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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
COMMISSION FILE NUMBER 000-30229
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SONUS NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 04-3387074
(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
5 CARLISLE ROAD, WESTFORD, MASSACHUSETTS 01886
(Address of principal executive offices, including zip code)
(978) 692-8999
(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 /X/ No / /
As of August 1, 2002, there were 205,132,659 shares of $0.001 par value per
share, common stock, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
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SONUS NETWORKS, INC.
FORM 10-Q
QUARTER ENDED JUNE 30, 2002
TABLE OF CONTENTS
PAGE
--------
PART I -- FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2002
(unaudited) and December 31, 2001......................... 1
Condensed Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 2002 and 2001
(unaudited)............................................... 2
Condensed Consolidated Statement of Stockholders' Equity for
the Six Months Ended June 30, 2002 (unaudited)............ 3
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 2002 and 2001 (unaudited)........... 4
Notes to Condensed Consolidated Financial Statements
(unaudited)............................................... 5
Item 2: Management's Discussion and Analysis of Financial Condition 16
and Results of Operations.................................
Cautionary Statements....................................... 22
Quantitative and Qualitative Disclosures About Market
Item 3: Risk...................................................... 31
PART II -- OTHER INFORMATION
Item 1: Legal Proceedings........................................... 32
Item 4: Submission of Matters to a Vote of Security Holders......... 32
Item 6: Exhibits and Reports on Form 8-K............................ 33
Signature................................................... 33
PART I--FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
SONUS NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, DECEMBER 31,
2002 2001
----------- ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 40,728 $ 49,123
Marketable securities..................................... 63,982 75,944
Accounts receivable, net.................................. 6,448 9,440
Inventories............................................... 9,847 18,865
Other current assets...................................... 1,804 2,952
-------- --------
Total current assets.................................... 122,809 156,324
PROPERTY AND EQUIPMENT, net................................. 16,978 23,335
GOODWILL, net............................................... 1,673 1,673
PURCHASED INTANGIBLE ASSETS, net............................ 2,074 2,863
OTHER ASSETS, net........................................... 561 689
-------- --------
$144,095 $184,884
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 4,804 $ 8,630
Accrued expenses.......................................... 27,164 27,671
Accrued restructuring expenses............................ 5,083 8,596
Deferred revenue.......................................... 11,310 13,349
Current portion of long-term obligations.................. 848 1,055
-------- --------
Total current liabilities............................... 49,209 59,301
LONG-TERM OBLIGATIONS, less current portion................. 2,037 12,698
CONVERTIBLE SUBORDINATED NOTES.............................. 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, 206,158,347 and 205,181,085 shares issued
and 204,593,633 and 204,167,335 shares outstanding at
June 30, 2002 and December 31, 2001, respectively....... 206 205
Capital in excess of par value............................ 861,042 860,883
Accumulated deficit....................................... (763,410) (729,398)
Deferred compensation..................................... (14,786) (28,721)
Treasury stock, at cost; 1,564,714 and 1,013,750 common
shares at June 30, 2002 and December 31, 2001,
respectively............................................ (203) (84)
-------- --------
Total stockholders' equity.............................. 82,849 102,885
-------- --------
$144,095 $184,884
======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
1
SONUS NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- --------------------
2002 2001 2002 2001
-------- -------- -------- ---------
REVENUES............................................ $ 21,295 $ 52,551 $ 42,453 $ 94,050
Cost of revenues:
Write-off of inventory and purchase commitments... -- -- 9,434 --
Other cost of revenues (1)........................ 9,948 22,160 19,823 40,171
-------- -------- -------- ---------
Total cost of revenues.......................... 9,948 22,160 29,257 40,171
-------- -------- -------- ---------
GROSS PROFIT........................................ 11,347 30,391 13,196 53,879
OPERATING EXPENSES:
Research and development (1)...................... 12,225 16,697 26,840 30,616
Sales and marketing (1)........................... 8,280 10,615 16,687 19,103
General and administrative (1).................... 1,690 3,279 3,156 5,942
Stock-based compensation.......................... 5,950 13,847 11,693 29,270
Amortization of goodwill and purchased intangible
assets.......................................... 383 38,704 789 65,911
Restructuring charges (benefit), net.............. 1,013 -- (11,128) --
In-process research and development............... -- -- -- 40,000
-------- -------- -------- ---------
Total operating expenses........................ 29,541 83,142 48,037 190,842
-------- -------- -------- ---------
LOSS FROM OPERATIONS................................ (18,194) (52,751) (34,841) (136,963)
Interest expense.................................... (136) (113) (275) (281)
Interest income..................................... 512 1,473 1,104 3,374
-------- -------- -------- ---------
NET LOSS............................................ $(17,818) $(51,391) $(34,012) $(133,870)
======== ======== ======== =========
BASIC AND DILUTED NET LOSS PER SHARE................ $ (0.09) $ (0.30) $ (0.18) $ (0.80)
======== ======== ======== =========
SHARES USED IN COMPUTING NET LOSS PER SHARE
(NOTE 1 (I))...................................... 189,193 171,329 187,593 166,689
======== ======== ======== =========
- ------------------------
(1) Excludes non-cash, stock-based compensation expense as follows:
Cost of revenues.................................... $ 298 $ 305 $ 398 $ 622
Research and development............................ 3,343 7,806 6,351 16,382
Sales and marketing................................. 1,922 3,720 3,672 7,894
General and administrative.......................... 387 2,016 1,272 4,372
-------- -------- -------- ---------
$ 5,950 $ 13,847 $ 11,693 $ 29,270
======== ======== ======== =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
2
SONUS NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
COMMON STOCK CAPITAL IN TREASURY STOCK
----------------------- EXCESS OF ACCUMULATED DEFERRED --------------------
SHARES PAR VALUE PAR VALUE DEFICIT COMPENSATION SHARES COST
----------- --------- ---------- ----------- ------------ --------- --------
BALANCE, DECEMBER 31, 2001............. 205,181,085 $205 $860,883 $(729,398) $(28,721) 1,013,750 $ (84)
Issuance of common stock in
connection with employee stock
purchase plan...................... 665,783 1 2,302 -- -- -- --
Exercise of stock options............ 311,479 -- 99 -- -- -- --
Amortization of deferred
compensation....................... -- -- -- -- 10,283 -- --
Deferred compensation for terminated
employees (Note 2)................. -- -- (2,242) -- 3,652 -- --
Repurchase of common stock........... -- -- -- -- -- 550,964 (119)
Net loss............................. -- -- -- (34,012) -- -- --
----------- ---- -------- --------- -------- --------- -----
BALANCE, JUNE 30, 2002................. 206,158,347 $206 $861,042 $(763,410) $(14,786) 1,564,714 $(203)
=========== ==== ======== ========= ======== ========= =====
TOTAL
STOCKHOLDERS'
EQUITY
-------------
BALANCE, DECEMBER 31, 2001............. $102,885
Issuance of common stock in
connection with employee stock
purchase plan...................... 2,303
Exercise of stock options............ 99
Amortization of deferred
compensation....................... 10,283
Deferred compensation for terminated
employees (Note 2)................. 1,410
Repurchase of common stock........... (119)
Net loss............................. (34,012)
--------
BALANCE, JUNE 30, 2002................. $ 82,849
========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
3
SONUS NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
--------------------------
2002 2001
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(34,012) $(133,870)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization......................... 8,191 6,684
Write-off of inventory................................ 7,026 --
Stock-based compensation.............................. 11,693 29,270
Amortization of goodwill and purchased intangible
assets.............................................. 789 65,911
Non-cash restructuring benefit........................ (16,557) --
In-process research and development................... -- 40,000
Changes in current assets and liabilities:
Accounts receivable................................. 2,992 (2,656)
Inventories......................................... 1,992 (3,385)
Other current assets................................ 1,148 467
Accounts payable.................................... (3,826) 251
Accrued expenses.................................... 1,959 7,194
Deferred revenue.................................... (2,039) (1,187)
-------- ---------
Net cash provided by (used in) operating
activities........................................ (20,644) 8,679
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (1,681) (16,760)
Maturities of marketable securities....................... 26,701 9,660
Purchases of marketable securities........................ (14,739) (38,749)
Other assets.............................................. (25) (455)
Acquisition, net of cash acquired......................... -- (5,743)
-------- ---------
Net cash provided by (used in) investing
activities........................................ 10,256 (52,047)
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock in connection with
employee stock purchase plan............................ 2,303 3,388
Proceeds from exercise of stock options................... 99 2,926
Payment of stock subscriptions receivable................. -- 238
Payments of long-term obligations......................... (290) (233)
Payment of note payable to bank........................... -- (8,000)
Proceeds from issuance of convertible subordinated
notes................................................... -- 10,000
Repurchase of common stock................................ (119) (12)
-------- ---------
Net cash provided by financing activities........... 1,993 8,307
-------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS................... (8,395) (35,061)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. 49,123 87,108
-------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 40,728 $ 52,047
======== =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
4
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The accompanying unaudited condensed consolidated financial statements have
been prepared by Sonus Networks, Inc. (Sonus) and reflect all adjustments,
consisting only of normal recurring adjustments, which 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 periods are not necessarily indicative of results to be expected for the
entire fiscal year. These statements should be read in conjunction with the
consolidated financial statements and related footnotes included in Sonus'
Annual Report on Form 10-K for the year ended December 31, 2001 filed with the
SEC.
The unaudited condensed consolidated financial statements include the
accounts of Sonus and its wholly-owned subsidiaries. All material intercompany
transactions and balances have been eliminated.
(B) 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 with contractual maturities of less than one year. There
have been no gains or losses to date.
(C) 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
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 between four financial
institutions.
We expect that for the foreseeable future, the majority of our revenues will
depend on sales of our products to a limited number of customers. For the six
months ended June 30, 2002 and 2001, two and three customers each contributed
more than 10% of our revenues and collectively represented an aggregate of 40%
and 68% of total revenues. As of June 30, 2002 and 2001, two customers each
accounted for more than 10% of Sonus' accounts receivable balance. International
revenues, primarily to Asia and Europe, were 22% and 28% of total revenues for
the six months ended June 30, 2002 and 2001. Certain components and software
licenses from third-parties used in Sonus' products are procured from a single
source. The failure of a supplier, including a subcontractor, to deliver on
schedule could delay or interrupt Sonus' delivery of products and thereby
adversely affect Sonus' revenues and operating results.
