

 

 

224,356

 

213,322

 

 

213,322

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

239,446

 

(15,090

)

224,356

 

213,322

 

 

213,322

 

 

7



 

 

 

Three Months Ended September 30, 2002

 

Nine Months Ended September 30, 2002

 

 

 

As Reported

 

Adjustments

 

As Restated

 

As Reported

 

Adjustments

 

As Restated

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

$

3,256

 

$

242

 

$

3,498

 

$

34,864

 

$

27,863

 

$

62,727

 

Service

 

4,189

 

1,471

 

5,660

 

15,034

 

3,680

 

18,714

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

7,445

 

1,713

 

9,158

 

49,898

 

31,543

 

81,441

 

Cost of revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

2,246

 

2,788

 

5,034

 

16,152

 

12,458

 

28,610

 

Service

 

2,501

 

384

 

2,885

 

8,418

 

474

 

8,892

 

Write-off of inventory and purchase commitments

 

 

 

 

9,434

 

(2,569

)

6,865

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total cost of revenues

 

4,747

 

3,172

 

7,919

 

34,004

 

10,363

 

44,367

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

2,698

 

(1,459

)

1,239

 

15,894

 

21,180

 

37,074

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

9,685

 

(467

)

9,218

 

36,525

 

(1,211

)

35,314

 

Sales and marketing

 

5,520

 

(1,054

)

4,466

 

22,207

 

(865

)

21,342

 

General and administrative

 

2,446

 

486

 

2,932

 

5,603

 

1,108

 

6,711

 

Stock-based compensation

 

3,962

 

(1,734

)

2,228

 

15,654

 

(1,709

)

13,945

 

Amortization of purchased intangible assets

 

366

 

807

 

1,173

 

1,155

 

2,398

 

3,553

 

Write-off of goodwill and purchased intangibles

 

1,673

 

9,277

 

10,950

 

1,673

 

9,277

 

10,950

 

Restructuring charges (benefit), net

 

987

 

20

 

1,007

 

(10,141

)

16,913

 

6,772

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

24,639

 

7,335

 

31,974

 

72,676

 

25,911

 

98,587

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss from operations

 

(21,941

)

(8,794

)

(30,735

)

(56,782

)

(4,731

)

(61,513

)

Interest expense

 

(163

)

1

 

(162

)

(438

)

1

 

(437

)

Interest income

 

466

 

(1

)

465

 

1,570

 

(1

)

1,569

 

Loss before income taxes

 

(21,638

)

(8,794

)

(30,432

)

(55,650

)

(4,731

)

(60,381

)

Provision for income taxes

 

 

22

 

22

 

 

65

 

65

 

Net loss

 

$

(21,638

)

$

(8,816

)

$

(30,454

)

$

(55,650

)

$

(4,796

)

$

(60,446

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted net loss per share

 

$

(0.11

)

$

(0.05

)

$

(0.16

)

$

(0.30

)

$

(0.02

)

$

(0.32

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares used in computing net loss per share

 

191,823

 

1,332

 

193,155

 

188,620

 

1,342

 

189,962

 

 

8



 

The following summarizes the effects of the restatement adjustments on various line items of Sonus’ condensed consolidated balance sheet as of September 30, 2003.

 

Condensed Consolidated Balance Sheet

September 30, 2003

(In thousands)

(Unaudited)

 

 

 

As Reported

 

Adjustments

 

As Restated

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

246,981

 

$

8,078

 

$

255,059

 

Marketable securities

 

45,875

 

 

45,875

 

Accounts receivable, net

 

5,604

 

2,732

 

8,336

 

Inventory, net

 

12,333

 

4,089

 

16,422

 

Other current assets

 

6,313

 

1,174

 

7,487

 

Total current assets

 

317,106

 

16,073

 

333,179

 

Property and equipment, net

 

6,514

 

419

 

6,933

 

Purchased intangible assets, net

 

361

 

2,643

 

3,004

 

Other assets

 

339

 

(40

)

299

 

 

 

$

324,320

 

$

19,095

 

$

343,415

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

3,637

 

$

(728

)

$

2,909

 

Accrued expenses

 

32,923

 

(15,453

)

17,470

 

Accrued restructuring expenses

 

845

 

 

845

 

Current portion of deferred revenue

 

34,036

 

38,783

 

72,819

 

Current portion of long-term liabilities

 

1,329

 

 

1,329

 

 

 

 

 

 

 

 

 

Total current liabilities

 

72,770

 

22,602

 

95,372

 

 

 

 

 

 

 

 

 

Long-term deferred revenue, less current portion

 

 

12,344

 

12,344

 

Long-term liabilities, less current portion

 

1,822

 

 

1,822

 

Convertible subordinated note

 

10,000

 

 

10,000

 

Commitments and contingencies

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

Preferred stock

 

 

 

 

Common stock

 

246

 

 

246

 

Capital in excess of par value

 

1,045,077

 

(4,559

)

1,040,518

 

Accumulated deficit

 

(804,250

)

(11,213

)

(815,463

)

Deferred compensation

 

(1,078

)

(79

)

(1,157

)

Treasury stock, at cost

 

(267

)

 

(267

)

Total stockholders’ equity

 

239,728

 

(15,851

)

223,877

 

 

 

$

324,320

 

$

19,095

 

$

343,415

 

 

These restated financial statements include a number of adjustments, which primarily relate to revenue, deferred revenue, inventory reserves, purchase accounting, impairments, accrued expenses and stock-based compensation. Adjustments to revenue result primarily in revenue being deferred and recognized in subsequent periods. Adjustments to inventory and accrued expenses are primarily to increase or decrease reserve levels previously reported. Adjustments to purchase accounting, impairment, and stock-based compensation relate primarily to the timing of expense recognition.  The following discussion provides additional information regarding these adjustments.

 

9



 

Revenue Adjustments

 

Deferral of product revenue

 

Sonus has deferred revenues of $36.7 million previously reported in 2001 and the first quarter of 2002 from a particular customer transaction. The amount of $27.5 million was subsequently recognized in the second quarter of 2002, while the remainder was allocated to maintenance revenue and recognized over the period the services are provided. This transaction involved a complex multiple element arrangement that required significant analysis with respect to the facts surrounding the transaction and technical accounting analysis to determine when revenue should be recognized. Sonus previously recognized revenue in 2001 under this contractual arrangement upon delivery and acceptance of certain product and software releases. As a result of a comprehensive review and analysis of this arrangement, and based on the application of complex revenue recognition guidance, Sonus has now determined that there was insufficient support to establish vendor specific objective evidence of fair value (VSOE) with respect to certain undelivered software releases and Sonus has determined the existence of certain previously unidentified specified software releases. As a result, Sonus has deferred product revenues associated with products and software releases shipped to this customer in 2001 and the first quarter of 2002 until the second quarter of 2002, when all software releases under the arrangement were delivered.

