##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION


Washington, D.C. 20549


FORM 10-Q



| |           
| | ----------
| | (Mark One)

| |   |                                                 
| | - | ------------------------------------------------
| | þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

| |                                       
| | --------------------------------------
| | OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended
September 30, 2001

or



| |   |                                                  
| | - | -------------------------------------------------
| | o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

| |                                       
| | --------------------------------------
| | OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period
from                               to

Commission File Number 000-26441

CLARENT CORPORATION

(Exact name of registrant as specified in its
charter)


|                                                                                |  |                                                        
|------------------------------------------------------------------------------- |  | -------------------------------------------------------
|Delaware
    (State or other jurisdiction of
    incorporation or organization) |  | 77-0433687
    (I.R.S. Employer
    Identification No.)

700 Chesapeake Drive

Redwood City, California 94063


(Address of principal executive offices and
zip code)


(650) 306-7511

(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  o          No  þ

The number of shares outstanding of the
Registrants Common Stock, $0.001 par value, was 41,001,419
at December 31, 2001.

This report consists of 51 pages of which this
page is number 1.







1



---

TABLE OF CONTENTS



|                                                               |                                                                                               |  |  |  |  |  |  | 
|-------------------------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION                                 
|                                                               | ITEM 1. FINANCIAL STATEMENTS                                                                 
|CLARENT CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS     
|NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                                                               | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                               | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|PART II. OTHER INFORMATION                                    
|                                                               | ITEM 1. LEGAL PROCEEDINGS                                                                    
|                                                               | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.                                                    
|SIGNATURES                                                    
|Exhibit 10.32                                                 
|EXHIBIT 10.33                                                 



---



##### Table of Contents



EXPLANATORY NOTE

Subsequent to the issuance of Clarent
Corporations (the Company) financial
statements on its Quarterly Report on Form 10-Q previously
filed for the quarter ended June 30, 2001, the Company
discovered accounting and financial irregularities affecting
such financial statements. Many of these irregularities related
to revenue recognition and cash reporting arising primarily from
operations in the Companys Asia-Pacific regional office.
The Company has determined that these irregularities require the
restatement of certain of its previously issued financial
statements. This Quarterly Report on Form 10-Q for the
quarter ended September 30, 2001 is filed simultaneously
with the filing of the Companys restatement of its
financial statements for the quarters ended March 31, 2000,
June 30, 2000, September 30, 2000, December 31,
2000, March 31, 2001 and June 30, 2001, as well as for
the year ended December 31, 2000. The circumstances
necessitating the restatement and their effects for the quarter
ended September 30, 2001 are more fully described in
Notes 1 and 10 of Notes to Unaudited Condensed Consolidated
Financial Statements. In addition, the Companys current
litigation proceedings are described in Item 1 of
Part II and Note 18 of Notes to Unaudited Condensed
Consolidated Financial Statements.

Financial statement information and related
disclosures included in this filing reflect, where appropriate,
changes as a result of the restatement. Statements used in this
Form 10-Q containing the words (i) now,
currently, present, to date,
and words of similar import, and
(ii) knowledge, and words of similar import,
are used to refer to conditions existing on the filing date of
this Form 10-Q. We direct you to refer to the other reports
we file with the Securities and Exchange Commission from time to
time after the date of this report for more current information
regarding Clarent, including Risk Factors that May Impact
Future Operating Results.

CLARENT CORPORATION

FORM 10-Q INDEX

|                                    |  |            |  |                                                                                                                                    |    |          |    | 
|----------------------------------- |  | ---------- |  | ---------------------------------------------------------------------------------------------------------------------------------- | -- | -------- | -- | 
|                                    |  |            |  |                                                                                                                                    |    | Page No.
|                                    |  |            |  |                                                                                                                                    |    |         
|PART I:   FINANCIAL
    INFORMATION |  |            |  |                                                                                                                                   
|                                    |  | Item 1.    |  | Financial Statements (Unaudited)                                                                                                   |    |          | 3  | 
|                                    |  |            |  | Condensed Consolidated Balance Sheets as of
    September 30, 2001 and December 31, 2000 (restated)                                |    |          | 3  | 
|                                    |  |            |  | Condensed Consolidated Statements of Operations
    for the Three and Nine Months Ended September 30, 2001 and
    2000 (restated) |    |          | 4  | 
|                                    |  |            |  | Condensed Consolidated Statements of Cash Flows
    for the Nine Months Ended September 30, 2001 and 2000
    (restated)           |    |          | 5  | 
|                                    |  |            |  | Notes to Unaudited Condensed Consolidated
    Financial Statements                                                                 |    |          | 6  | 
|                                    |  | Item 2.    |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations                                          |    |          | 23 | 
|                                    |  |            |  | Risk Factors That May Impact Future Operating
    Results                                                                          |    |          | 35 | 
|                                    |  | Item 3.    |  | Quantitative and Qualitative Disclosures about
    Market Risk                                                                     |    |          | 47 | 
|PART II:   OTHER
    INFORMATION    |  |            |  |                                                                                                                                   
|                                    |  | Item 1.    |  | Legal Proceedings                                                                                                                  |    |          | 48 | 
|                                    |  | Item 6.    |  | Exhibits and Reports on Form 8-K                                                                                                   |    |          | 50 | 
|                                    |  | Signatures |  |                                                                                                                                    | 51 |         

2



---



##### Table of Contents






PART I.