5
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(D) GOODWILL AND PURCHASED INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, GOODWILL AND OTHER
INTANGIBLE ASSETS. SFAS No. 142 eliminated the amortization of goodwill and
certain other intangibles with indefinite lives and instead subjects these
assets to periodic impairment assessments. SFAS No. 142 was effective for all
goodwill and certain other intangibles acquired after June 30, 2001 and
commenced on January 1, 2002 for all goodwill and certain other intangibles
existing on June 30, 2001. As of January 1, 2002, in accordance with SFAS
No. 142, Sonus ceased amortizing $796,000 of goodwill established in connection
with the acquisition of telecom technologies, inc. (TTI) (Notes 2(d) and 3).
Purchased intangible assets are carried at cost less accumulated
amortization. Amortization is computed over the estimated useful lives of the
respective assets, two and three years. Goodwill is carried net of an impairment
charge and accumulated amortization.
(E) REVENUE RECOGNITION
Sonus recognizes revenue from product sales to end users, resellers and
distributors upon shipment, provided there are no uncertainties regarding
acceptance, persuasive evidence of an arrangement exists, the sales price is
fixed or determinable and collection of the related receivable is probable. If
uncertainties exist, Sonus recognizes revenue when those uncertainties are
resolved. In multiple element arrangements, in accordance with Statement of
Position 97-2 and 98-9, Sonus uses the residual method when vendor-specific
objective evidence does not exist for one of the delivered elements in the
arrangement. Service revenue is recognized as the services are provided. Revenue
from maintenance and support arrangements is recognized ratably over the term of
the contract. Amounts collected prior to satisfying the revenue recognition
criteria are reflected as deferred revenue. Warranty costs are estimated and
recorded by Sonus at the time of product revenue recognition.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, REVENUE
RECOGNITION IN FINANCIAL STATEMENTS. This bulletin established guidelines for
revenue recognition. Sonus' revenue recognition policy complies with this
pronouncement.
(F) STOCK-BASED COMPENSATION
Sonus uses the intrinsic value-based method of Accounting Principles Board
(APB) Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, to account for
all of its employee stock-based compensation plans and uses the fair value
method to account for all non-employee stock-based compensation.
(G) COMPREHENSIVE LOSS
Sonus applies SFAS No. 130, REPORTING COMPREHENSIVE INCOME. The
comprehensive loss for the three and six months ended June 30, 2002 and 2001
does not differ from the reported loss.
(H) USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 expenses during the
reporting period. Actual results could differ from those estimates.
6
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(I) 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 potential common stock outstanding during the
period, if dilutive. Potential common stock consists of restricted shares of
common stock, shares of common stock issuable upon the exercise of stock
options, conversion of convertible subordinated notes and shares of common stock
issued in connection with our acquisition of TTI subject to the achievement of
milestones and employee retention (Note 3). There were no dilutive shares of
potential common stock for the three and six months ended June 30, 2002 and 2001
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2002 2001 2002 2001
-------- -------- -------- --------
(IN THOUSANDS)
Weighted average common shares outstanding.............. 204,536 201,201 204,339 198,491
Less weighted average restricted common shares
outstanding........................................... (15,343) (29,872) (16,746) (31,802)
------- ------- ------- -------
Shares used in computing net loss per share............. 189,193 171,329 187,593 166,689
======= ======= ======= =======
Excluded from the computation of 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 convertible subordinated notes representing an aggregate of
23,605,000 and 22,257,000 as of June 30, 2002 and 2001, as their effects would
have been anti-dilutive. Had Sonus recorded net income for the three and six
months ended June 30, 2002 and used the treasury stock method in accordance with
SFAS No. 128, EARNINGS PER SHARe, approximately 214,000,000 weighted average
shares of common stock would have been used in the computation of diluted
earnings per share.
(J) RECENT ACCOUNTING PRONOUNCEMENT
In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETs, which supersedes SFAS No. 121, ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF,
and the accounting and reporting provisions of APB No. 30, REPORTING THE RESULTS
OF OPERATIONS--REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A BUSINESS, AND
EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONs. SFAS
No. 144 addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and is effective for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. The
implementation of this statement did not have an effect on Sonus' consolidated
financial statements.
(K) RECLASSIFICATIONS
Certain reclassifications have been made to prior year's consolidated
financial statements to conform to the 2002 presentation.
7
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(2) RESTRUCTURING CHARGES (BENEFIT) AND WRITE-OFF OF GOODWILL AND PURCHASED
INTANGIBLE ASSETS
Commencing in the third quarter of fiscal 2001, in response to unfavorable
business conditions primarily caused by significant declines in capital spending
by telecommunications service providers, Sonus has implemented restructuring
plans designed to reduce expenses and align its cost structure with its revised
business outlook. The restructuring plans include worldwide workforce
reductions, consolidations of excess facilities and the write-off of excess
inventory and purchase commitments. Additionally, in the third quarter of fiscal
2001, Sonus recorded a write-off of goodwill and purchased intangible assets
related to the acquisition of TTI (Note 3) and in the first quarter of fiscal
2002, recorded a non-cash restructuring benefit for a lease renegotiation.
Sonus' restructuring related reserves as of June 30, 2002 are summarized as
follows, in thousands:
DEC. 31, CURRENT OPERATING ACTIVITY JUNE 30,
2001 ------------------------------- 2002
ACCRUAL NON-CASH CASH ACCRUAL CURRENT LONG-TERM
BALANCE ADDITIONS BENEFIT TOTAL PAYMENTS BALANCE PORTION PORTION
-------- --------- -------- -------- -------- -------- -------- ---------
Workforce reductions.......... $ 871 $2,513 $ -- $ 2,513 $(3,240) $ 144 $ 144 $ --
Consolidations of facilities
and other charges
(benefit)................... 20,185 2,916 (16,557) (13,641) (1,358) 5,186 3,304 1,882
------- ------ -------- ------- ------- ------ ------ ------
Sub-total..................... 21,056 5,429 (16,557) (11,128) (4,598) 5,330 3,448 1,882
Write-off of purchase
commitments................. -- 2,408 -- 2,408 (773) 1,635 1,635 --
------- ------ -------- ------- ------- ------ ------ ------
Total......................... $21,056 $7,837 $(16,557) $(8,720) $(5,371) $6,965 $5,083 $1,882
======= ====== ======== ======= ======= ====== ====== ======
Remaining cash expenditures relating to the workforce reductions are
expected to be substantially paid in the third quarter of fiscal 2002. The
remaining amounts related to the consolidation of excess facilities and other
miscellaneous charges will be paid through May 2004. The purchase commitment
obligations are expected to be substantially paid by the end of fiscal 2002.
(A) WORKFORCE REDUCTION
The restructuring actions from September 2001 through June 2002 have
resulted in an aggregate reduction of Sonus' workforce by approximately 230
employees, or 32%. The affected employees were entitled to severance and other
benefits for which Sonus recorded a charge of $4,506,000 in the third quarter of
fiscal 2001, of which $871,000 remained unpaid at December 31, 2001. In the
first and second quarters of fiscal 2002, Sonus recorded aggregate charges of
$2,513,000 for severance and other benefits associated with further
restructuring actions. In addition, Sonus recorded non-cash stock-based
compensation expense of $25,429,000 in the third quarter of fiscal 2001 and an
aggregate of $1,410,000 for the first and second quarters of fiscal 2002 related
to the acceleration of the amortization of deferred compensation associated with
shares and options held by terminated employees.
(B) CONSOLIDATION OF EXCESS FACILITIES AND OTHER CHARGES (BENEFIT)
In the third quarter of fiscal 2001, Sonus recorded a restructuring charge
of $21,301,000 for the consolidation of excess facilities and other
miscellaneous charges, of which $20,185,000 remained unpaid at December 31,
2001. In the first and second quarters of fiscal 2002, Sonus recorded aggregate
restructuring charges of $2,916,000 for the consolidation of excess facilities.
8
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In March 2002, Sonus' TTI subsidiary reduced its lease commitments for
excess space in its Texas facilities in exchange for a one-time payment of
$835,000 to a landlord and a guarantee by Sonus of TTI's rents owed through
April 2003, the remainder of the revised lease term. As a result of this
transaction, Sonus recorded a restructuring benefit of $16,557,000 in the first
quarter of fiscal 2002. The accruals for the consolidation of excess facilities
were determined assuming no sub-lease income and the amounts were recorded on
the balance sheet as accrued restructuring expenses and long-term obligations.
(C) WRITE-OFF OF INVENTORY AND PURCHASE COMMITMENTS
During the first quarter of fiscal 2002, Sonus' cost of revenues included
$7,026,000 for the write-off of inventory determined to be excess and obsolete
and $2,408,000 for materials that are expected to be purchased from third-party
contract manufacturers and suppliers under purchase commitments, but which are
in excess of required quantities. The liabilities related to purchase
commitments were recorded on the balance sheet as accrued restructuring
expenses.
(D) WRITE-OFF OF GOODWILL AND PURCHASED INTANGIBLE ASSETS
In light of negative industry and economic conditions, a general decline in
technology valuations and our decision to discontinue the development and use of
certain acquired technology, we performed an assessment of the carrying value of
the goodwill and purchased intangible assets recorded in connection with our
acquisition of TTI. In accordance with SFAS No. 121, Sonus recorded a non-cash
impairment charge of $374,735,000 in the third quarter of fiscal 2001 for the
write-off of goodwill and certain purchased intangibles because the estimated
undiscounted future cash flows of these assets was less than the carrying value.
(3) ACQUISITION OF TELECOM TECHNOLOGIES, INC.
In January 2001, Sonus acquired privately-held TTI. Upon the closing of this
acquisition, an aggregate of 10,800,000 shares of Sonus common stock (Merger
Shares) were exchanged for all outstanding shares of TTI common stock. Of the
10,800,000 shares issued to the TTI stockholders, 1,200,000 shares held as
security for indemnity obligations were released to TTI stockholders on
January 18, 2002. In addition to the Merger Shares, the TTI stockholders
received in fiscal 2001, 4,200,000 additional shares of Sonus common stock upon
the achievement of certain specified business expansion and product development
milestones. Sonus has also issued contingent awards of 3,000,000 shares of
common stock under the 2000 Retention Plan to certain former TTI employees who
became employees of Sonus.