 

In the fourth quarter of 2002, Sonus amended its arrangement with this customer to include, among other items, certain additional future software releases. Sonus previously recognized revenue from this arrangement in the fourth quarter of 2002 and in each of the first three quarters of 2003 upon delivery of the products and software releases. Upon review and analysis of the arrangement, Sonus has determined that, based on a technical analysis of software revenue recognition rules, that VSOE was not established for certain undelivered software releases. As a result, Sonus has deferred revenues of $16.2 million associated with products and software releases shipped to this customer during the fourth quarter of 2002 and the first three quarters of 2003, including the deferral of $3.1 million and $15.5 million of products and software releases shipped during the three and nine months ended September 30, 2003. Sonus recognized $10.9 million of those revenues in the fourth quarter of 2003 when the final software release specified in the amendment was delivered to the customer, and the remaining amount was deferred and allocated to maintenance services and estimated discounts on future purchases.

 

Maintenance revenue

 

A number of Sonus’ customer transactions involve multiple elements, including the delivery of product and maintenance services as part of a bundled offering. Statement of Position (SOP) 97-2, Software Revenue Recognition, requires maintenance revenue to be recognized over the period services are provided. Based on Sonus’ review and analysis, Sonus identified certain circumstances in which Sonus offered maintenance services at no additional charge or at discounted rates to certain customers but did not separate the fair value for the maintenance from product revenue. This resulted in revenue associated with the value of the undelivered maintenance services not being recognized over the service period. In the restated financial statements, Sonus has recognized maintenance revenue ratably over the period in which the maintenance services were provided based on the deferral of the applicable VSOE of maintenance services. In such cases, Sonus has reclassified maintenance services from product revenue to service revenue for the applicable periods presented. Based on Sonus’ review and analysis, Sonus also identified certain circumstances in which insufficient value was allocated to maintenance. In such cases, Sonus has reclassified additional amounts from product revenue to service revenue for the applicable periods presented. In connection with the recognition of the deferred product revenue described above in the second quarter of 2002 and the fourth quarter of 2003, a significant portion of the product revenue was allocated to the value of undelivered maintenance services and deferred over the five-year period in which the maintenance services are provided.

 

Delivery

 

Sonus identified transactions where it delivered some, but not all, of the product required under an arrangement. Previously, Sonus deferred a portion of the revenue for these undelivered products based on the pricing in the arrangement, and recognized the remaining revenue on the delivered products. On a restated basis, Sonus has deferred all revenue until all elements of the transaction were delivered because it was not able to establish VSOE for the undelivered product or, in some instances, because such undelivered product was essential to the functionality of the delivered

 

10



 

product.

 

Customer acceptance

 

Sonus identified certain circumstances where revenue was recognized in a period other than the one in which acceptance was achieved or other contingencies were resolved. As restated, revenue from such arrangements is recorded in the period in which customer acceptance occurred or other contingencies were resolved.

 

Summary

 

The following table is a reconciliation of revenue as previously reported to amounts as restated for the periods indicated, in thousands:

 

 

 

Three months
ended
September 30,
2003

 

Three months
ended
September 30,
2002

 

Nine months
ended
September 30,
2003

 

Nine months
ended
September 30,
2002

 

 

 

 

 

 

 

 

 

 

 

Revenues, as previously reported

 

$

28,644

 

$

7,445

 

$

66,019

 

$

49,898

 

Revenue Restatement Adjustments:

 

 

 

 

 

 

 

 

 

Deferral of product revenue

 

(3,072

)

2,255

 

(15,452

)

35,389

 

Maintenance revenue

 

(2,627

)

(1,575

)

(2,816

)

(11,934

)

Delivery

 

(12

)

(12

)

(332

)

3,908

 

Customer acceptance

 

(682

)

(35

)

(754

)

1,622

 

Other

 

 

1,080

 

161

 

2,558

 

Total Revenue Restatement Adjustments

 

(6,393

)

1,713

 

(19,193

)

31,543

 

Revenues, as restated

 

$

22,251

 

$

9,158

 

$

46,826

 

$

81,441

 

 

Expense Adjustments
 

Accrued expenses

 

During Sonus’ review and analysis, Sonus identified several accrued expense accounts that required adjustment to be in accordance with Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies. Accounting for accrued expenses requires estimates and judgments, which can be complex. Sonus adjusted accrual balances as the result of: (1) using more appropriate business assumptions to estimate certain liabilities, such as warranty reserves and post-shipment obligations to customers; (2) in those instances lacking available foundation or support for recorded balances at the time the original accrual was established, using currently known information, including actual disbursements and contemporaneous documentation in order to record the appropriate balances, such as royalties and professional fees; and (3) appropriately classifying certain balance sheet items, such as customer deposits to deferred revenues.

 

The following table is a reconciliation of accrued expense adjustments by category as of the dates indicated, in thousands:

 

 

 

Sept. 30, 2003

 

December 31, 2002

 

Accrued expense adjustments—increase/(decrease) for:

 

 

 

 

 

Employee compensation and related costs

 

$

(991

)

$

208

 

Professional fees

 

(1,080

)

(1,239

)

Royalties

 

1,163

 

1,492

 

Warranty reserve

 

(3,109

)

(3,385

)

Post-shipment obligations to customers

 

(2,527

)

(2,527

)

Customer deposits

 

(6,576

)

(7,240

)

Other

 

(2,333

)

(4,199

)

Total accrued expense adjustments

 

$

(15,453

)

$

(16,890

)

 

11



 

Restructuring expense and benefits

 

In connection with Sonus’ review and analysis, Sonus determined that a restructuring benefit of $16,557,000 for a lease renegotiation originally recorded in the first quarter of 2002 should have been recorded in 2001.  In addition, Sonus increased 2002 expenses by $356,000. The effect of these adjustments was to adjust the restructuring item from a benefit of $10,141,000 to an expense of $6,772,000 in the nine months ended September 30, 2002.

 

Valuation of Intangibles

 

During 2001, Sonus acquired two companies, telecom technologies, inc. (TTI) and Linguateq, Inc. (Linguateq). Sonus accounted for the TTI acquisition as a purchase in accordance with Accounting Principles Board (APB) No. 16, Business Combinations, and for Linguateq as a purchase in accordance with SFAS No. 141, Business Combinations. As part of Sonus’
re-examination of these acquisitions, Sonus hired an independent third-party appraiser. In connection with the TTI acquisition
re-appraisal, Sonus has re-examained the total consideration paid, net liabilities assumed, and certain assumptions and calculations supporting the original appraisal of the identified intangible assets acquired from TTI. These assumptions included the customer turnover rate, the gross and operating margin percentages and inconsistencies in the profit assumptions used to value in-process research and development compared to other identified intangible assets. The results of these changes to the purchase price and related allocation for the TTI acquisition are as follows, in thousands:

 

Purchase Price of TTI

 

As Reported

 

Adjustments

 

As Restated

 

Fair market value of shares issued

 