FINANCIAL INFORMATION




ITEM 1.     FINANCIAL
STATEMENTS




CLARENT CORPORATION

CONDENSED CONSOLIDATED BALANCE
SHEETS

(In thousands)


|                                         |                                           |                            |                                            |              |         |         |        |          |         |         | 
|---------------------------------------- | ----------------------------------------- | -------------------------- | ------------------------------------------ | ------------ | ------- | ------- | ------ | -------- | ------- | ------- | 
|                                         |                                           | September 30,              |                                            | December 31,
|                                         |                                           | 2001                       |                                            | 2000        
|                                         |                                           |                            |                                            |             
|                                         |                                           | (Unaudited)                |                                            | (Restated)  
|ASSETS                                  
|Current assets:                          |                                           |                            |                                            |              |         |         |        |         
|                                         | Cash and cash equivalents                 |                            | $                                          | 76,317       |         |         | $      | 185,627  |        
|                                         | Restricted cash                           |                            |                                            | 10,000       |         |         |        |         |        
|                                         | Short-term investments                    |                            |                                            | 9,959        |         |         |        | 74,987   |        
|                                         | Accounts receivable, gross                |                            |                                            | 11,635       |         |         |        | 28,142   |        
|                                         | Receivables allowance                     |                            |                                            | (2,827       | )       |         |        | (6,973   | )      
|                                         |                                           |                            |                                            |              |         |         |        |         
|                                         | Accounts receivable, net                  |                            |                                            | 8,808        |         |         |        | 21,169   |        
|                                         | Inventories                               |                            |                                            | 11,351       |         |         |        | 17,662   |        
|                                         | Prepaid expenses and other current assets |                            |                                            | 3,547        |         |         |        | 5,942    |        
|                                         |                                           |                            |                                            |              |         |         |        |         
|                                         |                                           | Total current assets       |                                            |              | 119,982 |         |        |          | 305,387 |        
|Investments                              |                                           |                            | 6,890                                      |              |         |         | 14,479 |         
|Property and equipment, net              |                                           |                            | 12,020                                     |              |         |         | 36,938 |         
|Goodwill, net                            |                                           |                            |                                           |              |         |         | 93,644 |         
|Purchased intangible assets, net         |                                           |                            |                                           |              |         |         | 38,057 |         
|Deferred tax assets                      |                                           |                            |                                           |              |         |         | 14,534 |         
|Other assets                             |                                           |                            | 4,827                                      |              |         |         | 4,517  |         
|Note receivable from a leasing company   |                                           |                            | 5,000                                      |              |         |         |       |         
|                                         |                                           |                            |                                            |              |         |         |        |         
|                                         |                                           | Total assets               |                                            | $            | 148,719 |         |        | $        | 507,556 |        
|                                         |                                           |                            |                                            |              |         |         |        |         
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                           |                            |                                            |              |         |         |        |         
|                                         | Line of credit                            |                            | $                                          | 9,964        |         |         | $      |         |        
|                                         | Accounts payable                          |                            |                                            | 10,593       |         |         |        | 14,337   |        
|                                         | Deferred revenue                          |                            |                                            | 4,069        |         |         |        | 8,528    |        
|                                         | Accrued liabilities                       |                            |                                            | 18,076       |         |         |        | 22,775   |        
|                                         | Customer advances                         |                            |                                            | 20,892       |         |         |        | 2,551    |        
|                                         | Restructuring and merger related accrual  |                            |                                            | 11,045       |         |         |        | 6,248    |        
|                                         |                                           |                            |                                            |              |         |         |        |         
|                                         |                                           | Total current liabilities  |                                            |              | 74,639  |         |        |          | 54,439  |        
|Deferred tax liabilities                 |                                           |                            |                                           |              |         |         | 14,534 |         
|Restructuring accrual  long term        |                                           |                            | 34,150                                     |              |         |         |       |         
|Contingencies                            |                                           |                            |                                            |              |         |         |        |         
|Stockholders equity:                    |                                           |                            |                                            |              |         |         |        |         
|                                         | Common stock                              |                            |                                            | 583,277      |         |         |        | 583,328  |        
|                                         | Deferred compensation                     |                            |                                            | (1,644       | )       |         |        | (9,740   | )      
|                                         | Accumulated other comprehensive loss      |                            |                                            | (861         | )       |         |        | (326     | )      
|                                         | Accumulated deficit                       |                            |                                            | (540,842     | )       |         |        | (134,679 | )      
|                                         |                                           |                            |                                            |              |         |         |        |         
|                                         |                                           | Total stockholders equity |                                            |              | 39,930  |         |        |          | 438,583 |        
|                                         |                                           |                            |                                            |              |         |         |        |         
|                                         |                                           |                            | Total liabilities and stockholders equity |              | $       | 148,719 |        |          | $       | 507,556 | 
|                                         |                                           |                            |                                            |              |         |         |        |         

See accompanying notes to condensed consolidated
financial statements.

3



---



##### Table of Contents



CLARENT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except per share
amounts)


(Unaudited)