9
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED STATEMENTS (CONTINUED)
(UNAUDITED)
The acquisition of TTI was accounted for using the purchase method of
accounting in accordance with APB Opinion No. 16, BUSINESS COMBINATIONS.
Accordingly, the total purchase price was allocated to the assets acquired and
liabilities assumed based upon their estimated fair values. The purchase price
was determined by using the average market value of Sonus common stock for the
period from two days before to two days after the announcement of the TTI
acquisition ($41.61 per share) to value the Merger Shares at the closing date
and adding the fair value of liabilities assumed and expenses of the
acquisition. Additionally, since the closing date, the purchase price has been
increased as the 4,200,000 shares of common stock which were subject to
milestone conditions were earned. The final purchase price was computed as
follows, in thousands:
Fair market value of shares issued.......................... $527,613
Liabilities assumed......................................... 21,184
Acquisition expenses........................................ 5,833
--------
$554,630
========
In accordance with APB Opinion No. 16 and with the assistance of valuation
experts, the final purchase price was allocated to the tangible and intangible
assets acquired based upon their fair values as follows, in thousands:
Tangible assets............................................. $ 8,296
Intangible assets:
Workforce, developed technology and customer list......... 32,300
In-process research and development....................... 40,000
Deferred compensation related to unvested stock options... 22,600
Goodwill.................................................. 451,434
--------
$554,630
========
Sonus engaged third-party appraisers to conduct a valuation of the tangible
and intangible assets and to assist in the determination of the useful lives for
such assets. Based on the results of the appraisal, $40,000,000 was allocated to
in-process research and development, which was expensed in the first quarter of
fiscal 2001. In the third quarter of fiscal 2001, Sonus recorded a non-cash
impairment charge of $374,735,000 for the write-off of TTI goodwill and certain
purchased intangible assets (Note 2). Deferred compensation was computed based
on the intrinsic value of the unvested TTI stock options assumed by Sonus and is
being expensed over the remaining vesting period of up to four years.
Amortization of goodwill and purchased intangible assets for the TTI acquisition
was $283,000 and $38,704,000 for the three months ended June 30, 2002 and 2001
and $589,000 and $65,911,000 for the six months ended June 30, 2002 and 2001.
The valuation of in-process research and development was determined using
the income method. Revenue and expense projections for the in-process
development project were prepared by the management of Sonus through 2008 and
the present value was computed using a discount rate of 22.5%. In the event that
the project is not completed and technological feasibility is not achieved,
there is no alternative future use for the in-process technology. The
assumptions used for the valuation of in-process research and development are
the responsibility of management.
10
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED STATEMENTS (CONTINUED)
(UNAUDITED)
PRO FORMA INFORMATION
The following unaudited pro forma information presents a summary of the
consolidated results of operations of Sonus and TTI as if the acquisition had
occurred on January 1, 2001. The pro forma adjustments exclude the one-time
write-off of TTI in-process research and development.
SIX MONTHS ENDED
JUNE 30, 2001
---------------------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
Revenues.................................................. $ 94,384
Net loss.................................................. (102,251)
Basic and diluted net loss per share...................... $ (0.61)
The pro forma results are not necessarily indicative of what would have
occurred if the acquisition had been in effect for the period presented. In
addition, it is not intended to be a projection of future results and does not
reflect any synergies from combining operations.
(4) ACQUISITION OF CERTAIN ASSETS OF LINGUATEQ, INC.
In July 2001, Sonus completed the acquisition of certain intellectual
property and other assets of privately-held Linguateq Incorporated. Linguateq
was a provider of data distribution and billing application software for both
next generation and legacy networks. The acquisition of certain intellectual
property and other assets was accounted for using the purchase method of
accounting in accordance with SFAS No. 141, BUSINESS COMBINATIONS. The purchase
price was determined by using the average market value of Sonus common stock for
the period from two days before to two days after the terms were agreed upon for
the acquisition ($22.53 per share) to value the 221,753 Sonus common shares
issued to the Linguateq stockholders at the closing date and adding payments to
employees and vendors and expenses of the acquisition. The final purchase price
was computed as follows, in thousands:
Fair market value of shares issued.......................... $4,995
Payments to employees and vendors........................... 241
Acquisition expenses........................................ 141
------
$5,377
======
In accordance with SFAS No. 142, and with the assistance of valuation
experts, the purchase price was allocated to the intangible assets acquired
based upon their fair values. Based upon these appraisals, the purchase price
was allocated as follows, in thousands:
Intangible assets:
Developed technology and customer list.................... $ 700
In-process research and development....................... 3,800
Goodwill.................................................. 877
------
$5,377
======
11
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED STATEMENTS (CONTINUED)
(UNAUDITED)
Sonus engaged third-party appraisers to conduct a valuation of the
intangible assets and to assist in the determination of useful lives for such
assets. Based on the results of the appraisal, $3,800,000 was allocated to
in-process research and development, which was expensed in the third quarter of
fiscal 2001. During the three and six months ended June 30, 2002, amortization
of purchased intangible assets for Linguateq was $100,000 and $200,000.
(5) INVENTORIES
Inventories consist of the following, in thousands:
JUNE 30, DECEMBER 31,
2002 2001
-------- ------------
Raw materials........................................... $3,179 $ 4,899
Work in progress........................................ 177 525
Finished goods.......................................... 6,491 13,441
------ -------
$9,847 $18,865
====== =======
(6) LONG-TERM OBLIGATIONS
Long-term obligations consist of capital leases and restructuring expenses
(Note 2). Sonus assumed certain capital leases as part of the acquisition of
TTI. The capital leases are due in monthly installments expiring at various
dates through March 2005 and accrue interest at annual rates ranging from 4.62%
to 14.39%. The future minimum annual payments under capital leases and amounts
due for long-term obligations, as of June 30, 2002, are as follows, in
thousands:
CAPITAL LEASES:
Total minimum lease payments................................ $1,073
Less amount representing interest........................... (70)
------
Present value of minimum payments........................... 1,003
Less current portion of capital leases...................... (848)
------
Long-term portion of capital leases......................... 155
RESTRUCTURING EXPENSES:
Long-term portion of restructuring expenses................. 1,882
------
Total long-term obligations................................. $2,037
======
(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, available through March 24, 2003. Amounts borrowed under the
equipment line shall be repaid over a 36-month period. Sonus must comply with
certain covenants including a minimum tangible stockholders' equity and quick
ratio, as defined in the credit agreement, and maintain minimum investment
balances with the bank. The availability of the working capital line is
dependent upon Sonus maintaining certain minimum tangible stockholders' equity
balances. If such minimum balances are not achieved then the amounts available
for borrowings under the working capital line will be based on a percentage of
eligible accounts
12
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED STATEMENTS (CONTINUED)
(UNAUDITED)
receivable balances. Under the agreement, all of Sonus' assets, except
intellectual property, have been pledged as collateral. As of June 30, 2002,
Sonus had no borrowings outstanding under the lines of credit and is in
compliance with all covenants.
(8) CONVERTIBLE SUBORDINATED NOTES
In May 2001, Sonus completed a private placement of an aggregate principal
amount of $10,000,000 of 4.75% convertible subordinated notes, 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 notes may be converted by the
holder into shares of Sonus' common stock at any time before their maturity or
prior to their redemption or repurchase by Sonus. The conversion rate is 33.314
shares per each $1,000 principal amount of notes, subject to adjustment in
certain circumstances. After May 1, 2004, Sonus has the option to redeem all or
a portion of the notes 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 these notes 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 notes
through the issuance of common stock or cash. Interest expense related to our
convertible subordinated notes was $119,000 and $238,000 for the three and six
months ended June 30, 2002 and $79,000 for the three and six months ended
June 30, 2001.
(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. The future minimum payments under
operating lease arrangements as of June 30, 2002, are as follows: $1,741,000 in
2002 (six months); $2,956,000 in 2003; $942,000 in 2004; $186,000 in 2005;
$195,000 in 2006; and $418,000 thereafter.
(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 our 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. The 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 11 of the Securities Act of 1933 and against
the individual defendants under Sections 11 and 15 of that Act. Sonus intends to
vigorously defend this action.
In July and August 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. 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 money damages. The
complaints are
13
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED STATEMENTS (CONTINUED)
(UNAUDITED)
essentially identical and allege that Sonus made false and misleading statements
about its products and business. The Company believes the claims are without
merit and that it has substantial legal and factual defenses, which it intends
to pursue vigorously.
(10) STOCKHOLDERS' EQUITY
(A) 1997 STOCK INCENTIVE PLAN
On January 1 of each year, the aggregate number of shares of common stock
available for issuance under the 1997 Stock Incentive Plan (the Plan) shall
increase by the lesser of (i) 5% of the outstanding shares on December 31 of the
preceding year or (ii) an amount determined by the Board of Directors. As of
June 30, 2002, 100,381,966 shares were authorized under the Plan.
(B) 2000 EMPLOYEE STOCK PURCHASE PLAN
On January 1 of each year, the aggregate number of shares of common stock
available for purchase under the 2000 Employee Stock Purchase Plan (ESPP) shall
increase by the lesser of (i) 2% of the outstanding shares on December 31 of the
preceding year or (ii) an amount determined by the Board of Directors. As of
June 30, 2002, 11,352,786 shares were authorized under the ESPP.
(C) STOCK-BASED COMPENSATION
Stock-based compensation expense includes the amortization of deferred
employee compensation and other equity related expenses for non-employees.
In connection with certain employee stock option grants and the issuance of
employee restricted common stock during the years ended December 31, 2000 and
1999, Sonus recorded deferred stock-based compensation of $39,433,000 and
$20,859,000. This represents the aggregate difference between the exercise price
or purchase price and the fair value of the common stock on the date of grant or
sale for accounting purposes. The deferred compensation is recognized as an
expense over the vesting period of the underlying stock options and restricted
common stock.