$

527,613

 

$

(612

)

$

527,001

 

Liabilities assumed

 

21,184

 

(1,375

)

19,809

 

Acquisition expenses

 

5,833

 

(67

)

5,766

 

Total

 

$

554,630

 

$

(2,054

)

$

552,576

 

 

As a result of re-appraisal of assets acquired, the final purchase price has been allocated to the tangible and intangible assets acquired based upon their fair values as follows, in thousands:

 

Purchase Price Allocation of TTI

 

As Reported

 

Adjustments

 

As Restated

 

Tangible assets

 

$

8,296

 

$

1,096

 

$

9,392

 

Intangible assets:

 

 

 

 

 

 

 

Workforce

 

3,000

 

3,900

 

6,900

 

Developed technology

 

11,900

 

2,100

 

14,000

 

Customer relationships

 

17,400

 

6,800

 

24,200

 

In-process research and development

 

40,000

 

800

 

40,800

 

Deferred compensation related to unvested stock option

 

22,600

 

 

22,600

 

Goodwill

 

451,434

 

(16,750

)

434,684

 

Total

 

$

554,630

 

$

(2,054

)

$

552,576

 

 

In connection with the revised appraisals, Sonus has determined that the useful life of the TTI customer relationships and goodwill should be five years, compared to three years as previously reported. The impact to amortization expense as a result of the change in estimated useful lives and valuation of intangibles was an increase of $331,000 and $807,000 for the three months ended September 30, 2003 and 2002 and $993,000 and $2,398,000 for the nine months ended September 30, 2003 and 2002.

 

Impairment

 

In 2001, in light of negative industry and economic conditions, a general decline in technology valuations, and

 

12



 

Sonus’ decision to discontinue the development and use of certain acquired technology, Sonus performed an assessment of the carrying value of goodwill and purchased intangible assets from TTI recorded in connection with SFAS No. 121, Accounting for the Impairment of Long-lived Assets and Assets to be Disposed of, which resulted in the net remaining value as of December 31, 2001 as originally reported below. Due to the changes in the valuation of intangible assets and their useful lives described above and the use of more appropriate revenue projections supporting the impairment calculation performed under SFAS No. 121 in 2001, Sonus performed a new impairment assessment with the assistance of a new third-party appraiser, which resulted in the net remaining value as of December 31, 2001 as restated below (after the reallocation of goodwill to the purchased intangibles):

 

SFAS No. 121 Impairment of Assets Acquired from TTI

(in thousands)

 

 

 

Remaining
Value as of
December 31, 2001

 

Remaining
Value as of
December 31, 2001

 

 

 

(as reported)

 

(as restated)

 

Customer relationships

 

$

2,308

 

$

16,350

 

Developed technology

 

 

 

Workforce

 

797

 

2,381

 

Fixed assets

 

 

 

Total

 

$

3,105

 

$

18,731

 

 

In 2002, Sonus adopted SFAS No. 141, which resulted in a reclassification of all remaining workforce-related intangible assets into goodwill. As a result of the continuing and significant decline in the market for telecommunications equipment and pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets, Sonus performed an impairment analysis of certain technology acquired from Linguateq. In addition, Sonus performed an impairment analysis on its remaining goodwill for both the TTI and Linguateq acquisitions pursuant to SFAS No. 142, Goodwill and Other Intangible Assets. The results of these analyses are summarized in the following table, in thousands:

 

 

 

Three and Nine Months Ended September 30, 2002

 

 

 

Impairment
charge,
As Reported

 

Adjustments

 

Impairment
charge,
As Restated

 

TTI customer relationships

 

$

 

$

7,669

 

$

7,669

 

TTI goodwill

 

796

 

1,585

 

2,381

 

Linguateq developed technology and customer relationship

 

175

 

 

175

 

Linguateq goodwill

 

877

 

(152

)

725

 

Total

 

$

1,848

 

$

9,102

 

$

10,950

 

 

Stock-based Compensation

 

Sonus identified items in the calculation of stock-based compensation and related items that required adjustments to the stockholders’ equity section of its balance sheet, and stock-based compensation expense. These items pertain to errors involving the amortization and recapture of deferred compensation, the 2002 exchange of outstanding employee stock options, and intrinsic value charges for restricted stock and stock options grants and modifications.

 

Sonus previously adopted the accelerated method of amortizing all deferred compensation defined under Financial Accounting Standards Board (FASB) Financial Interpretation No. (FIN) 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. In the event of forfeiture of a stock-based award, FIN 44,

 

13



 

Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, requires that compensation expense be adjusted to recapture the compensation expense previously recorded related to unvested stock-based awards, in the period of forfeiture. Sonus previously had not recorded recapture of any such excess compensation expense upon the forfeiture of a stock-based award upon employee termination. As a result, Sonus has decreased stock-based compensation by $55,000 and $2,051,000 for the three months ended September 30, 2003 and 2002 and $229,000 and $4,119,000 for the nine months ended September 30, 2003 and 2002, in these restated financial statements, which includes the recapture of excess compensation expense related to the items discussed in the following two paragraphs.

 

Sonus also determined that option grants made to certain newly hired employees had intrinsic value on the start date of the new employee. Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, requires that such intrinsic value be recorded as deferred stock-based compensation and amortized over the vesting period. Previously, Sonus had not recorded any deferred stock-based compensation expense for these grants, and Sonus is now recording an adjustment of $1,215,000 to deferred compensation and additional paid-in-capital in 2001. As a result and under Sonus’ policy of amortization under FIN 28, Sonus has increased stock-based compensation expense by $18,000 and $74,000 for the three and nine months ended September 30, 2003 and $79,000 and $328,000 for the three and nine months ended September 30, 2002, in these restated financial statements.

 

Sonus recorded employee deferred stock-based compensation prior to its initial public offering and in connection with its acquisition of TTI, and established a policy to amortize these amounts on an accelerated method under FIN 28. Sonus determined as a result of its review and analysis that the deferred stock-based compensation related to one category of employees was incorrectly amortized using the straight-line method and has made adjustments to consistently apply the FIN 28 method. As a result, Sonus increased stock-based compensation by $17,000 and $72,000 for the three and nine months ended September 30, 2003 and decreased stock-based compensation by  $12,000 and $183,000 for the three and nine months ended September 30, 2002, in these restated financial statements.

 

Sonus has determined that it improperly calculated deferred stock-based compensation and the related amortization associated with the restricted stock issued under the TTI Retention Plan. As a result, Sonus decreased stock-based compensation by $3,000 and $4,000 for the three and nine months ended September 30, 2003 and increased stock-based compensation by  $176,000 and $2,133,000 for the three and nine months ended September 30, 2002 to reflect the amortization of deferred stock-based compensation that should have been recorded.