|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |        |         | 
|----------------------------------------------------------------- | ------------------------------------------------------------------------------ | ------------------------ | -------- | ----------------- | ------- | ---- | ------- | ---------- | ------ | - | -------- | ------ | ------- | - | ------- | ------ | ------- | 
|                                                                  |                                                                                |                          |          |                  
|                                                                  |                                                                                | Three Months Ended       |          | Nine Months Ended
|                                                                  |                                                                                | September 30,            |          | September 30,    
|                                                                  |                                                                                |                          |          |                  
|                                                                  |                                                                                | 2001                     |          | 2000              |         | 2001 |         | 2000      
|                                                                  |                                                                                |                          |          |                   |         |      |         |           
|                                                                  |                                                                                |                          |          | (Restated)        |         |      |         | (Restated)
|Net revenue:                                                      |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|                                                                  | Product and software                                                           |                          | $        | 15,430            |         |      | $       | 23,218     |        |   | $        | 45,025 |         |   | $       | 61,131 |        
|                                                                  | Service                                                                        |                          |          | 3,308             |         |      |         | 4,003      |        |   |          | 12,331 |         |   |         | 9,566  |        
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|                                                                  |                                                                                | Total revenue            |          |                   | 18,738  |      |         |            | 27,221 |   |          |        | 57,356  |   |         |        | 70,697  | 
|Cost of revenue:                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|                                                                  | Product and software                                                           |                          |          | 37,771            |         |      |         | 14,210     |        |   |          | 85,032 |         |   |         | 30,223 |        
|                                                                  | Service                                                                        |                          |          | 3,429             |         |      |         | 2,176      |        |   |          | 11,725 |         |   |         | 5,894  |        
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|                                                                  |                                                                                | Total cost of revenue    |          |                   | 41,200  |      |         |            | 16,386 |   |          |        | 96,757  |   |         |        | 36,117  | 
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|Gross profit (loss)                                               |                                                                                |                          | (22,462  | )                 |         |      | 10,835  |            |        |   | (39,401  | )      |         |   | 34,580  |       
|Operating expenses:                                               |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|                                                                  | Research and development                                                       |                          |          | 14,759            |         |      |         | 8,414      |        |   |          | 45,992 |         |   |         | 18,320 |        
|                                                                  | Sales and marketing                                                            |                          |          | 17,881            |         |      |         | 15,255     |        |   |          | 67,507 |         |   |         | 38,129 |        
|                                                                  | General and administrative                                                     |                          |          | 7,952             |         |      |         | 5,092      |        |   |          | 20,214 |         |   |         | 10,399 |        
|                                                                  | Amortization of deferred compensation and other
    stock compensation charges |                          |          | 1,855             |         |      |         | 1,763      |        |   |          | 6,037  |         |   |         | 4,073  |        
|                                                                  | Amortization of goodwill and other intangibles                                 |                          |          | 9,106             |         |      |         | 6,023      |        |   |          | 27,324 |         |   |         | 6,474  |        
|                                                                  | Impairment of goodwill and other intangibles                                   |                          |          | 99,149            |         |      |         |           |        |   |          | 99,149 |         |   |         |       |        
|                                                                  | Impairment of property and equipment                                           |                          |          | 40,518            |         |      |         |           |        |   |          | 40,518 |         |   |         |       |        
|                                                                  | Restructuring and merger related costs                                         |                          |          | 36,009            |         |      |         | 1,386      |        |   |          | 50,150 |         |   |         | 1,386  |        
|                                                                  | Purchased in-process research and development                                  |                          |          |                  |         |      |         | 31,496     |        |   |          |       |         |   |         | 31,496 |        
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|                                                                  |                                                                                | Total operating expenses |          |                   | 227,229 |      |         |            | 69,429 |   |          |        | 356,891 |   |         |        | 110,277 | 
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|Loss from operations                                              |                                                                                |                          | (249,691 | )                 |         |      | (58,594 | )          |        |   | (396,292 | )      |         |   | (75,697 | )     
|Other income (expense), net                                       |                                                                                |                          | (13,128  | )                 |         |      | 5,088   |            |        |   | (9,140   | )      |         |   | 13,602  |       
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|Loss before provision for income taxes                            |                                                                                |                          | (262,819 | )                 |         |      | (53,506 | )          |        |   | (405,432 | )      |         |   | (62,095 | )     
|Provision for income taxes                                        |                                                                                |                          | (405     | )                 |         |      | (2      | )          |        |   | (730     | )      |         |   | (286    | )     
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|Net loss                                                          |                                                                                | $                        | (263,224 | )                 |         | $    | (53,508 | )          |        | $ | (406,162 | )      |         | $ | (62,381 | )     
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|Basic and diluted net loss per share                              |                                                                                | $                        | (6.45    | )                 |         | $    | (1.47   | )          |        | $ | (10.11   | )      |         | $ | (1.85   | )     
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       
|Shares used in computing basic and diluted net
    loss per share |                                                                                |                          | 40,813   |                   |         |      | 36,482  |            |        |   | 40,165   |        |         |   | 33,763  |       
|                                                                  |                                                                                |                          |          |                   |         |      |         |            |        |   |          |        |         |   |         |       

See accompanying notes to condensed consolidated
financial statements.

4



---



##### Table of Contents



CLARENT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands)


(Unaudited)