In connection with the TTI acquisition, Sonus recorded deferred stock-based
compensation of $22,600,000 during the year ended December 31, 2001, related to
the intrinsic value of unvested TTI stock options assumed by Sonus. This
deferred compensation is recognized as an expense over the remaining vesting
period of the underlying stock options of up to four years. Additionally, Sonus
recorded $55,196,000 of deferred stock-based compensation on 3,000,000 shares
awarded to TTI employees under the 2000 Retention Plan, based on the fair value
of Sonus common stock on the closing date of the acquisition, adjusted for
changes in the fair value of Sonus' common stock on the date the related
specific escrow release conditions were satisfied (Note 3). This deferred
compensation is being expensed ratably over the approximate two-year vesting
period of the retention shares. Upon termination of an employee, the remaining
deferred compensation associated with the retention shares is expensed.
Sonus has valued stock options and issuances of restricted common stock to
non-employees based upon the fair market value of the services rendered where
Sonus believes the value of these services is more readily determinable than the
value of the options or restricted stock. All other grants of options and
issuances of restricted stock to non-employees are valued based upon the
Black-Scholes option pricing model. As of June 30, 2002, Sonus has 35,000 shares
of restricted common stock outstanding to
14
SONUS NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED STATEMENTS (CONTINUED)
(UNAUDITED)
non-employees. In accordance with Emerging Issues Task Force 96-18, Sonus will
record the value at the time the services are provided.
Sonus recorded stock-based compensation expense of $5,950,000 and
$13,847,000 for the three months ended June 30, 2002 and 2001 and $11,693,000
and $29,270,000 for the six months ended June 30, 2002 and 2001. Stock-based
compensation expense for the three and six months ended June 30, 2002 includes
$1,029,000 and $1,410,000 related to the write-off of deferred compensation with
respect to shares held by terminated employees impacted by the restructuring
plan (Note 2). Sonus expects stock-based compensation expense to impact its
results through fiscal 2004.
(11) SUPPLEMENTAL CASH FLOW INFORMATION
SIX MONTHS ENDED
JUNE 30,
--------------------
2002 2001
-------- ---------
(IN THOUSANDS)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest................ $275 $ 202
==== =========
ACQUISITION OF TELECOM TECHNOLOGIES, INC:
Tangible assets......................................... $ -- $ 6,312
Liabilities assumed..................................... -- (21,184)
Goodwill and purchased intangibles...................... -- 497,218
Issuance of common stock in connection with the
acquisition........................................... -- (476,513)
Cash acquired........................................... -- (90)
---- ---------
Acquisition, net of cash acquired....................... $ -- $ 5,743
==== =========
(12) SUBSEQUENT EVENT
On August 8, 2002, Sonus announced that as part of its ongoing cost
reduction initiatives, it is further reducing its worldwide workforce by
approximately 85 personnel or 17%. Sonus expects to record a restructuring
charge of approximately $3 million in the third quarter of fiscal 2002,
primarily representing severance expenses and charges associated with excess
facilities.
15
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS, WHICH ARE SUBJECT TO A NUMBER
OF RISKS AND UNCERTAINTIES. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON OUR
CURRENT EXPECTATIONS, ASSUMPTIONS, ESTIMATES AND PROJECTIONS ABOUT OURSELVES AND
OUR INDUSTRY. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS, INCLUDING
THE FACTORS SET FORTH IN "CAUTIONARY STATEMENTS" BEGINNING ON PAGE 22 OF THIS
QUARTERLY REPORT ON FORM 10-Q. THIS DISCUSSION SHOULD BE READ IN CONJUNCTION
WITH THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES
FOR THE PERIODS SPECIFIED. FURTHER REFERENCE SHOULD BE MADE TO SONUS' ANNUAL
REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2001 ON FILE WITH THE SEC.
OVERVIEW
Sonus is a leading provider of voice infrastructure products for the new
public network. We offer a new generation of carrier-class switching equipment
and software that enables voice services to be delivered over packet-based
networks.
Since our inception, we have incurred significant losses and, as of
June 30, 2002, had an accumulated deficit of $763.4 million. We have not
achieved profitability on a quarterly or an annual basis, and anticipate that we
will continue to incur net losses. We have a lengthy sales cycle for our
products and, accordingly, we expect to incur sales and other expenses before we
realize any related revenues. We expect to continue to incur significant sales
and marketing, research and development and general and administrative expenses
and, as a result, we will need to generate significant revenues to achieve and
maintain profitability.
We sell our products primarily through a direct sales force and, in some
markets, through resellers and distributors. Customers' decisions to purchase
our products to deploy in commercial networks involve a significant commitment
of resources and a lengthy evaluation, testing and product qualification
process. We believe these long sales cycles, as well as our expectation that
customer orders will tend to be placed sporadically and with short lead times,
will cause our revenues and results of operations to vary significantly and
unexpectedly from quarter to quarter. We expect to recognize revenues from a
limited number of customers for the foreseeable future.
Sonus began shipping product to customers during the fourth quarter of
fiscal 1999 and recorded its first revenues of $51.8 million in fiscal 2000 and
$173.2 million in fiscal 2001. In January 2001, we acquired privately-held
telecom technologies, inc. (TTI) and accounted for the acquisition as a purchase
for financial reporting purposes. Upon the closing of this acquisition, we
issued 10,800,000 shares of common stock to the TTI shareholders and during
fiscal 2001 issued an additional 4,200,000 shares of common stock to them upon
the achievement of certain milestones. See Note 3 to our unaudited condensed
consolidated financial statements.
Revenues for the three and six months ended June 30, 2002 were
$21.3 million and $42.5 million, representing decreases of 60% and 55%, from
$52.6 million and $94.1 million for the same periods in fiscal 2001, due to
unfavorable business conditions primarily caused by significant declines in
capital spending by telecommunications service providers. As a result of the
current challenging business environment in the telecommunications industry,
many service providers, including some of Sonus' customers, are experiencing
financial difficulties, and some are in the process of restructuring their
businesses or have filed for bankruptcy.
In response to these unfavorable economic conditions, in the third quarter
of fiscal 2001, Sonus commenced restructuring plans designed to reduce expenses
and align its cost structure with its revised business outlook. Accordingly,
Sonus recorded a restructuring charge in the third quarter of fiscal 2001 of
$25.8 million for a worldwide workforce reduction, consolidation of excess
facilities and other
16
charges, a $374.7 million non-cash impairment charge for the write-off of
goodwill and certain purchased intangible assets related to the acquisition of
TTI and a $25.4 million write-off of deferred compensation for shares and
options held by terminated employees.
Further restructuring actions were implemented in the first and second
quarters of fiscal 2002, resulting in aggregate charges of $5.4 million for
worldwide workforce reductions and consolidations of excess facilities, a
$9.4 million write-off of excess inventory and purchase commitments and a
$1.4 million write-off of deferred compensation for shares and options held by
terminated employees. In addition, in the first quarter of fiscal 2002, Sonus
recorded a $16.6 million non-cash restructuring benefit for a lease
renegotiation. As a result of the restructuring actions to date, including those
recently announced in August 2002, we believe that our future operating expenses
will be reduced modestly from their current level. See Notes 2 and 12 to our
unaudited condensed consolidated financial statements.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
requires management to make judgments, assumptions and estimates that affect the
amounts reported in the unaudited condensed consolidated financial statements
and accompanying notes. Actual results could differ from these estimates. The
following critical accounting policies are impacted significantly by judgments,
assumptions and estimates used in the preparation of our unaudited condensed
consolidated financial statements. Our revenue recognition policy complies with
SEC Staff Accounting Bulletin No. 101, REVENUE RECOGNITION IN FINANCIAL
STATEMENTS. See Note 1(e) to our unaudited condensed consolidated financial
statements.
The allowance for doubtful accounts is based on our assessment of the
collectibility of specific customer accounts. If there is a deterioration of a
major customer's credit worthiness or actual defaults are higher than our
historical experience, the actual results could materially differ from these
estimates.
Inventory purchases and commitments are based upon estimated future demand
for our products. If there is a sudden and significant decrease in demand for
our products or there is a higher risk of inventory obsolescence because of
rapidly changing technology and customer requirements, we may be required to
increase our inventory allowances and our gross profit could be adversely
affected.
We accrue for warranty costs based on the historical rate of claims and
costs to provide warranty services. If we experience an increase in warranty
claims greater than our historical experience or our costs to provide warranty
services increase, our gross profit could be adversely affected.
We are subject to the possibility of various loss contingencies arising in
the ordinary course of business. We consider the likelihood of the loss or
impairment of an asset or the incurrence of a liability as well as our ability
to reasonably estimate the amount of loss in determining loss contingencies. An
estimated loss contingency is accrued when it is probable that a liability has
been incurred or an asset has been impaired and the amount of loss can be
reasonably estimated. We regularly evaluate current information available to us
to determine whether such accruals should be adjusted.
17
THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
REVENUES. Revenues were $21.3 million for the three months ended June 30,
2002, a decrease of $31.3 million, or 60%, from $52.6 million for the same
period in fiscal 2001. Revenues were $42.5 million for the six months ended
June 30, 2002, a decrease of $51.6 million, or 55%, from $94.1 million for the
same period in fiscal 2001. The decrease in revenues was the result of
significant declines in capital spending by our telecommunications service
provider customers. For the six months ended June 30, 2002 and 2001, two and
three customers each contributed more than 10% of our revenues and collectively
represented an aggregate of 40% and 68% of total revenues. International
revenues, primarily to Asia and Europe, were 22% and 28% of total revenues for
the six months ended June 30, 2002 and 2001.
COST OF REVENUES/GROSS PROFIT. Cost of revenues consist primarily of
amounts paid to third-party manufacturers for purchased materials and services,
manufacturing and professional services personnel and related costs and
inventory allowances and write-offs. Cost of revenues for the six months ended
June 30, 2002 included a charge of $9.4 million for the write-off of excess
inventory and purchase commitments.
Gross profit was $11.3 million, or 53%, of revenues, for the three months
ended June 30, 2002, compared with $30.4 million, or 58%, of revenues, for the
same period in fiscal 2001. Gross profit, excluding the write-off of excess
inventory and purchase commitments, was $22.6 million, or 53%, of revenues, for
the six months ended June 30, 2002, compared with $53.9 million, or 57%, of
revenues, for the same period in fiscal 2001. The decrease in gross profit as a
percentage of revenues, excluding the write-offs, was primarily due to a
decrease in revenue volume. We expect gross profit as a percentage of revenues
to remain consistent with the current level (excluding the write-offs) in the
near-term.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist primarily of salaries and related personnel costs, recruiting expenses
and prototype costs related to the design, development, testing and enhancement
of our products. Research and development expenses were $12.2 million for the
three months ended June 30, 2002, a decrease of $4.5 million, or 27%, from
$16.7 million for the same period in fiscal 2001. Research and development
expenses were $26.8 million for the six months ended June 30, 2002, a decrease
of $3.8 million, or 12%, from $30.6 million for the same period in fiscal 2001.