 

Sonus also determined that it improperly calculated stock-based compensation expense for any intrinsic value associated with the modification of certain stock options and restricted stock to accelerate the vesting of a portion or all of these awards in connection with certain employee terminations. These adjustments resulted in increases in stock-based compensation expense of $204,000 for the three and nine months ended September 30, 2003 and $74,000 and $132,000 for the three and nine months ended September 30, 2002.

 

The following table is a summary of stock-based compensation restatement adjustments by type for the periods indicated, in thousands:

 

 

 

Three months
ended
September 30,
2003

 

Three months
ended
September 30,
2002

 

Nine months
ended
September 30,
2003

 

Nine months
ended
September 30,
2002

 

Stock-based Compensation
Adjustments—increase/(decrease) for:

 

 

 

 

 

 

 

 

 

Recapture of compensation expense in connection with employee terminations

 

$

(55

)

$

(2,051

)

$

(229

)

$

(4,119

)

Amortization related to the intrinsic value of options granted to new employees

 

18

 

79

 

74

 

328

 

Adjusted amortization under accelerated method prescribed by FIN 28

 

17

 

(12

)

72

 

(183

)

Amortization related to restricted stock issued in connection with TTI Retention Plan

 

(3

)

176

 

(4

)

2,133

 

Charge for modification in connection with employee terminations

 

204

 

74

 

204

 

132

 

Total Stock-based Compensation Restatement Adjustments

 

$

181

 

$

(1,734

)

$

117

 

$

(1,709

)

 

14



 

As described in Note 3 (l) to Sonus’ condensed consolidated financial statements, Sonus calculated the fair value of its stock options and the options under its employee stock purchase plan for disclosure purposes as required under SFAS No. 123, Accounting for Stock-Based Compensation. These calculations depend, among other factors, on the characteristics of Sonus’ 2000 Employee Stock Purchase Plan (ESPP) and options with intrinsic value at the grant date. Sonus’ calculation did not properly consider these two items.

 

Inventory Reserves
 

As of September 30, 2003 and September 30, 2002 Sonus’ originally reported excess, obsolete and evaluation reserve balances were $17,904,000 and $17,914,000. Sonus has determined that its excess, obsolete and evaluation reserve balances were not consistently calculated and, as a result of Sonus’ review of its reserves and consideration of contemporaneous facts and circumstances, Sonus decreased its reserves and reduced cost of product revenues by $937,000 and $266,000 as of and for the nine months ended September 30, 2003 and 2002.

 

Other Balance Sheet Adjustments

 

Sonus identified certain customer checks received by it prior to the end of fiscal year 2002 and the quarter ended September 30, 2003, which were deposited after the reporting period and not recorded in the period received. Accordingly, Sonus has increased its cash and cash equivalents and deferred revenue balances by $8,078,000 and $6,971,000 as of September 30, 2003 and December 31, 2002.

 

Sonus previously did not record deferred revenue for product shipments and related services for which customers had been invoiced but for which no revenue was recognized and for which payment had not been collected. In this restatement, customer billings for which Sonus has a contractual right to invoice and collectibility is probable have been recorded as accounts receivable on the balance sheet, with a corresponding increase to deferred revenue. Accounts receivable and deferred revenue have increased by $2,123,000 and $90,000 at September 30, 2003 and December 31, 2002.

 

Sonus previously reported customer deposits as accrued liabilities. In connection with Sonus’ review and analysis, Sonus has determined that it should report customer deposits as deferred revenue rather than accrued expenses. Accordingly, deferred revenue has increased and accrued liabilities have decreased by $6,576,000 and $7,240,000 as of September 30, 2003 and December 31, 2002.

 

Other Statement of Operations Adjustments

 

As described in Note 3 (p) to Sonus’ condensed consolidated financial statements, Sonus calculated the weighted average common shares outstanding utilized in the determination of loss per share in accordance with the treasury stock method as required under SFAS No. 148, Earnings Per Share. Sonus’ calculation did not properly consider certain activity and, accordingly, Sonus has modified the weighted average common shares outstanding for the three months ended September 30, 2002.

 

15



 

(3) Summary of Significant Accounting Policies

 

The accompanying condensed consolidated financial statements reflect the application of certain significant accounting policies as described in this note and elsewhere in the accompanying condensed consolidated financial statements and notes.

 

(a) Basis of Presentation and Principles of Consolidation

 

The accompanying unaudited condensed consolidated financial statements have been prepared by Sonus and reflect all adjustments, consisting only of normal recurring adjustments that in the opinion of management are necessary for a fair statement of the results for the interim periods. The unaudited condensed consolidated financial statements have been prepared in accordance with the regulations of the Securities and Exchange Commission (SEC), and omit or condense certain information and footnote disclosures pursuant to existing SEC rules and regulations. Results for the interim period are not necessarily indicative of results to be expected for any other interim period or the entire fiscal year. These statements should be read in conjunction with the consolidated financial statements and related notes included in Sonus’ Annual Report on Form 10-K/A for the year ended December 31, 2003 filed with the SEC.

 

The accompanying condensed consolidated financial statements include the accounts of Sonus and its wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated.

 

(b) Use of Estimates and Judgments

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates relied upon in preparing these financial statements include revenue recognition for multiple element arrangements, allowances for doubtful accounts, estimated fair value of investments, including whether any decline in such fair value is other-than-temporary, expected future cash flows used to evaluate the recoverability of long-lived assets, estimated fair values of long-lived assets used to record impairment charges related to intangible assets, restructuring and other related charges, contingencies associated with revenue contracts, contingent liabilities, and recoverability of Sonus’ net deferred tax assets and related valuation allowance. Although Sonus regularly assesses these estimates, actual results could differ materially from these estimates. Changes in estimates are recorded in the period in which they become known. Sonus bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results may differ from Sonus’ estimates if past experience or other assumptions do not turn out to be substantially accurate.

 

(c) Cash Equivalents and Marketable Securities

 

Cash equivalents are stated at cost plus accrued interest, which approximates market value, and have maturities of three months or less at the date of purchase.

 

Marketable securities are classified as held-to-maturity, as Sonus has the intent and ability to hold to maturity. Marketable securities are reported at amortized cost. Cash equivalents and marketable securities are invested in high-quality credit instruments, primarily U.S. Government obligations and corporate obligations. Current marketable securities have remaining contractual maturities of less than one year as of the balance sheet date. There have been no material gains or losses to date.

 

(d) Concentrations of Credit and Off-Balance Sheet Risk, Significant Customers and Limited Suppliers

 

The financial instruments that potentially subject Sonus to concentrations of credit risk are cash, cash equivalents, marketable securities and accounts receivables. Sonus has no off-balance sheet concentrations such as foreign exchange contracts, options contracts or other foreign hedging arrangements. Sonus’ cash and cash equivalent holdings are diversified among four financial institutions.