|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |          |         |        |  
|------------------------------------------------------------------------------ | ------------------------------------------------------------------------------- | ------------------------------------------------------------------------------ | ----------------------------------------- | ---------- | -------- | ------ | ------- | -------- | ------- | ------ | -
|                                                                               |                                                                                 |                                                                               
|                                                                               |                                                                                 | Nine Months Ended                                                             
|                                                                               |                                                                                 | September 30,                                                                 
|                                                                               |                                                                                 |                                                                               
|                                                                               |                                                                                 | 2001                                                                           |                                           | 2000      
|                                                                               |                                                                                 |                                                                                |                                           |           
|                                                                               |                                                                                 |                                                                                |                                           | (Restated)
|Operating activities:                                                          |                                                                                 |                                                                                |                                           |            |          |        |         |         
|                                                                               | Net loss                                                                        |                                                                                | $                                         | (406,162   | )        |        | $       | (62,381  | )      
|                                                                               | Adjustments to reconcile net loss to net cash
    used in operating activities: |                                                                                |                                           |            |          |        |         |          |        
|                                                                               |                                                                                 | Depreciation and fixed asset impairment charges                                |                                           |            | 15,678   |        |         |          | 6,081   |       
|                                                                               |                                                                                 | Impairment of property and equipment                                           |                                           |            | 40,518   |        |         |          |        |       
|                                                                               |                                                                                 | Amortization of deferred compensation and other
    stock compensation charges |                                           |            | 6,037    |        |         |          | 4,073   |       
|                                                                               |                                                                                 | Loss on property and equipment disposal                                        |                                           |            | 314      |        |         |          |        |       
|                                                                               |                                                                                 | Amortization of goodwill and other intangibles                                 |                                           |            | 29,403   |        |         |          | 6,860   |       
|                                                                               |                                                                                 | Purchased in-process research and development                                  |                                           |            |         |        |         |          | 31,496  |       
|                                                                               |                                                                                 | Impairment of goodwill and other intangibles                                   |                                           |            | 99,149   |        |         |          |        |       
|                                                                               |                                                                                 | Impairment of investments                                                      |                                           |            | 8,880    |        |         |          |        |       
|                                                                               |                                                                                 | Changes in operating assets and liabilities:                                   |                                           |            |          |        |         |          |         |       
|                                                                               |                                                                                 |                                                                                | Accounts receivable                       |            |          | 12,336 |         |          |         | 8,234  |  
|                                                                               |                                                                                 |                                                                                | Inventories                               |            |          | 6,276  |         |          |         | (4,801 | )
|                                                                               |                                                                                 |                                                                                | Prepaid expenses and other current assets |            |          | 1,145  |         |          |         | (84    | )
|                                                                               |                                                                                 |                                                                                | Other assets                              |            |          | (310   | )       |          |         | (1,339 | )
|                                                                               |                                                                                 |                                                                                | Accounts payable and accrued liabilities  |            |          | (8,429 | )       |          |         | (4,917 | )
|                                                                               |                                                                                 |                                                                                | Deferred revenue                          |            |          | (4,459 | )       |          |         | (740   | )
|                                                                               |                                                                                 |                                                                                | Customer advances                         |            |          | 18,341 |         |          |         | 7,164  |  
|                                                                               |                                                                                 |                                                                                | Restructuring and merger related accrual  |            |          | 42,096 |         |          |         | 6,354  |  
|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |         
|                                                                               |                                                                                 | Net cash used in operating activities                                          |                                           |            | (139,187 | )      |         |          | (4,000  | )     
|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |         
|Investing activities:                                                          |                                                                                 |                                                                                |                                           |            |          |        |         |         
|                                                                               | Purchases of short-term investments                                             |                                                                                |                                           | (34,970    | )        |        |         | (120,519 | )      
|                                                                               | Purchases of long-term investments                                              |                                                                                |                                           | (3,041     | )        |        |         | (15,250  | )      
|                                                                               | Sale and maturities of short-term investments                                   |                                                                                |                                           | 100,007    |          |        |         | 88,450   |        
|                                                                               | Restricted cash                                                                 |                                                                                |                                           | (10,000    | )        |        |         |         |        
|                                                                               | Sale of long-term investments                                                   |                                                                                |                                           | 3,000      |          |        |         |         |        
|                                                                               | Note receivable from a leasing company                                          |                                                                                |                                           | (5,000     | )        |        |         |         |        
|                                                                               | Purchases of property and equipment                                             |                                                                                |                                           | (31,997    | )        |        |         | (19,026  | )      
|                                                                               | Acquisition of businesses, net cash acquired                                    |                                                                                |                                           |           |          |        |         | 33,316   |        
|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |         
|                                                                               |                                                                                 | Net cash provided by (used in) investing
    activities                        |                                           |            | 17,999   |        |         |          | (33,029 | )     
|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |         
|Financing activities:                                                          |                                                                                 |                                                                                |                                           |            |          |        |         |         
|                                                                               | Proceeds from line of credit                                                    |                                                                                |                                           | 10,000     |          |        |         |         |        
|                                                                               | Repayments of line of credit                                                    |                                                                                |                                           | (50        | )        |        |         |         |        
|                                                                               | Proceeds from issuance of common stock                                          |                                                                                |                                           | 2,007      |          |        |         | 5,369    |        
|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |         
|                                                                               |                                                                                 | Net cash provided by financing activities                                      |                                           |            | 11,957   |        |         |          | 5,369   |       
|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |         
|Effect of exchange rate changes on cash and cash
    equivalents               |                                                                                 |                                                                                | (79                                       | )          |          |        | (89     | )       
|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |         
|Net decrease in cash and cash equivalents                                      |                                                                                 |                                                                                | (109,310                                  | )          |          |        | (31,749 | )       
|Cash and cash equivalents at beginning of period                               |                                                                                 |                                                                                | 185,627                                   |            |          |        | 238,724 |         
|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |         
|Cash and cash equivalents at end of period                                     |                                                                                 | $                                                                              | 76,317                                    |            |          | $      | 206,975 |         
|                                                                               |                                                                                 |                                                                                |                                           |            |          |        |         |         
|Supplemental disclosure of non-cash activities:                                |                                                                                 |                                                                                |                                           |            |          |        |         |         
|Preferred stock received in exchange for
    settlement of accounts receivable |                                                                                 | $                                                                              |                                          |            |          | $      | 1,500   |         
|Issuance of common stock in connection with
    acquisition                    |                                                                                 | $                                                                              |                                          |            |          | $      | 194,412 |         
|Conversion of promissory notes into strategic
    investments                  |                                                                                 | $                                                                              | 1,250                                     |            |          | $      |        |         

See accompanying notes to condensed consolidated
financial statements.