These decreases primarily reflect a reduction in salaries and related expenses
and consulting fees attributed to restructuring actions partially offset by
increases in depreciation expense. Some aspects of our research and development
efforts require significant short-term expenditures, the timing of which can
cause significant variability in our expenses. We believe that rapid
technological innovation is critical to our long-term success and we intend to
continue to make substantial investments to enhance our products and
technologies to meet the requirements of our customers and market.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of salaries and related personnel expenses, commissions, travel and
entertainment expenses, promotions, customer evaluations and other marketing
expenses. Sales and marketing expenses were $8.3 million for the three months
ended June 30, 2002, a decrease of $2.3 million, or 22%, from $10.6 million for
the same period in fiscal 2001. Sales and marketing expenses were $16.7 million
for the six months ended June 30, 2002, a decrease of $2.4 million, or 13%, from
$19.1 million for the same period in fiscal 2001. These decreases primarily
reflect a reduction in salaries and related expenses attributed to restructuring
actions and commissions, partially offset by increased costs related to customer
evaluations of our products.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of salaries and related expenses for executive and
administrative personnel, recruiting expenses, provision
18
for bad debts and professional fees. General and administrative expenses were
$1.7 million for the three months ended June 30, 2002, a decrease of
$1.6 million, or 48%, from $3.3 million for the same period in fiscal 2001.
General and administrative expenses were $3.2 million for the six months ended
June 30, 2002, a decrease of $2.7 million, or 47%, from $5.9 million for the
same period in fiscal 2001. These decreases primarily reflect reductions in
salaries and related expenses attributed to restructuring actions and
professional fees.
STOCK-BASED COMPENSATION EXPENSES. Stock-based compensation expenses
include the amortization of stock compensation charges resulting from the
granting of stock options, including TTI stock options assumed by Sonus, stock
awards to TTI employees under the 2000 Retention Plan and the sales of
restricted common stock. See Note 10(c) to our unaudited condensed consolidated
financial statements. Stock-based compensation expenses were $6.0 million for
the three months ended June 30, 2002, a decrease of $7.8 million, or 57%, from
$13.8 million for the same period in fiscal 2001. Stock-based compensation
expenses were $11.7 million for the six months ended June 30, 2002, a decrease
of $17.6 million, or 60%, from $29.3 million for the same period in fiscal 2001.
These decreases are primarily related to the write-off of deferred compensation
of shares and options held by terminated employees impacted by the restructuring
plans. Sonus expects stock-based compensation expense to impact its results
through fiscal 2004.
GOODWILL, PURCHASED INTANGIBLE ASSETS AND IN-PROCESS RESEARCH AND
DEVELOPMENT EXPENSES. In January 2001, Sonus acquired certain intellectual
property, in-process research and development and intangible assets in
connection with our acquisition of TTI, which resulted in the recording of
$523.7 million of goodwill and other intangibles. Amortization of TTI purchased
intangible assets was $283,000 for the three months ended June 30, 2002, a
decrease of $38.4 million from $38.7 million for the same period in fiscal 2001.
Amortization of TTI purchased intangible assets was $589,000 for the six months
ended June 30, 2002, a decrease of $65.3 million from $65.9 million for the same
period in fiscal 2001. These decreases are primarily the result of a write-off
of $374.7 million of TTI goodwill and purchased intangibles in the third quarter
of fiscal 2001. The results of operations for the six months ended June 30, 2001
were impacted by a $40.0 million write-off of TTI purchased in-process research
and development recorded upon closing of the acquisition. See Notes 2 and 3 to
our unaudited condensed consolidated financial statements.
In July 2001, Sonus completed the acquisition of certain intellectual
property and other assets of privately-held Linguateq Incorporated, a provider
of data distribution and billing application software, which resulted in the
recording of $5.4 million of goodwill and purchased intangible assets.
Amortization of purchased intangible assets was $100,000 and $200,000 for the
three and six months ended June 30, 2002. See Note 4 to our unaudited condensed
consolidated financial statements.
RESTRUCTURING CHARGES (BENEFIT), NET. During the first and second quarters
of fiscal 2002, in response to unfavorable business conditions primarily caused
by significant declines in capital spending by telecommunications service
providers, Sonus continued restructuring actions designed to reduce expenses and
align its cost structure with its revised business outlook. The restructuring
actions included worldwide workforce reductions, consolidations of excess
facilities and the write-off of inventory and purchase commitments.
Additionally, in the first quarter of fiscal 2002, Sonus recorded a non-cash
restructuring benefit for a lease renegotiation. See Notes 2 and 3 to our
unaudited condensed consolidated financial statements.
WORKFORCE REDUCTION. The restructuring actions in the first and second
quarters of fiscal 2002 resulted in the reduction of Sonus' workforce with
aggregate charges of $2.5 million for severance and other benefits.
Remaining cash expenditures of $144,000 at June 30, 2002 related to the
workforce reductions are expected to be substantially paid in the third
quarter of fiscal 2002.
19
CONSOLIDATION OF EXCESS FACILITIES. During the first and second
quarters of fiscal 2002, Sonus recorded aggregate restructuring charges of
$2.9 million for the consolidation of excess facilities, which are included
on the balance sheet as accrued restructuring expenses and long-term
obligations.
In March 2002, Sonus' TTI subsidiary reduced its lease commitments for
excess space in its Texas facilities in exchange for a one-time payment of
$835,000 to a landlord and a guarantee by Sonus of TTI's rents owed through
April 2003, the remainder of the revised lease term. As a result of this
transaction, Sonus recorded a non-cash restructuring benefit of
$16.6 million in the first quarter of fiscal 2002. The remaining cash
expenditures of $5.2 million at June 30, 2002 relating to the consolidation
of excess facilities are expected to be paid through May 2004.
WRITE-OFF OF INVENTORY AND PURCHASE COMMITMENTS. During the first
quarter of fiscal 2002, Sonus' cost of revenues included $7.0 million for
the write-off of inventory determined to be excess and obsolete and
$2.4 million for materials that are expected to be purchased from
third-party contract manufacturers and suppliers under purchase commitments,
but which are in excess of required quantities. The remaining liabilities
for purchase commitments of $1.6 million at June 30, 2002, which were
recorded as accrued restructuring expenses, are expected to be substantially
paid by the end of fiscal 2002.
INTEREST INCOME (EXPENSE), NET. Interest income consists of interest earned
on our cash balances and marketable securities. Interest expense consists of
interest incurred on convertible subordinated notes and capital lease
arrangements. Interest income, net of interest expense, was $376,000 for the
three months ended June 30, 2002, a decrease of $1.0 million from $1.4 million
for the same period in fiscal 2001. Interest income, net of interest expense,
was $829,000 for the six months ended June 30, 2002, a decrease of $2.3 million
from $3.1 million for the same period in fiscal 2001. These decreases primarily
reflect a reduction in interest rates and invested balances.
INCOME TAXES. No provision for income taxes has been recorded for the three
and six months ended June 30, 2002 and 2001, due to accumulated net losses. We
did not record any tax benefits relating to these losses or other tax benefits
due to the uncertainty surrounding the realization of these future tax benefits.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $20.6 million for the six months
ended June 30, 2002, as compared to net cash provided by operating activities of
$8.7 million for the same period in fiscal 2001. The increase in net cash used
primarily reflects a reduction in the net loss and non-cash charges and
decreases in accounts payable and deferred revenue, partially offset by
decreases in accounts receivable and inventories.
Net cash provided by investing activities was $10.3 million for the six
months ended June 30, 2002, as compared to net cash used in investing activities
of $52.0 million for the same period in fiscal 2001. Net cash provided by
investing activities for the six months ended June 30, 2002 primarily reflects
net maturities of marketable securities of $12.0 million offset by purchases of
property and equipment of $1.7 million. Net cash used in investing activities
for the six months ended June 30, 2001 primarily reflects net purchases of
marketable securities of $29.1 million, purchases of property and equipment of
$16.8 million and cash expenditures associated with our acquisition of TTI for
$5.7 million. Sonus has no current material commitments for capital expenditures
but does expect to incur approximately $8.0 million in purchases during the next
twelve months.
In January 2002, we established a $10.0 million equipment line of credit and
a $20.0 million working capital line of credit with a bank available through
March 24, 2003. The lines of credit are collateralized by all of our assets,
except intellectual property and bear interest at the banks' prime
20
rate. We are required to comply with various financial and restrictive
covenants. As of June 30, 2002, we had no borrowings outstanding under the lines
of credit and are in compliance with all covenants. See Note 7 to our unaudited
condensed consolidated financial statements.
Net cash provided by financing activities was $2.0 million for the six
months ended June 30, 2002, as compared to $8.3 million for the same period in
fiscal 2001. The net cash provided by financing activities for the six months
ended June 30, 2002 primarily resulted from the sale of common stock in
connection with our employee stock purchase plan (ESPP). The net cash provided
by financing activities for the six months ended June 30, 2001 primarily
resulted from the issuance of convertible subordinated notes, the sale of common
stock under the ESPP and the exercise of stock options partially offset by the
repayment of $8.0 million in a bank note assumed as part of the TTI acquisition.
The following summarizes our future contractual cash obligations as of
June 30, 2002, in thousands:
(SIX MONTHS)
2002 2003 2004 2005 2006 THEREAFTER TOTAL
------------ -------- -------- -------- -------- ---------- --------
Capital lease obligations.............. $ 311 $ 539 $ 193 $ 30 $ -- $ -- $ 1,073
Operating leases....................... 1,741 2,956 942 186 195 418 6,438
Convertible subordinated notes......... 238 475 475 475 10,238 -- 11,901
------ ------ ------ ---- ------- ---- -------
Total contractual cash obligations..... $2,290 $3,970 $1,610 $691 $10,433 $418 $19,412
====== ====== ====== ==== ======= ==== =======
At June 30, 2002, we had cash, cash equivalents and marketable securities
which totaled $104.7 million. We believe our current cash, cash equivalents,
marketable securities and available bank financing will be sufficient to meet
our anticipated cash needs for working capital and capital expenditures for at
least 12 months. The rate at which we will consume cash will be dependent on the
cash needs of future operations which will, in turn, be directly affected by the
levels of demand for our products. If our existing resources and cash generated
from operations are insufficient to satisfy our liquidity requirements, we may
seek to raise additional funds through public or private debt or equity
financings. The sale of additional equity or convertible debt securities could
result in additional dilution to our stockholders, and we cannot be certain that
additional financing will be available in amounts or on terms acceptable to us,
if at all. If we are unable to obtain this additional financing, we may be
required to reduce the scope of our planned product development and sales and
marketing efforts, which could harm our business, financial condition and
operating results.