 

16



 

For the three months ended September 30, 2003 and 2002, two customers each contributed 10% or more of Sonus’ revenues, representing an aggregate of 42% and 53% of total revenues.  For the nine months ended September 30, 2003 and 2002, three customers and one customer each contributed 10% or more of Sonus’ revenues, representing an aggregate of 49% and 47% of total revenues. The following customers contributed 10% or more of Sonus’ revenues in the three and nine months ended September 30, 2003 and 2002:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

Customer:

 

2003

 

2002

 

2003

 

2002

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Verizon Global Networks

 

28

%

*

%

21

%

*

%

Global Crossing

 

14

 

*

 

18

 

*

 

Qwest Communications

 

*

 

36

 

*

 

47

 

T-Nova Deutsche Telekom

 

*

 

17

 

*

 

*

 

Nissho Electronics Corporation

 

*

 

*

 

10

 

*

 

 


*                                         Represents less than 10% of revenues.

 

As of September 30, 2003 and December 31, 2002, two and three customers each accounted for 10% or more of Sonus’ accounts receivable balance, representing an aggregate of 55% and 78% of total accounts receivable. Sonus performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable.  Sonus maintains allowances for potential credit losses and such losses have been within management’s expectations.

 

International revenues, primarily attributable to Asia and Europe, were 37% and 32% of total revenues for the three months ended September 30, 2003 and 2002.  International revenues, primarily attributable to Asia and Europe, were 33% and 18% of total revenues for the nine months ended September 30, 2003 and 2002.

 

Certain components and software licenses from third parties used in Sonus’ products are procured from single sources of supply. The failure of a supplier, including a subcontractor, to deliver on schedule could delay or interrupt Sonus’ delivery of products and thereby materially adversely affect Sonus’ revenues and operating results.

 

(e) Accounts Receivable

 

Accounts receivable consist of the following, in thousands:

 

 

 

September 30,
2003

 

December 31,
2002

 

 

 

(As Restated)

 

 

 

Earned accounts receivable

 

$

6,355

 

$

4,873

 

Unearned accounts receivable

 

2,123

 

90

 

Accounts receivable, gross

 

8,478

 

4,963

 

Allowance for doubtful accounts

 

(142

)

(341

)

Accounts receivable, net

 

$

8,336

 

$

4,622

 

 

Unearned accounts receivable represent products shipped to customers where Sonus has a contractual right to bill the customer and collectibility is probable prior to satisfying Sonus’ revenue recognition criteria. The allowance for doubtful accounts is based on Sonus’ detailed assessment of the collectibility of specific customer accounts.

 

(f) Inventory

 

Inventory consists of the following, in thousands:

 

17



 

 

 

September 30,
2003

 

December 31,
2002

 

 

 

(As Restated)

 

 

 

On-hand final assemblies and finished goods inventory

 

$

15,779

 

$

12,292

 

Unearned inventory

 

13,735

 

10,441

 

Evaluation inventory

 

3,982

 

6,022

 

Inventory, gross

 

33,496

 

28,755

 

Excess, obsolete and evaluation reserve

 

(17,074

)

(18,306

)

Inventory, net

 

$

16,422

 

$

10,449

 

 

Unearned inventory represents deferred cost of revenues for product shipments prior to satisfaction of Sonus’ revenue recognition criteria.

 

Sonus values inventory at the lower of cost or net realizable value and provides inventory reserves based on excess and obsolete inventories determined primarily by future demand forecasts and records changes to such reserves through charges to cost of revenues. Sonus also records a full inventory reserve for evaluation equipment at the time of shipment to its customers as a charge to sales and marketing expense as Sonus’ experience with this type of inventory indicates it is probable that the inventory will not be realizable. If these evaluation shipments should convert to revenue, Sonus records a benefit to sales and marketing expense and records the full cost of revenues in the period of revenue recognition.

 

(g) Property and Equipment

 

Property and equipment are stated at cost, net of accumulated depreciation. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method over the estimated useful life of the related assets, which ranges from three to five years. Leasehold improvements are amortized over the lesser of the life of the lease or five years. When an item is sold or retired, the cost and related accumulated depreciation is relieved, and the resulting gain or loss, if any, is recognized in the statement of operations.

 

(h) Purchased Intangible Assets

 

Purchased intangible assets of $3,004,000 as of September 30, 2003 and $4,810,000 as of December 31, 2002 are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets. Sonus expects that the remaining amount of purchased intangible assets will be fully amortized by December 2004.

 

(i) Deferred Revenue

 

Deferred revenue consists of the following, in thousands:

 

 

 

September 30,
2003

 

December 31,
2002

 

 

 

(As Restated)

 

 

 

Maintenance and support contracts

 

$

29,612

 

$

24,832

 

Customer deposits

 

53,428

 

34,830

 

Unearned revenue

 

2,123

 

90

 

Total deferred revenue

 

85,163

 

59,752

 

Less current portion

 

(72,819

)

(51,728

)

 

 

$

12,344

 

$

8,024

 

 

Maintenance and support contracts are recognized ratably over the life of the service contract. Customer deposits represent payments received in advance of revenue recognition. Unearned revenue represents billings for which payment has not been received and revenue recognition criteria have not been met.

 

18



 

(j) Revenue Recognition

 

Sonus recognizes revenue from product sales when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility of the related receivable is probable under ordinary payment terms. When Sonus has future obligations, including a requirement to deliver additional elements which are essential to the functionality of the delivered elements or for which vendor specific objective evidence of fair value (VSOE) does not exist or customer acceptance is required, Sonus defers revenue recognition and related costs until those obligations are satisfied. The ordering pattern and sales lead times associated with customer orders may vary significantly from period to period.

 

Many of Sonus’ sales are generated from complex contractual arrangements which require significant revenue recognition judgments, particularly in the case of multiple element arrangements. When a sale involves multiple elements, such as products, maintenance or professional services, Sonus allocates the entire sales price to each respective element based on VSOE or using the residual method when VSOE cannot be established for a single delivered element in the arrangement. Sonus then recognizes revenue on each element in accordance with its policies for revenue recognition related to each element. Sonus determines VSOE based upon the price charged when the same element is sold separately. If Sonus cannot establish VSOE for each undelivered element, it defers revenue recognition on the entire arrangement until the earlier of the establishment of VSOE or delivery of the undelivered element.

 

In addition, if an arrangement with a customer includes a specified upgrade right for which VSOE cannot be established, Sonus defers all revenue related to the arrangement until the earlier of the delivery of the specified upgrade or the establishment of VSOE for the specified upgrade. Sonus has concluded that a specified upgrade right exists if it is included in the customer contract or otherwise becomes part of the arrangement with the customer. Sonus has concluded that communications with customers in the normal course of business regarding customer feature requests and Sonus’ product plans do not create specified upgrade rights.

 

Maintenance and support services are recognized ratably over the life of the maintenance and support service period, which typically is one year when the services are sold separately and up to five years when the fees for the services are bundled with the product fees as part of a multiple element arrangement. Maintenance and support services include telephone support and unspecified rights to product upgrades and enhancements. Maintenance and support VSOE represents a consistent percentage of the sales prices charged to customers. The application of judgment could affect the continued determination of maintenance and support VSOE and Sonus’ ability to recognize revenue using the residual method.