5



---



##### Table of Contents



CLARENT CORPORATION






NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS


1.     BASIS OF
PRESENTATION

The accompanying unaudited condensed consolidated
financial statements of the Company as of September 30,
2001 and for the three-and nine-months ended September 30,
2001 and September 30, 2000 (restated) have been
prepared in accordance with generally accepted accounting
principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of
Regulation S-X. In the opinion of management, the condensed
consolidated financial statements include all adjustments that
management considers necessary for a fair presentation of the
results of operations for the interim periods shown. The results
of operations for such periods are not necessarily indicative of
the results expected for the full fiscal year or for any future
period. The balance sheet at December 31, 2000
(restated) has been derived from the audited financial
statements at that date but does not include all of the
information and footnotes required by generally accepted
accounting principles for complete financial statements. These
financial statements should be read in conjunction with the
consolidated financial statements and related notes included in
the Companys Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2000, as amended in
connection with the restatement of the Companys financial
statements. Certain prior period balances have been reclassified
to conform to current period presentation.

Restatement of Financial
Statements

On August 26, 2001, the Companys Board
of Directors formed a special committee, comprised of three
outside directors, Messrs. Pape, Forman and Barker. The
special committee directed and instructed the Companys
outside counsel to investigate certain facts that had come to
the Boards attention and that the Board determined could
reflect potential accounting and financial irregularities. The
Companys outside counsel, at the direction of the special
committee, requested the Companys independent auditors to
assist in the investigation. On September 4, 2001, the
Company announced that it had discovered accounting and
financial irregularities that materially affected the
Companys previously reported financial results for the
first two quarters of the year 2001. Subsequently on
October 23, 2001, the Company announced that it also had
discovered accounting and financial irregularities that
materially affected the Companys previously reported
financial results for the year 2000.

To address the activities discovered in its
investigation, the Company has implemented remedial actions,
including the prompt termination of employees who appear to have
been involved in activities relating to the irregularities,
closure of the Companys Asia-Pacific regional
headquarters, and the adoption of new and more stringent
subsidiary cash control and expense approval policies, such as
new banking and internal reporting procedures, improved controls
over sales representatives and sales orders and hiring and
payroll procedures, and new and more stringent credit approval
policies.

In the course of the investigation, the Company
discovered accounting and financial irregularities arising from
activities that appear to have been initiated by a number of
parties no longer associated with the Company, resulting in,
among other things, an overstatement in revenue of an aggregate
amount of $129.4 million over the restated periods. The
circumstances necessitating the restatement, and the impact on
the Company, can be described in the following general
categories:

Revenue
Restatement:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Company discovered that its revenue had been
    overstated for certain periods because revenue from sales in the
    Asia-Pacific region had been recognized in situations where
    customers had indirectly received Company funds from third
    parties, by means of arrangements effected through unauthorized
    acts of Company employees. These arrangements were entered into
    in violation of Company procedures and were not reported to the
    appropriate personnel within the Company.

6



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenue also had been overstated for certain
    periods because revenue had been recognized from certain sales
    in the Asia-Pacific region where customers now claim to have
    return rights or that the Company has repurchase obligations.
    The Company now believes that certain Company personnel may have
    entered into agreements with customers in the Asia-Pacific
    region purporting to provide such return rights or repurchase
    obligations. These agreements were entered into in violation of
    Company procedures and were not reported to the appropriate
    personnel within the Company.
|
| |  | The Company has restated revenue for certain
    periods because, based on current information and actual payment
    history, it now appears that certain customers may not have been
    creditworthy at the time of purchase.                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Revenue also had been overstated for certain
    periods because of transactions involving the sale of products
    over which the Company continued to have some control until a
    subsequent period.                                                                                                                                                                                                                                                                                                                                                                                                                      

Impact on
Expenses:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In connection with the restatement, the Company
    has adjusted certain accruals and reserves related to accounts
    receivable, warranty and inventory and has made reclassification
    entries. The Company also recorded additional losses in the form
    of restructuring and asset impairments in the third quarter of
    2001. These losses resulted from what the Company now knows was
    an over-expansion of its operating capacity and operating
    expenses as well as the overall downturn in the
    telecommunications industry. The Company increased its operating
    capacity based on forecasts that included revenue levels that
    the Company now knows, based on the discovery of financial
    irregularities, were overstated, but which the Company believed
    at the time were appropriate.
|
| |  | The Company also determined that expenses were
    understated because certain payments or loans made from the
    Asia-Pacific regional office were effected in violation of
    Company procedures and were not reported to the appropriate
    personnel within the Company. The Company believes that such
    payments or loans are not recoverable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

Financial
Condition:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Companys cash position was overstated
    in the March 31, 2001 and June 30, 2001 financial
    statements because personnel in the Asia Pacific region
    transferred cash in violation of the Companys policies and
    procedures. These cash transfers were not reported to the
    appropriate personnel within the Company. As a result, the cash
    transfers were accounted for in improper periods. As of
    September 30, 2001, in the aggregate, there was no direct
    material impact on the cash position of the Company as a result
    of the improper recording of these transactions, including the
    cash transfers, although the Company had recorded liabilities of
    approximately $24 million associated with the
    irregularities giving rise to the restatement. As of the date of
    filing of this report, the Companys cash position has been
    materially impacted by several factors, as discussed below.
|
| |  | The unauthorized transactions with third parties
    that appear to have used Company funds to purchase the
    Companys products had a material impact on the
    Companys financial condition because of the expense of the
    inventory for which the Company will probably not be able to
    recover any value and the associated distribution costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | The Companys primary source of liquidity is
    its operating cash flows, which have been disrupted by the
    activities giving rise to, and the impact of, the restatement as
    well as the downturn in demand for telecommunications equipment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

7



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Company suffered substantial operating losses
    due to the activities necessitating the restatement because it
    over-expanded its operating capacity and operating expenses in
    2000 and the first two quarters of 2001. The Company increased
    its operating capacity based on forecasts that included revenue
    levels that the Company now knows, based on the discovery of
    financial irregularities, were overstated, but which the Company
    believed at the time were appropriate.