RECENT ACCOUNTING PRONOUNCEMENT
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 144, ACCOUNTING FOR THE IMPAIRMENT OR
DISPOSAL OF LONG-LIVED ASSETs, which supersedes SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, and
the accounting and reporting provisions of APB No. 30, REPORTING THE RESULTS OF
OPERATIONS--REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A BUSINESS, AND
EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONs. SFAS
No. 144 addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and is effective for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. The
implementation of this statement did not have an effect on Sonus' consolidated
financial statements.
21
CAUTIONARY STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of the Securities Litigation Reform Act of 1995 that involve
risks and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of a number of
factors, including those set forth in the following cautionary statements and
elsewhere in this Quarterly Report on Form 10-Q. If any of the following risks
were to occur, our business, financial condition or results of operations would
likely suffer and the trading price of our common stock would likely decline.
OUR BUSINESS HAS BEEN ADVERSELY AFFECTED BY RECENT DEVELOPMENTS IN THE
TELECOMMUNICATIONS INDUSTRY AND THESE DEVELOPMENTS WILL CONTINUE TO IMPACT OUR
REVENUES AND OPERATING RESULTS.
From our inception through the end of 2000, the telecommunications market
was experiencing rapid growth spurred by a number of factors including
deregulation in the industry, entry of a large number of new emerging service
providers, growth in data traffic and the availability of significant capital
from the financial markets. In 2001 and 2002, the telecommunications industry
experienced a reversal of some of these trends, marked by a dramatic reduction
in current and projected future capital expenditures by service providers,
financial difficulties and, in some cases, bankruptcies experienced by service
providers and a sharp contraction in the availability of capital. These
conditions caused a substantial reduction in demand for telecommunications
equipment, including our products.
We expect the developments described above to continue to affect our
business for the next several quarters in the following manner:
- our ability to accurately forecast revenue will be diminished;
- our revenues could be reduced; and
- our losses may increase because operating expenses are largely based on
anticipated revenue trends and a high percentage of our expenses are and
will continue to be fixed in the short-term.
Our business, operating results and financial condition could be materially
and adversely impacted by any one or a combination of the above.
THE WEAKENED FINANCIAL POSITION OF MANY EMERGING SERVICE PROVIDERS WILL INCREASE
THE UNPREDICTABILITY OF OUR RESULTS.
A substantial portion of our revenues to date are from emerging service
providers who have been the primary early adopters of our voice infrastructure
products. Several of our emerging service provider customers, including Global
Crossing and XO Communications, who contributed 13.2% and 16.6% of our total
2001 revenues, are experiencing financial difficulties and are in the process of
restructuring their operations or have filed for bankruptcy. Our operating
results could be materially and adversely affected if any present or future
service provider chooses to reduce its level of orders, delays or fails to pay
our receivables, or fails to successfully and timely reorganize its operations
including emerging from bankruptcy.
WE EXPECT THAT A MAJORITY OF OUR REVENUES WILL BE GENERATED FROM A LIMITED
NUMBER OF CUSTOMERS AND WE WILL NOT BE SUCCESSFUL IF WE DO NOT GROW OUR CUSTOMER
BASE.
To date, we have shipped our products to a limited number of customers. We
expect that in the foreseeable future, the majority of our revenues will depend
on sales of our products to a limited number of customers. For the year ended
December 31, 2001, Fusion Communications, Global Crossing, Qwest Communications
and XO Communications each contributed more than 10% of our revenues and
collectively represented an aggregate of 67% of our total revenues. For the six
months
22
ended June 30, 2002, Qwest Communications and Touch America each contributed
more than 10% of our revenues and collectively represented an aggregate of 40%
of our total revenues. At June 30, 2002, two customers accounted for the
majority of our accounts receivable balance. Our future success will depend on
our ability to attract additional customers beyond our current limited number.
The growth of our customer base could be adversely affected by:
- customer unwillingness to implement our new voice infrastructure products;
- any delays or difficulties that we may incur in completing the development
and introduction of our planned products or product enhancements;
- additional bankruptcies of service providers or their inability to raise
capital to finance business plans and capital expenditures;
- new product introductions by our competitors;
- any failure of our products to perform as expected; or
- any difficulty we may incur in meeting customers' delivery requirements.
The loss of any of our significant customers or any substantial reduction in
orders from these customers or their delay or failure to pay our receivables
could materially adversely affect our financial condition and results of
operations. If we do not expand our customer base to include additional
customers that deploy our products in operational commercial networks, our
revenues will not grow significantly, or at all.
THE MARKET FOR VOICE INFRASTRUCTURE PRODUCTS FOR THE NEW PUBLIC NETWORK IS NEW
AND EVOLVING AND OUR BUSINESS WILL SUFFER IF IT DOES NOT DEVELOP AS WE EXPECT.
The market for our products is evolving. Packet-based technology may not be
widely accepted as a platform for voice and a viable market for our products may
not develop or be sustainable. If this market does not develop, or develops more
slowly than we expect, we may not be able to sell our products in significant
volume, or at all.
WE WILL NOT RETAIN CUSTOMERS OR ATTRACT NEW CUSTOMERS IF WE DO NOT ANTICIPATE
AND MEET SPECIFIC CUSTOMER REQUIREMENTS OR IF OUR PRODUCTS DO NOT INTEROPERATE
WITH OUR CUSTOMERS' EXISTING NETWORKS.
To achieve market acceptance for our products, we must effectively
anticipate, and adapt in a timely manner to, customer requirements and offer
products and services that meet changing customer demands. Prospective customers
may require product features and capabilities that our current products do not
have. The introduction of new or enhanced products also requires that we
carefully manage the transition from older products in order to minimize
disruption in customer ordering patterns and ensure that adequate supplies of
new products can be delivered to meet anticipated customer demand. If we fail to
develop products and offer services that satisfy customer requirements, or to
effectively manage the transition from older products, our ability to create or
increase demand for our products would be seriously harmed and we may lose
current and prospective customers.
Many of our customers will require that our products be designed to
interface with their existing networks, each of which may have different
specifications. Issues caused by an unanticipated lack of interoperability may
result in significant warranty, support and repair costs, divert the attention
of our engineering personnel from our hardware and software development efforts
and cause significant customer relations problems. If our products do not
interoperate with those of our customers' networks, installations could be
delayed or orders for our products could be cancelled, which would seriously
harm our gross margins and result in loss of revenues or customers.
23
WE MAY NOT BECOME PROFITABLE.
We have incurred significant losses since inception and expect to continue
to incur losses in the future. As of June 30, 2002, we had an accumulated
deficit of $763.4 million and had only recognized cumulative revenues since
inception of $267.4 million through June 30, 2002. We have not achieved
profitability on a quarterly or annual basis. Our revenues may not grow and we
may never generate sufficient revenues to achieve or sustain profitability.
WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE, WHICH MAY NOT BE AVAILABLE TO US,
AND IF IT IS AVAILABLE, MAY DILUTE THE OWNERSHIP OF OUR COMMON STOCK.
We may need to raise additional funds through public or private debt or
equity financings in order to:
- fund ongoing operations and capital requirements;
- take advantage of opportunities, including more rapid expansion or
acquisition of complementary products, technologies or businesses;
- develop new products; or
- respond to competitive pressures.
Any additional capital raised through the sale of equity may dilute an
investor's percentage ownership of our common stock. Furthermore, additional
financings may not be available on terms favorable to us, or at all. A failure
to obtain additional funding could prevent us from making expenditures that may
be required to grow or maintain our operations.
THE UNPREDICTABILITY OF OUR QUARTERLY RESULTS MAY ADVERSELY AFFECT THE TRADING
PRICE OF OUR COMMON STOCK.
Our revenues and operating results will vary significantly from quarter to
quarter due to a number of factors, many of which are outside of our control and
any of which may cause our stock price to fluctuate. Generally, purchases by
service providers of telecommunications equipment from manufacturers have been
unpredictable and clustered, rather than steady, as the providers build out
their networks. The primary factors that may affect our revenues and results
include the following:
- fluctuation in demand for our voice infrastructure products and the timing
and size of customer orders;
- the cancellation or deferral of existing customer orders;
- the failure of certain of our customers to successfully and timely
reorganize their operations, including emerging from bankruptcy;
- the length and variability of the sales cycle for our products and the
corresponding timing of recognizing or deferring revenues;
- new product introductions and enhancements by our competitors and us;
- changes in our pricing policies, the pricing policies of our competitors
and the prices of the components of our products;
- our ability to develop, introduce and ship new products and product
enhancements that meet customer requirements in a timely manner;
- the mix of product configurations sold;
- our ability to obtain sufficient supplies of sole or limited source
components;
- our ability to attain and maintain production volumes and quality levels
for our products;
24
- costs related to acquisitions of complementary products, technologies or
businesses; and
- general economic conditions, as well as those specific to the
telecommunications, networking and related industries.
As with other telecommunications product suppliers, we may recognize a
substantial portion of our revenue in a given quarter from sales booked and
shipped in the last weeks of that quarter. As a result, a delay in customer
orders is likely to result in a delay in shipments and recognition of revenue
beyond the end of a given quarter, which would have a significant impact on our
operating results for that quarter.
Our operating expenses are largely based on anticipated organizational
growth and revenue trends. As a result, a delay in generating or recognizing
revenues for the reasons set forth above, or for any other reason, could cause
significant variations in our operating results. We believe that
quarter-to-quarter comparisons of our operating results are not a good
indication of our future performance. It is likely that in some future quarters,
our operating results may be below the expectations of public market analysts
and investors. In this event, the price of our common stock will probably
substantially decrease.