 

Installation service revenues are generally recognized at the time of the related product revenue recognition as installation is typically complete by such time. Professional services are typically recognized as the services are performed.

 

Sonus sells the majority of its products directly to end-users. For products sold through resellers and distributors, Sonus recognizes revenue on a sell-through method utilizing information provided to Sonus from its resellers and distributors.

 

Sonus records deferred revenue for product shipped to customers and related services where amounts are billed pursuant to a contractual right and collection is probable, or collected, in the ordinary course of business if the revenue recognition criteria have not been satisfied. Deferred revenues include customer deposits and amounts associated with maintenance contracts Deferred revenues not expected to be recognized within one year of the balance sheet date are classified as long-term deferred revenues.

 

Sonus defers recognition of incremental direct costs, such as cost of goods, royalties, commissions and third-party installation costs, until satisfaction of the criteria for recognition of the related revenue.

 

(k) Software Development Costs

 

Sonus accounts for its software development costs in accordance with Statement of Financial Accounting

 

19



 

Standards (SFAS) No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed. Accordingly, the costs for the development of new software and substantial enhancements to existing software are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized. Sonus has determined that technological feasibility is established at the time a working model of the software is completed. Because Sonus believes its current process for developing software is essentially completed concurrently with the establishment of technological feasibility, no costs have been capitalized to date.

 

(l) Stock-Based Compensation

 

SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 provides that companies may account for stock-based compensation under either the fair value-based method of accounting under SFAS No. 123 or the intrinsic value-based method provided by Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees. Sonus uses the intrinsic value-based method of APB No. 25 to account for all of its employee stock-based compensation plans and uses the fair value method of SFAS No. 123 to account for all non-employee stock-based compensation. Sonus follows FASB Interpretation (FIN) No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans and amortizes the intrinsic value for all awards as measured under APB No. 25 on an accelerated basis. SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123, requires companies following APB No. 25 to make pro forma disclosure in the notes to the financial statements using the measurement provisions of SFAS No. 123.

 

Sonus has computed the pro forma disclosures required under SFAS No. 123 for stock options granted to employees and shares purchased under the 2000 Employee Stock Purchase Plan (ESPP) using the Black-Scholes option-pricing model. In valuing the stock options granted, Sonus used an assumed risk-free interest rate of 3% for both the three and nine months ended September 30, 2003 and 2002; volatility of 137% for both the three and nine months ended September 30, 2003, and 150% for the three and nine months ended September 30, 2002; and an expected life of four to five and three to five years for both the three and nine months ended September 30, 2003 and 2002, with the assumption that dividends will not be paid. In valuing the ESPP, Sonus used an assumed risk-free interest rate of 1.0 - 3.8% for the three months ended September 30, 2003 and 1.0 - 4.7% for the nine months ended September 30, 2003, and of 1.7 - 6.8% for both the three and nine months ended September 30, 2002; volatility of 137- 150% for both the three and nine months ended September 30, 2003, and 80 -150% for both the three and nine months ended September 30, 2002; and an expected life ranging from six months to two years, with the assumption that dividends will not be paid. The pro forma information is as follows (in thousands, except per share data):

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

Net loss—

 

 

 

 

 

 

 

 

 

As reported

 

$

(5,029

)

$

(30,454

)

$

(22,037

)

$

(60,446

)

Plus: Employee stock-based compensation expense included in net loss under intrinsic value method related to options

 

540

 

2,130

 

1,894

 

12,894

 

Less: Employee stock-based compensation under fair value method

 

(11,932

)

(11,628

)

(31,330

)

(35,745

)

Pro forma

 

$

(16,421

)

$

(39,952

)

$

(51,473

)

$

(83,297

)

 

 

 

 

 

 

 

 

 

 

Basic and diluted net loss per share—

 

 

 

 

 

 

 

 

 

As reported

 

$

(0.02

)

$

(0.16

)

$

(0.10

)

$

(0.32

)

Pro forma

 

$

(0.07

)

$

(0.21

)

$

(0.24

)

$

(0.44

)

 

(m) Comprehensive Loss

 

Sonus applies SFAS No. 130, Reporting Comprehensive Income. The comprehensive net loss for the three and

 

20



 

nine months ended September, 2003 and 2002 does not differ from the reported net loss.

 

(n) Fair Value of Financial Instruments

 

The carrying amounts of Sonus’ financial instruments, which include cash equivalents, marketable securities, accounts payable, long-term liabilities and the convertible subordinated note, approximate their fair value.

 

(o) Disclosures about Segments of an Enterprise

 

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, established standards for reporting information regarding operating segments and established standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker in making decisions regarding resource allocation and assessing performance. To date, the chief operating decision maker has made such decisions and assessed performance at the company level.

 

(p) Net Loss Per Share

 

Basic net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of unrestricted common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of unrestricted common stock and dilutive potential common shares outstanding based on the average market price of Sonus’ common stock (under the treasury stock method). Dilutive potential common shares consist of restricted common stock and common stock issuable upon the exercise of stock options and conversion of a convertible subordinated note.  There were no dilutive shares of potential common stock for the three and nine months ended September 30, 2003 and 2002 as Sonus incurred a net loss in each period.

 

The following table sets forth the computation of shares used in calculating the net loss per share, in thousands:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

(As Restated)

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

227,343

 

203,853

 

217,893

 

203,450

 

Less weighted average restricted common shares outstanding

 

(2,987

)

(10,698

)

(4,571

)

(13,488

)

Shares used in basic and diluted per share calculation

 

224,356

 

193,155

 

213,322

 

189,962

 

 

Excluded from the shares used in calculating the net loss per share in the above table are options to purchase shares of common stock and shares of common stock issuable upon conversion of a convertible subordinated note representing an aggregate of 29,036,863 and 23,020,656 shares as of September 30, 2003 and 2002, as their effects would have been anti-dilutive.

 

(q) Recent Accounting Pronouncements

 

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses the recognition, measurement and reporting of costs associated with exit and disposal activities, including restructuring activities that were accounted for in accordance with Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The scope of SFAS No. 146 includes costs related to terminating a contract that is not a capital lease, costs to consolidate facilities or relocate employees, and certain termination benefits provided to employees who are involuntarily terminated. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. The implementation of this statement did not have a material impact on its financial position or results of operations.

 

In November 2002, the FASB issued Interpretation No. (FIN) 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of the interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002 and the disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The FIN No. 45 disclosure requirements are included in Note 5 to

 

21



 

Sonus’ unaudited condensed consolidated financial statements. The adoption of FIN 45 did not have a material impact on Sonus’ financial position or results of operations.