As a result of the information discovered in the
investigation, the Company has determined that it is appropriate
to restate its financial statements for the quarters ended
March 31, 2000, June 30, 2000, September 30,
2000, December 31, 2000, March 31, 2001 and
June 30, 2001, as well as for the year ended
December 31, 2000.

Recent Events

In January 2002, the Company engaged Regent
Pacific Management Corporation, an international firm that
specializes in the recovery and restructuring of
under-performing companies, and appointed Gary J. Sbona of
Regent Pacific as its chief executive officer. Mr. Sbona
has also joined the Companys board of directors and has
been appointed chairman of the board. On March 9, 2002, the
Company appointed James B. Weil of Regent Pacific as its
president.

At March 31, 2002, the Companys cash,
cash equivalents and short-term investments were approximately
$34 million, which may not be adequate to meet the
Companys operating cash needs through the end of 2002,
unless the Company achieves increased revenues and further
reduces its expenses. To reduce its expenditures, the Company
restructured in several areas, including reducing staffing,
implementing expense management and curtailing capital spending.
For example, since July 2001, the Companys headcount
decreased by approximately 82%, from approximately
1,018 employees to approximately 180 employees
currently. In addition, the Company has sustained, and expects
to continue to sustain, substantial expenses arising from the
restatement of its financial statements and related litigation
matters. Until the Company resolves the claims against it and
reduces its commitments, the Company expects that its expenses
will continue to exceed its revenues for the foreseeable future.
The Company plans to take further measures to conserve cash, and
to continue to evaluate its strategic alternatives.

For the quarter ended September 30, 2001,
the Company reported revenues of $18.7 million. In quarters
subsequent to the quarter ended September 30, 2001,
revenues have declined substantially. The Companys
revenues have been, and the Company expects will continue to be,
materially affected by the downturn in demand for
telecommunications equipment and by events causing, and the
impact of, the restatement of its financial statements. The
Company does not expect demand for its products to recover for
the remainder of 2002, and the Company expects operating losses
and negative cash flows from operations to continue for the
foreseeable future.

If the Company is not able to achieve increased
revenues and resolve the claims against it, or if the Company
incurs unexpected expenditures, then it will need to reduce
expenses further and raise additional funds to continue as a
going concern. The Company continues to evaluate its strategic
alternatives, including financing transactions or a sale of
assets. Due to the unavailability of a public market for the
Companys stock as well as the Companys current stock
price, additional funding may not be available to the Company on
favorable terms or at all. If the Company raises additional
funds through the issuance of equity securities, the percentage
ownership of its stockholders could be significantly diluted.
Furthermore, these securities may have rights, preferences or
privileges senior to the Companys common stock. If
additional funding is not available when needed, the Company may
be unable to continue as a going concern and achieve its
intended business objectives.

8



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


2.     SIGNIFICANT
ACCOUNTING POLICIES

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States requires the Company to make estimates and
judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and the related disclosure
of contingent assets and liabilities. On an ongoing basis, the
Company evaluates its estimates, including those related to
allowance for doubtful accounts, inventories, investments,
deferred tax assets, intangible assets, income taxes, warranty
obligations, restructuring, and contingencies and litigation.
The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different
assumptions or conditions.

Revenue Recognition

Revenue is recognized at the time of shipment of
the products when persuasive evidence of an arrangement exists,
the fee is fixed and determinable, when no significant
contractual obligations or acceptance terms, if any, remain
outstanding and collection of the resulting receivable is deemed
probable. Service revenue, which is substantially all
maintenance revenue, is generally deferred and, in most cases,
recognized when the services are performed. Maintenance revenue
is recognized ratably over the service period obligations, which
is typically one year. Cash payments received in advance of the
recording of product or service revenue are recorded as customer
advances. Amounts billed or received in advance of satisfying
all revenue recognition criteria are classified as deferred
revenue in the accompanying balance sheets.

Cash Equivalents and Short-Term
Investments

The Company considers all highly liquid
investment securities with a maturity date from the date of
purchase of three months or less to be cash equivalents, and
investment securities with maturity from date of purchase of
more than three months but less than one year to be short-term
investments.

Management determines the appropriate
classification of debt and equity securities at the time of
purchase and reevaluates such designation as of each balance
sheet date. To date, all investments have been classified as
available-for-sale and are carried at fair value with unrealized
gains and losses reported net-of-tax as a separate component of
comprehensive income. Realized gains and losses on
available-for-sale securities are included in interest income.
The cost of securities sold is based on specific identification.
Premiums and discounts are amortized over the period from
acquisition to maturity and are included in investment income
along with interest and dividends.

Concentrations of Credit Risk and Credit
Evaluations

Financial instruments, which subject the Company
to concentrations of credit risk, primarily consist of cash,
short and long-term investments and accounts receivable. The
Company maintains its cash and cash equivalents principally in
domestic financial institutions of high-credit standing.

The Companys receivables are derived
primarily from sales of software and hardware products and
services to companies primarily in the domestic and
international telecommunications arena. Approximately 19% of the
accounts receivable at September 30, 2001 were from the
Asia-Pacific region, 54% from Europe, Middle East and Africa and
27% from the Americas. The Company performs ongoing credit
evaluations of its customers and generally does not require
collateral. Reserves are maintained for potential credit losses.