IF WE FAIL TO HIRE AND RETAIN NEEDED PERSONNEL, THE IMPLEMENTATION OF OUR
BUSINESS PLAN COULD SLOW OR OUR FUTURE GROWTH COULD HALT.
Competition for highly skilled engineering, sales, marketing and support
personnel is intense because there are a limited number of people available with
the necessary technical skills and understanding of our market. Any failure to
attract, assimilate or retain qualified personnel to fulfill our current or
future needs could impair our growth. The support of our products requires
highly trained customer support and professional services personnel. Once we
hire them, they may require extensive training in our voice infrastructure
products. If we are unable to hire, train and retain our customer support and
professional services personnel, we may not be able to increase sales of our
products. Our future success depends upon the continued services of our
executive officers who have critical industry experience and relationships that
we rely on to implement our business plan. None of our officers or key employees
are bound by employment agreements for any specific term. The loss of the
services of any of our officers or key employees could delay the development and
introduction of, and negatively impact our ability to sell, our products.
WE MAY FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL EXPANSION THAT COULD IMPAIR
OUR ABILITY TO GROW OUR REVENUES ABROAD.
International revenues, primarily to Asia and Europe, were 18% and 22% of
our revenues for fiscal 2001 and the first six months of fiscal 2002, and we
intend to continue to expand our sales into international markets. This
expansion will require significant management attention and financial resources
to successfully develop direct and indirect international sales and support
channels. In addition, we may not be able to develop international market demand
for our products, which could impair our ability to grow our revenues. We have
limited experience marketing, distributing and supporting our products
internationally and, to do so, we expect that we will need to develop versions
of our products that comply with local standards. Furthermore, international
operations are subject to other inherent risks, including:
- greater difficulty collecting accounts receivable and longer collection
periods;
- difficulties and costs of staffing and managing international operations;
- the impact of differing technical standards outside the United States;
- the impact of recessions in economies outside the United States;
25
- unexpected changes in regulatory requirements and currency exchange rates;
- certification requirements;
- reduced protection for intellectual property rights in some countries;
- potentially adverse tax consequences; and
- political and economic instability.
WE ARE ENTIRELY DEPENDENT UPON OUR VOICE INFRASTRUCTURE PRODUCTS AND OUR FUTURE
REVENUES DEPEND UPON THEIR COMMERCIAL SUCCESS.
Our future growth depends upon the commercial success of our voice
infrastructure products. We intend to develop and introduce new products and
enhancements to existing products in the future. We may not successfully
complete the development or introduction of these products. If our target
customers do not adopt, purchase and successfully deploy our current or planned
products, our revenues will not grow.
BECAUSE OUR PRODUCTS ARE SOPHISTICATED AND DESIGNED TO BE DEPLOYED IN COMPLEX
ENVIRONMENTS, THEY MAY HAVE ERRORS OR DEFECTS THAT WE FIND ONLY AFTER FULL
DEPLOYMENT, WHICH COULD SERIOUSLY HARM OUR BUSINESS.
Our products are sophisticated and are designed to be deployed in large and
complex networks. Because of the nature of our products, they can only be fully
tested when substantially deployed in very large networks with high volumes of
traffic. Some of our customers have only recently begun to commercially deploy
our products and they may discover errors or defects in the software or
hardware, or the products may not operate as expected. If we are unable to fix
errors or other performance problems that may be identified after full
deployment of our products, we could experience:
- loss of, or delay in, revenues;
- loss of customers and market share;
- a failure to attract new customers or achieve market acceptance for our
products;
- increased service, support and warranty costs and a diversion of
development resources; and
- costly and time-consuming legal actions by our customers.
IF WE DO NOT RESPOND RAPIDLY TO TECHNOLOGICAL CHANGES OR TO CHANGES IN INDUSTRY
STANDARDS, OUR PRODUCTS COULD BECOME OBSOLETE.
The market for voice infrastructure products for the new public network is
likely to be characterized by rapid technological change and frequent new
product introductions. We may be unable to respond quickly or effectively to
these developments. We may experience difficulties with software development,
hardware design, manufacturing or marketing that could delay or prevent our
development, introduction or marketing of new products and enhancements. The
introduction of new products by our competitors, the market acceptance of
products based on new or alternative technologies or the emergence of new
industry standards could render our existing or future products obsolete. If the
standards adopted are different from those that we have chosen to support,
market acceptance of our products may be significantly reduced or delayed. If
our products become technologically obsolete, we may be unable to sell our
products in the marketplace and generate revenues.
26
IF WE FAIL TO COMPETE SUCCESSFULLY, OUR ABILITY TO INCREASE OUR REVENUES OR
ACHIEVE PROFITABILITY WILL BE IMPAIRED.
Competition in the telecommunications market is intense. This market has
historically been dominated by large companies, such as Lucent Technologies and
Nortel Networks, both of whom are our direct competitors. We also face
competition from other large telecommunications and networking companies,
including Cisco Systems, which have entered our market by acquiring companies
that design competing products. In addition, a number of smaller and mostly
private companies have announced plans for new products that target market
opportunities similar to those we address. Because this market is rapidly
evolving, additional competitors with significant financial resources may enter
these markets and further intensify competition.
Many of our current and potential competitors have significantly greater
selling and marketing, technical, manufacturing, financial and other resources,
including the ability to offer vendor-sponsored financing programs. If we are
unable or unwilling to offer vendor-sponsored financing, prospective customers
may decide to purchase products from one of our competitors that offers this
type of financing. Furthermore, some of our competitors are currently selling
significant amounts of other products to our current and prospective customers.
Our competitors' broad product portfolios, coupled with already existing
relationships, may cause our customers to buy our competitors' products or harm
our ability to attract new customers.
To compete effectively, we must deliver innovative products that:
- provide extremely high reliability and voice quality;
- scale easily and efficiently;
- interoperate with existing network designs and other vendors' equipment;
- provide effective network management;
- are accompanied by comprehensive customer support and professional
services; and
- provide a cost-effective and space-efficient solution for service
providers.
If we are unable to compete successfully against our current and future
competitors, we could experience price reductions, order cancellations, loss of
revenues and reduced gross profit margins.
WE DEPEND UPON CONTRACT MANUFACTURERS AND ANY DISRUPTION IN THESE RELATIONSHIPS
MAY CAUSE US TO FAIL TO MEET THE DEMANDS OF OUR CUSTOMERS AND DAMAGE OUR
CUSTOMER RELATIONSHIPS.
We rely on a small number of contract manufacturers to manufacture our
products according to our specifications and to fill orders on a timely basis.
Our contract manufacturers provide comprehensive manufacturing services,
including assembly of our products and procurement of materials. Each of our
contract manufacturers also builds products for other companies and may not
always have sufficient quantities of inventory available to fill our orders or
may not allocate their internal resources to fill these orders on a timely
basis. We do not have long-term supply contracts with our manufacturers and they
are not required to manufacture products for any specified period. We do not
have internal manufacturing capabilities to meet our customers' demands.
Qualifying a new contract manufacturer and commencing commercial-scale
production is expensive and time consuming and could result in a significant
interruption in the supply of our products. If a change in contract
manufacturers results in delays in our fulfillment of customer orders or if a
contract manufacturer fails to make timely delivery of orders, we may lose
revenues and suffer damage to our customer relationships.
27
WE AND OUR CONTRACT MANUFACTURERS RELY ON SINGLE OR LIMITED SOURCES FOR SUPPLY
OF SOME COMPONENTS OF OUR PRODUCTS AND IF WE FAIL TO ADEQUATELY PREDICT OUR
MANUFACTURING REQUIREMENTS OR IF OUR SUPPLY OF ANY OF THESE COMPONENTS IS
DISRUPTED, WE WILL BE UNABLE TO SHIP OUR PRODUCTS.
We and our contract manufacturers currently purchase several key components
of our products, including commercial digital signal processors, from single or
limited sources. We purchase these components on a purchase order basis. If we
overestimate our component requirements, we could have excess inventory, which
would increase our costs. If we underestimate our requirements, we may not have
an adequate supply, which could interrupt manufacturing of our products and
result in delays in shipments and revenues.
We currently do not have long-term supply contracts with our component
suppliers and they are not required to supply us with products for any specified
periods, in any specified quantities or at any set price, except as may be
specified in a particular purchase order. In the event of a disruption or delay
in supply, or inability to obtain products, we may not be able to develop an
alternate source in a timely manner or at favorable prices, or at all. A failure
to find acceptable alternative sources could hurt our ability to deliver
high-quality products to our customers and negatively affect our operating
margins. In addition, reliance on our suppliers exposes us to potential supplier
production difficulties or quality variations. Our customers rely upon our
ability to meet committed delivery dates, and any disruption in the supply of
key components would seriously impact our ability to meet these dates and could
result in legal action by our customers, loss of customers or harm to our
ability to attract new customers.
IF WE ARE NOT ABLE TO OBTAIN NECESSARY LICENSES OF THIRD-PARTY TECHNOLOGY AT
ACCEPTABLE PRICES, OR AT ALL, OUR PRODUCTS COULD BECOME OBSOLETE.
We have incorporated third-party licensed technology into our current
products. From time to time, we may be required to license additional technology
from third parties to develop new products or product enhancements. Third-party
licenses may not be available or continue to be available to us on commercially
reasonable terms. The inability to maintain or re-license any third-party
licenses required in our current products or to obtain any new third-party
licenses to develop new products and product enhancements could require us to
obtain substitute technology of lower quality or performance standards or at
greater cost, and delay or prevent us from making these products or
enhancements, any of which could seriously harm the competitiveness of our
products.
OUR ABILITY TO COMPETE AND OUR BUSINESS COULD BE JEOPARDIZED IF WE ARE UNABLE TO
PROTECT OUR INTELLECTUAL PROPERTY OR BECOME SUBJECT TO INTELLECTUAL PROPERTY
RIGHTS LITIGATION, WHICH COULD REQUIRE US TO INCUR SIGNIFICANT COSTS.
We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
Despite our efforts to protect our proprietary rights, unauthorized parties may
attempt to copy or otherwise obtain and use our products or technology.