 

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of SFAS No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value-based method of accounting for employee stock-based compensation. These alternative methods will only impact Sonus if it voluntarily changes to the fair value-based method of accounting for employee stock-based compensation. SFAS No. 148 also requires companies who account for employee stock-based compensation under the intrinsic value-based method to disclose additional footnote information in annual financial statements effective for fiscal years ending after December 15, 2002 and in financial statements for interim periods beginning after December 15, 2002. The requisite disclosure appears in Note 3(l) to Sonus’ unaudited condensed consolidated financial statements.

 

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN No. 46) to clarify the conditions under which assets, liabilities and activities of another entity should be consolidated into the financial statements of a company. FIN No. 46 requires the consolidation of a variable interest entity by a company that bears the majority of the risk of loss from the variable interest entity’s activities, is entitled to receive a majority of the variable interest entity’s residual returns or both. Sonus does not have any variable interest entities.

 

In May 2003, the FASB issued SFAS No. 150, Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity, which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have any impact on Sonus’ overall financial position or results of operations.

 

In August 2003, the EITF reached a consensus on Issue No. 03-05, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software. EITF Issue No. 03-05 addresses the applicability of SOP 97-2 to non-software deliverables in an arrangement containing more-than-incidental software. In an arrangement that includes software that is more-than-incidental to the products or services as a whole, software and software-related elements are included within the scope of SOP 97-2. Software-related elements include software products and services, as well as any non-software deliverables for which a software deliverable is essential to its functionality. The adoption of this statement did not have a material impact on Sonus’ consolidated financial results.

 

(r) Warranty Reserve

 

Sonus’ products are covered by a standard warranty of 90 days for software and one year for hardware. In addition, certain customer contracts include warranty-type provisions for epidemic or similar product failures, generally for the contractual period or the life of the product in accordance with published telecommunications standards. Sonus accrues for such contingent obligations when the occurrence of such obligation is probable and the amount of such obligation is reasonably estimable. Sonus has not incurred significant costs related to such obligations. Sonus’ customers typically purchase maintenance and support contracts, which encompass its warranty obligations. Sonus’ estimates of anticipated rates of warranty claims and costs are primarily based on historical information and future forecasts.

 

In addition, certain of Sonus’ customer contracts include provisions under which Sonus may be obligated to pay penalties generally for the contractual period or for the life of the product if its products fail or do not perform in accordance with specifications. Sonus accrues for such contingent obligations when the occurrence of such obligation is probable and the amount of such obligation is reasonably estimable. Sonus has not incurred significant costs related to such provisions. Sonus periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. Increases in product failures rates, material usage or service delivery costs may result in increases to Sonus’ warranty reserve and its gross profit could be adversely affected.

 

22



 

(4) Restructuring Charges

 

Commencing in the third quarter of fiscal 2001 and extending through fiscal 2002, in response to unfavorable business conditions primarily caused by significant declines in capital spending by telecommunications service providers, Sonus implemented restructuring plans designed to reduce expenses and align its cost structure with its revised business outlook. The restructuring plans included worldwide workforce reductions, consolidation of excess facilities and the write-off of excess inventory and purchase commitments.

 

2002 Restructuring Accrual

 

The following table summarizes the activity during the nine months ended September 30, 2003 relating to Sonus’ accrual for fiscal 2002 restructuring actions, in thousands:

 

 

 

December 31,
2002
Accrual
Balance

 

Cash
Payments

 

September
30, 2003
Accrual
Balance

 

Current
Portion

 

Long-term
Portion

 

 

 

 

 

 

 

(As Restated)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Workforce reduction

 

$

534

 

$

(534

)

$

 

$

 

$

 

Consolidation of facilities

 

2,214

 

(885

)

1,329

 

485

 

844

 

Sub-total

 

2,748

 

(1,419

)

1,329

 

485

 

844

 

Write-off of purchase commitments

 

340

 

(260

)

80

 

80

 

 

Total

 

$

3,088

 

$

(1,679

)

$

1,409

 

$

565

 

$

844

 

 

The remaining cash expenditures relating to the consolidation of excess facilities are expected to be paid through 2008. The purchase commitment obligations are expected to be substantially paid by the end of fiscal 2003.

 

(a) Workforce reduction

 

The restructuring actions in fiscal 2002 included a reduction in Sonus’ workforce. The affected employees were entitled to severance and other benefits for which Sonus recorded a charge of $5,282,000 in fiscal 2002, of which $1,507,000 and $4,355,000 were recorded in the three and nine months ended September 30, 2002. In addition, Sonus recorded non-cash stock-based compensation expense of $1,467,000 in the nine months ended September 30, 2002 related to the write-off of deferred compensation associated with shares and options held by terminated employees.

 

(b) Consolidation of excess facilities

 

Sonus recorded a net restructuring benefit of $500,000 in the three months ended September 30, 2002 and a net restructuring charge of $2,417,000 in the nine months ended September 30, 2002 for the consolidation of excess facilities, which is included on the balance sheet in accrued restructuring expenses and long-term liabilities. The accrual for the consolidation of excess facilities was determined assuming no sublease income.

 

(c) Write-off of inventory and purchase commitments

 

During the nine months ended September 30, 2002, Sonus recorded additional cost of revenues of $6,865,000 consisting of $4,457,000 for the write-off of inventory determined to be excess and obsolete and $2,408,000 for materials that were committed to be purchased from third-party contract manufacturers and suppliers under purchase commitments, but that were in excess of required quantities. The charge for purchase commitments was recorded on the balance sheet as accrued restructuring expenses.

 

23



 

2001 Restructuring Accrual

 

The following table summarizes the activity during the nine months ended September 30, 2003 relating to Sonus’ accrual for fiscal 2001 restructuring actions, in thousands:

 

 

 

December 31,
2002
Accrual
Balance

 

Cash
Payments

 

September 30,
2003
Accrual
Balance

 

Current
Portion

 

Long-Term
Portion

 

 

 

 

 

 

 

(As Restated)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidation of facilities and other charges

 

$

571

 

$

(291

)

$

280

 

$

280

 

$

 

 

Remaining cash expenditures relating to the consolidation of excess facilities and other charges are expected to be paid through the second quarter of fiscal 2004.

 

(5) Warranty Reserve

 

The following table summarizes the activity related to product warranty reserve, included in accrued expenses, during the nine months ended September 30, 2003, in thousands and as restated:

 

Balance at December 31, 2002

 

$

1,300

 

Charges to costs and expenses

 

1,600

 

Deductions

 

 

Balance at September 30, 2003

 

$

2,900

 

 

(6) Long-term Liabilities

 

Long-term liabilities consist of capital leases, borrowings from a bank for equipment purchases (Note 7) and restructuring expenses (Note 4). Sonus assumed certain capital leases as part of the acquisition of telecom technologies, inc. (TTI). The capital leases are due in monthly installments expiring at various dates through March 2005 and accrue interest at annual rates ranging from 4.8% to 10.3%. The future minimum annual payments under capital leases and amounts due for long-term liabilities, as of September 30, 2003, are as follows, in thousands:

 

Capital Leases:

 

 

 

2003 obligations (three months)

 

$

83

 

2004 obligations

 

189

 

2005 obligations

 

30

 

Total minimum lease payments

 

302

 

Less amount representing interest

 

(13

)

Present value of minimum payments

 

289

 

Borrowings under equipment line of credit with bank

 

2,017

 

Long-term portion of restructuring expenses

 

845

 

Total long-term liabilities

 

3,151

 

Less current portion

 

(1,329

)

Long-term liabilities, net of current portion

 

$

1,822

 

 

The future principal payments on total long-term liabilities, excluding the capital leases, as of September 30, 2003 are: $275,000 in 2003 (three months); $1,147,000 in 2004; $828,000 in 2005; $195,000 in 2006; $204,000 in 2007; and $213,000 in 2008.