A limited number of customers have historically
accounted for a substantial portion of the Companys
revenue. One customer accounted for 17% of net revenue for the
nine months ended September 30, 2001.

9



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


Allowance for Doubtful
Accounts

The Company records an allowance for doubtful
accounts based on estimates of potential uncollectability of its
accounts receivables. The Company specifically analyzes its
accounts receivable and historical bad debts, customer
credit-worthiness, current economic trends, and changes in its
customer payment terms when evaluating the adequacy of the
allowance for doubtful accounts. Historically, the Company has,
from time to time, experienced material differences between its
estimated allowance for doubtful accounts and actual results. If
the financial condition of the Companys customers were to
deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required.

Inventories

Inventories are stated at the lower of cost or
market on a first-in, first-out basis. Inventory which is
obsolete or in excess of the Companys forecasted usage is
written down to its estimated market value based on assumptions
about future demand and market conditions. See Note 4
Inventories for further discussion on charges
incurred during the three and nine months ended
September 30, 2001 and 2000.

Investments

Long-term investments primarily consist of
strategic investments of less than 20% equity interest in
certain private companies. The Company does not have the ability
to exercise significant influence over any of these companies,
therefore these investments are recorded at cost and are
accounted for under the cost method of accounting. Realized
gains and losses are recorded in interest and other income when
the related investments are sold. The Companys long-term
investments in privately held companies are regularly assessed
for impairment through review of operations and indications of
continued viability of such companies. The Companys
reviews of operations of these companies, to assess the carrying
values of these investments, include evaluation of operating
performance, financing status, liquidity prospects and cash flow
forecasts. Impairment losses on these long-term investments are
recorded when events and circumstances indicate that such assets
might be impaired and the decline in value is other than
temporary.

Property & Equipment, Goodwill and
Intangible Assets

Property and equipment are stated at the lower of
cost or fair value. Depreciation and amortization is computed
using the straight-line method over the estimated useful lives
of the assets. Estimated useful lives ranging from one to three
years are used for computer equipment, purchased software,
production and engineering equipment and five-year lives for
office equipment, furniture and fixtures. Leasehold improvements
are amortized over the shorter of five years or the remaining
term of the applicable lease.

Intangible assets consisted of the Companys
assembled workforce, customer base, purchased technology and
goodwill related to the acquisitions of ACT Networks, Inc., PEAK
Software Inc. and Global Media Concepts. These acquisitions were
accounted for as purchases. Goodwill and other intangible assets
are amortized, on a straight-line basis, over the estimated
useful lives of the assets, which generally range from three to
five years. Purchased in-process research and development,
without alternative future use, was charged to operations at the
date of acquisition.

The Company records impairment losses on
goodwill, intangible assets and fixed assets when events and
circumstances indicate that such assets might be impaired and
the estimated fair value of such asset is less than its recorded
amount. Conditions that would trigger an impairment assessment
include material adverse changes in operations or a decision to
abandon products, services or technologies. Measurement of fair
value is based on discounted cash flows and utilizes the
Companys incremental borrowing rate. As of
September 30, 2001, the Company has determined that all
goodwill and other intangible assets and a substantial portion
of its

10



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


fixed assets are impaired, and consequently has
recorded an impairment charge to reduce the recorded value to
fair value. See Note 6 Impairment of Goodwill,
Intangibles, and Property and Equipment for further
discussion.

Warranties

The Companys warranty policy generally
states that the Company will provide warranty coverage, for a
predetermined amount of time, on products for material and labor
to repair and service the products. The Company records the
estimated cost of warranty coverage upon product shipment. The
estimated cost of warranty coverage is determined by the
warranty term as well as the average historical warranty expense
for a specific product. Should actual product failure rates or
material usage costs differ from the Companys estimates,
revisions to the estimated warranty and installation liability
may be required.

Recent Accounting
Pronouncements

In July 2001, the Financial Accounting Standards
Board (FASB) issued Statement of Financial
Accounting Standards No. 141, Business
Combinations (SFAS 141). SFAS 141
requires the purchase method of accounting for all business
combinations and eliminates the pooling-of-interests method for
business combinations initiated after June 30, 2001.
SFAS 141 also includes guidance on the initial recognition
and measurement of goodwill and other intangible assets arising
from business combinations completed after June 30, 2001.
The Company does not expect the adoption of SFAS 141 to
have a material effect on its financial conditions or results of
operations.

In July 2001, the FASB issued SFAS 142,
Goodwill and Other Intangible Assets
(SFAS 142). SFAS 142 discontinues
amortization of goodwill and intangible assets deemed to have
indefinite lives and requires such assets to be reviewed at
least annually for impairment. SFAS 142 also includes
provisions on the identification of intangible assets,
reclassification of certain intangibles from previously reported
goodwill, and reassessment of the useful lives of existing
intangibles. The Company will apply SFAS 142 beginning in
the first quarter of 2002. The Company does not expect the
adoption of SFAS 142 to have a material effect on its financial
conditions or results of operations.

In July 2001, the FASB issued SFAS 143,
Accounting for Asset Retirement Obligations
(SFAS 143) which addresses accounting and
reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement
costs. SFAS 143 is effective for fiscal years beginning
after June 15, 2002. The Company is currently assessing the
impact of this new standard, and as such, it is possible that
its adoption could have a material effect on its financial
condition or results of operations.

In August 2001, the FASB issued SFAS 144,
Impairment or Disposal of Long-Lived Assets
(SFAS 144) which is effective for fiscal years
beginning after December 15, 2001. SFAS 144 supersedes
SFAS 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of and
provides a single accounting model for impairment of long-lived
assets. The Company is currently assessing the impact of this
new standard, and as such, it is possible that its adoption
could have a material effect on its financial condition or
results of operations.