Monitoring unauthorized use of our products is difficult and we cannot be
certain that the steps we have taken will prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. If competitors are able to
use our technology, our ability to compete effectively could be harmed. In
addition, we may become involved in litigation as a result of allegations that
we infringe the intellectual property rights of others. Any parties asserting
that our products infringe upon their proprietary rights would force us to
defend ourselves and possibly our customers or contract manufacturers against
the alleged infringement. These claims and any resulting lawsuit, if successful,
could subject us to significant
28
liability for damages and invalidation of our proprietary rights. Any potential
intellectual property litigation also could force us to do one or more of the
following:
- stop selling, incorporating or using our products that use the challenged
intellectual property;
- obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on reasonable terms, or at all; or
- redesign those products that use any allegedly infringing technology.
Any lawsuits regarding intellectual property rights, regardless of their
success, would be time-consuming, expensive to resolve and would divert our
management's time and attention.
ANY INVESTMENTS OR ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND SERIOUSLY
HARM OUR FINANCIAL CONDITION.
Although we have no current agreements to do so, we intend to consider
investing in, or acquiring, complementary products, technologies or businesses.
In the event of future investments or acquisitions, we could:
- issue stock that would dilute our current stockholders' percentage
ownership;
- incur debt or assume liabilities;
- incur significant impairment charges related to the write-off of goodwill
and purchased intangible assets;
- incur significant amortization expenses related to purchased intangible
assets; or
- incur large and immediate write-offs for in-process research and
development and stock-based compensation.
Our integration of any acquired products, technologies or businesses will
also involve numerous risks, including:
- problems and unanticipated costs associated with combining the purchased
products, technologies or businesses;
- diversion of management's attention from our core business;
- adverse effects on existing business relationships with suppliers and
customers;
- risks associated with entering markets in which we have limited or no
prior experience; and
- potential loss of key employees, particularly those of the acquired
organizations.
We may be unable to successfully integrate any products, technologies,
businesses or personnel that we might acquire in the future without significant
costs or disruption to our business.
IF WE ARE SUBJECT TO UNFAIR HIRING CLAIMS, WE COULD INCUR SUBSTANTIAL COSTS IN
DEFENDING OURSELVES.
Companies in our industry whose employees accept positions with competitors
frequently claim that their competitors have engaged in unfair hiring practices.
We may be subject to claims of this kind in the future as we seek to hire
qualified personnel. Those claims may result in material litigation. We could
incur substantial costs defending ourselves or our employees against those
claims, regardless of their merits. In addition, defending ourselves from those
types of claims could divert our management's attention from our operations. If
we are found to have engaged in unfair hiring practices, or our employees are
found to have violated agreements with previous employers, we may suffer a
significant disruption in our operations.
29
SECURITIES LITIGATION COULD RESULT IN SUBSTANTIAL COST AND DIVERT THE ATTENTION
OF KEY PERSONNEL, WHICH COULD SERIOUSLY HARM OUR BUSINESS.
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 our 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. The 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 11 of the Securities Act of 1933 and against
the individual defendants under Sections 11 and 15 of that Act. Sonus intends to
vigorously defend this action.
In July and August 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. 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 money damages. The
complaints are essentially identical and allege that Sonus made false and
misleading statements about its products and business. The Company believes the
claims are without merit and that it has substantial legal and factual defenses,
which it intends to pursue vigorously.
In the past, securities class action litigation has often been brought
against companies following periods of volatility in the market price of their
securities. Securities litigation could result in substantial costs and divert
management's attention and resources, which could seriously harm our business.
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE.
The market for technology stocks has been and will likely continue to be
extremely volatile. The following factors could cause the market price of our
common stock to fluctuate significantly:
- loss of any of our major customers;
- changes in the financial condition or anticipated capital expenditure
purchases of any of our major customers;
- the addition or departure of key personnel;
- variations in our quarterly operating results;
- announcements by us or our competitors of significant contracts, new
products or product enhancements, acquisitions, distribution partnerships,
joint ventures or capital commitments;
- changes in financial estimates by securities analysts;
- sales of common stock or other securities by us or by our stockholders in
the future;
- economic conditions for the telecommunications, networking and related
industries;
- worldwide economic instability; and
- any acquisitions, distribution partnerships, joint ventures or capital
commitments.
30
SALES OF A SUBSTANTIAL AMOUNT OF OUR COMMON STOCK IN THE FUTURE COULD CAUSE OUR
STOCK PRICE TO FALL.
Some stockholders who acquired shares prior to our IPO or in connection with
our acquisition of TTI hold a substantial number of shares of our common stock
that have not yet been sold in the public market. Further, additional shares may
become available for sale upon the conversion or redemption of convertible
subordinated notes. Sales of a substantial number of shares of our common stock
within a short period of time in the future could impair our ability to raise
capital through the sale of additional debt or stock and /or cause our stock
price to fall.
IF WE FAIL TO COMPLY WITH CERTAIN CONTINUED NASDAQ NATIONAL MARKET LISTING
STANDARDS, OUR COMMON STOCK COULD BE DELISTED AND THE MARKET VALUE AND LIQUIDITY
OF OUR COMMON STOCK MAY BE SIGNIFICANTLY REDUCED.
Sonus' common stock is currently listed on the Nasdaq National Market under
the symbol SONS. All Nasdaq National Market companies are required to comply
with certain continued listing standards, including maintaining a minimum bid
price of at least $1.00 per share and minimum stockholders' equity of
$10,000,000. Since August 2, 2002, Sonus' common stock has traded at a minimum
bid price of less than $1.00 per share. If our common stock trades at less than
a minimum bid price of $1.00 per share for 30 consecutive trading days, then
Sonus will not be in compliance with the current Nasdaq National Market
standards. Upon notification of non-compliance under the current rules, Nasdaq
will provide for an additional 90 calendar days to regain compliance with the
continued listing standards.
We cannot assure you that Sonus' common stock will meet the required Nasdaq
National Market continued listing standards at any time in the future or that
Sonus will continue to maintain its listing on the Nasdaq National Market. In
the event that Sonus is unable to maintain its listing on the Nasdaq National
Market, the market value and liquidity of Sonus' common stock could be
significantly reduced and the holders of Sonus' common stock may be unable to
sell their shares at a favorable price.
INSIDERS HAVE SUBSTANTIAL CONTROL OVER US AND COULD LIMIT YOUR ABILITY TO
INFLUENCE THE OUTCOME OF KEY TRANSACTIONS, INCLUDING A CHANGE OF CONTROL.
Our executive officers, directors and entities affiliated with them
beneficially own, in the aggregate, a significant portion of our outstanding
common stock. These stockholders, if acting together, would be able to influence
significantly all matters requiring approval by our stockholders, including the
election of directors and the approval of mergers or other business combination
transactions.
PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY HAVE ANTI-TAKEOVER
EFFECTS THAT COULD PREVENT A CHANGE OF CONTROL.
Provisions of our amended and restated certificate of incorporation, our
amended and restated by-laws and Delaware law could make it more difficult for a
third party to acquire us, even if doing so would be beneficial to our
stockholders.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not currently use derivative financial instruments. We generally place
our marketable security investments in high-quality credit instruments,
primarily U.S. Government obligations and corporate obligations with contractual
maturities of less than one year. We do not expect any material loss from our
marketable security investments and therefore believe that our potential
interest rate exposure is not material. We have no current material exposure to
foreign currency rate fluctuations, though we will continue to evaluate the
impact of foreign currency exchange risk on our results of operations as we
expand internationally.
31
PART II--OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
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 our 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. The 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 11 of the Securities Act of 1933 and against
the individual defendants under Sections 11 and 15 of that Act. Sonus intends to
vigorously defend this action.
In July and August 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. 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 money damages. The
complaints are essentially identical and allege that Sonus made false and
misleading statements about its products and business. The Company believes the
claims are without merit and that it has substantial legal and factual defenses,
which it intends to pursue vigorously.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 2002 Annual Meeting of Shareholders of Sonus Networks, Inc. was held on
May 2, 2002 at the Westford Regency, 219 Littleton Road in Westford,
Massachusetts 01886. Of the 204,675,407 shares outstanding as of March 22, 2002,
the record date, 155,214,723 shares (75.8%) were present or represented by proxy
at the meeting. The table below presents the results of the election to Sonus'
board of directors.
VOTES FOR AGAINST ABSTENTIONS
----------- ---------- -----------
Hassan M. Ahmed.......................... 137,849,890 17,364,833 --
Paul J. Severino......................... 146,275,590 8,939,133 --
32
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
99.1........ Certificate of Sonus Networks, Inc. chief executive officer
and chief financial officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
Sonus filed on April 10, 2002, a Current Report on Form 8-K with the SEC
reporting its actual financial results for the first quarter ended March 31,
2002.
Sonus filed on June 27, 2002, a Current Report on Form 8-K with the SEC
dismissing Arthur Andersen LLP as its independent accountants and appointing
Ernst and Young LLP as its new independent accountants.
Sonus filed on July 11, 2002, a Current Report on Form 8-K with the SEC
reporting its actual financial results for the second quarter ended June 30,
2002.
Sonus filed on August 9, 2002, a Current Report on Form 8-K with the SEC
announcing a reduction in its worldwide workforce.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
Dated: August 14, 2002 SONUS NETWORKS, INC.
By: /s/ STEPHEN J. NILL
-----------------------------------------
Stephen J. Nill
CHIEF FINANCIAL OFFICER, VICE PRESIDENT OF
FINANCE AND ADMINISTRATION AND TREASURER
(AUTHORIZED OFFICER AND PRINCIPAL
FINANCIAL AND ACCOUNTING OFFICER)
33
EXHIBIT 99.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF
THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Sonus Networks, Inc. (the
"Company") on Form 10-Q for the period ending June 30, 2002, as filed with
the Securities and Exchange Commission on the date hereof (the "Report"),
each of the undersigned, Hassan M. Ahmed, President and Chief Executive
Officer and Stephen J. Nill, Chief Financial Officer, Vice President of
Finance and Administration and Treasurer of the Company, certify, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Hassan M. Ahmed /s/ Stephen J. Nill
- ------------------------------------- ------------------------------------
Hassan M. Ahmed Stephen J. Nill
PRESIDENT AND CHIEF CHIEF FINANCIAL OFFICER,
EXECUTIVE OFFICER VICE PRESIDENT OF FINANCE AND
ADMINISTRATION AND TREASURER
Dated: August 14, 2002 Dated: August 14, 2002