 

24



 

(7) Bank Agreement

 

In January 2002, Sonus established a $10,000,000 equipment line of credit and a $20,000,000 working capital line of credit with a bank at the bank’s prime rate. In March 2003, Sonus extended these existing lines of credit at the bank’s prime rate (4.00% at September, 2003), available through March 23, 2004. Amounts borrowed under the equipment line were repayable over a 36-month period. For both lines of credit, Sonus had to comply with certain restrictive covenants including maintaining certain minimum investment balances with the bank, a minimum tangible stockholders’ equity of $131,000,000 as of September 30, 2003 and a quick ratio of 1.5 to 1.0, as defined in the credit agreement. Under the agreement, all of Sonus’ assets, except intellectual property, had been pledged as collateral. As of September 30, 2003, Sonus had $2,017,000 outstanding under the equipment line of credit (Note 6) and was in compliance with all bank covenants.  Interest expense related to the line of credit was $2,000 and $59,000 for the three and nine months ended September 30, 2003.

 

(8) Convertible Subordinated Note

 

In May 2001, Sonus completed a private placement of an aggregate principal amount of $10,000,000 of a 4.75% convertible subordinated note, due May 1, 2006, with a customer. Interest payments are due semi-annually on May 1 and November 1 of each year through May 2006. The note may be converted by the holder into shares of Sonus’ common stock at any time before its maturity or prior to its redemption or repurchase by Sonus. The conversion rate is 33.314 shares per each $1,000 principal amount of the note, subject to adjustment in certain circumstances. As of May 1, 2004, Sonus has the option to redeem all or a portion of the note at 100% of the principal amount. Also, at any time if the market price of Sonus’ common stock exceeds $60.04 per share for twenty trading days in any thirty trading-day period, Sonus may redeem this note through the issuance of shares of common stock or for cash. In the event of a change of control in Sonus, the holder at its option may require Sonus to redeem the note through the issuance of common stock or cash. Interest expense related to Sonus’ convertible subordinated note was $119,000 for both the three months ended September 30, 2003 and 2002 and $357,000 for both the nine months ended September 30, 2003 and 2002.

 

(9) Commitments and Contingencies

 

(a) Leases

 

Sonus leases its facilities under operating leases, which expire through December 2008. Sonus is responsible for certain real estate taxes, utilities and maintenance costs under these leases.

 

In October 2003, Sonus entered into a sublease agreement (Sublease) for a new corporate headquarters facility with rent commencing in April 2004 and extending through January 2007. The future minimum payments under operating lease arrangements as of September 30, 2003, including the new Sublease, are as follows: $1,949,000 in 2003 (three months); $1,693,000 in 2004; $1,068,000 in 2005; $876,000 in 2006; $261,000 in 2007; and $213,000 in 2008. The 2003 payment includes a rent prepayment in the amount of $1,250,000 due upon signing of the Sublease.

 

(b) Pending Litigation

 

In November 2001, a purchaser of Sonus’ common stock filed a complaint in the federal district court for the Southern District of New York against Sonus, two of its officers and the lead underwriters alleging violations of the federal securities laws in connection with Sonus’ initial public offering (IPO) and seeking unspecified monetary damages. The purchaser seeks to represent a class of persons who purchased Sonus’ common stock between the IPO on May 24, 2000 and December 6, 2000. An amended complaint was filed in April 2002. The amended complaint alleges that Sonus’ registration statement contained false or misleading information or omitted to state material facts concerning the alleged receipt of undisclosed compensation by the underwriters and the existence of undisclosed arrangements between underwriters and certain purchasers to make additional purchases in the after market. The claims against Sonus are asserted under Section 10(b) of the Securities Exchange Act of 1934 and Section 11 of the Securities Act of 1933 and against the individual defendants under Sections 11 and 15 of the Securities Act. Other plaintiffs have filed substantially similar class action cases against approximately 300 other publicly traded companies and their IPO underwriters which, along with the actions against Sonus, have been transferred to a single federal judge for purposes of coordinated case management. On July 15, 2002, Sonus, together with the other issuers named as defendants in these coordinated proceedings, filed a collective motion to dismiss the consolidated amended complaints on various legal grounds common to all or most of the issuer defendants. The plaintiffs voluntarily dismissed the claims against the individual defendants, including those Sonus officers named in the

 

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complaint. On February 19, 2003, the court granted a portion of the motion to dismiss by dismissing the Section 10(b) claims against certain defendants including Sonus, but denied the remainder of the motion as to the defendants. Accordingly, the case proceeded against Sonus on the Section 11 claims. In June 2003, a special committee of Sonus’ Board of Directors authorized Sonus to enter into a proposed settlement with the plaintiffs on terms substantially consistent with the terms of a Memorandum of Understanding negotiated among representatives of the plaintiffs, the issuer defendants and the insurers for the issuer defendants. The settlement contemplated by the Memorandum of Understanding is subject to a number of conditions including approval by the court. It remains uncertain whether and when the conditions will be met and the settlement will become final. Sonus does not expect that the settlement contemplated by the Memorandum of Understanding would have a material impact on Sonus’ business or financial results.

 

Beginning in July 2002, several purchasers of Sonus’ common stock filed complaints in federal district court for the District of Massachusetts against Sonus, certain officers and directors and a former officer under Sections 10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934 (Class Action Complaints). The purchasers seek to represent a class of persons who purchased common stock of Sonus between December 11, 2000 and January 16, 2002, and seek unspecified monetary damages. The Class Action Complaints were essentially identical and alleged that Sonus made false and misleading statements about its products and business. On March 3, 2003, the plaintiffs filed a Consolidated Amended Complaint. On April 22, 2003, Sonus filed a motion to dismiss the Consolidated Amended Complaint on various grounds. The plaintiffs’ filed an opposition to the motion on June 6, 2003. Sonus filed its reply on July 8, 2003. The parties have requested oral argument on the motion, but a date has not yet been set. Sonus believes the claims in the Consolidated Amended Complaint are without merit and that it has substantial legal and factual defenses, which it intends to pursue vigorously.

 

(10) Stockholders’ Equity

 

(a) Public Offerings