3.     FINANCIAL
INSTRUMENTS

Available-for-sale securities are carried at fair
value, with the unrealized gains or losses reported as a
separate component of stockholders equity. Expected
maturities may differ from contractual maturities because the
issuers of the securities may have the right to prepay or call
obligations without prepayment penalties. Realized gains and
losses on sales of available-for-sale securities were not
material for the nine months ended September 30, 2001.

11



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


4.     INVENTORIES

Inventories consist of the following (in
thousands):

|                |  |               |        |              |  |   |        | 
|--------------- |  | ------------- | ------ | ------------ |  | - | ------ | 
|                |  | September 30, |        | December 31,
|                |  | 2001          |        | 2000        
|                |  |               |        |             
|                |  |               |        | (Restated)  
|Raw materials   |  | $             | 8,992  |              |  | $ | 10,901 | 
|Work-in-process |  |               |       |              |  |   | 83     | 
|Finished goods  |  |               | 2,359  |              |  |   | 6,678  | 
|                |  |               |        |              |  |   |        | 
|                |  | $             | 11,351 |              |  | $ | 17,662 | 
|                |  |               |        |              |  |   |        | 

Inventory charges totaling $27.5 million and
$56.8 million were taken during the three and nine months
ended September 30, 2001, respectively, reflecting excess
inventories resulting from changes in forecasted demand, the
Companys decision to discontinue certain products, the
write-down of leased inventory and product costs associated with
products shipped to certain customers in the Asia-Pacific region
for which revenue was not recognizable, and for which the
inventory shipped is not expected to be recoverable.

5.     INVESTMENTS

The Company invests in equity instruments of
privately held companies for the promotion of business and
strategic objectives. The Company has also invested in a venture
capital management fund. These investments are recorded at their
initial fair value, net of impairment losses. Impairment losses
are recorded when events and circumstances indicate that such
assets might be impaired and the decline in value is other than
temporary. Through September 30, 2001, the Company had
invested $7.5 million in a venture capital management fund.
The Company is committed to investing an additional
$7.5 million in the venture capital management fund through
2007.

At September 30, 2001, the Company recorded
impairment losses on strategic investments of $6.1 and
$8.9 million for the three and nine months ended
September 30, 2001, resulting in a net book value of
$6.9 million. The losses represent the write-down of the
Companys carrying amount of these investments and were
determined by considering, among other factors, the inability of
the investees to obtain additional private financing, the
suspension of one investees current operations, and the
uncertain financial condition of the investees and the market in
which they operate. As such, the Company believes the changes in
the current market environment and decrease in the valuations of
these companies are other than temporary, and it has written
down the carrying value accordingly.

6.     IMPAIRMENT OF
GOODWILL, INTANGIBLES AND PROPERTY AND EQUIPMENT

The Company has evaluated the carrying value of
certain long-lived assets and acquired intangibles, consisting
primarily of goodwill and tangible fixed assets, recorded on its
balance sheet at September 30, 2001. Pursuant to accounting
rules, the majority of goodwill is recorded based on stock
prices at the time acquisition agreements are executed and
announced. Goodwill and intangible assets are generally
evaluated on an individual acquisition, market, or product basis
whenever events or changes in circumstances indicate that such
assets are impaired or the estimated useful lives are no longer
appropriate. Periodically, the Company reviews its goodwill and
other intangible assets for impairment based on estimated future
undiscounted cash flows attributable to the assets in accordance
with SFAS No. 121. In the event such cash flows are not
expected to be sufficient to recover the recorded value of the
assets, the assets are written down to their estimated fair
values based on the expected discounted future cash flows
attributable to the assets.

12



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


During the third quarter of 2001, the Company
determined that due to the continuing downturn of the
telecommunications market as well as the activities giving rise
to, and the impact of, the restatement on the Companys
business, the carrying amounts of certain assets might be
impaired. The Company then determined that the undiscounted cash
flows estimated to be generated by those assets are less than
the carrying amounts of those assets.

During the quarter ended September 30, 2001,
the Company recorded an impairment charge against the goodwill
and intangibles associated with its business acquisitions of
PEAK Software Solutions, Inc. and ACT Networks, Inc., acquired
in 2000 due to circumstances described above. The Company
calculated the impairment charge by comparing the expected
discounted future cash flows to the carrying amount of the
related intangible assets with some weighting attributed to a
market based approach. The values assigned by the Company to the
assets resulting from the impairment analysis were based upon
established valuation techniques provided by an independent
firm. The cash flow periods used were over 4.25 years
including annual growth rates of 10% to 25%, a discount rate of
27% and a terminal value based upon a sales market multiple of
1.2. The assumptions supporting the estimated future cash flows,
including the discount rate and estimated terminal values
reflect managements best estimates. The discount rate was
based upon the Companys weighted average cost of capital
as adjusted for the risks associated with its operations. This
resulted in a $99.1 million write-down of goodwill and
other intangible assets and a $40.5 million write-down of
property and equipment for the quarter ended September 30,
2001.

7.     RESTRUCTURING
ACCRUAL

In May 2001, the Company announced a
restructuring program to prioritize its initiatives around
high-growth areas of its business, reduce expenses, and improve
efficiency. This restructuring resulted in part from the
significant slowdown in the overall telecommunications market,
as well as the Companys plan to align its cost structure
with anticipated revenues.

The May 2001 restructuring plan resulted in a 10%
reduction in the number of regular employees across all business
functions, operating units, and geographic regions. All
employees who have been included in the restructuring charge
were identified, and the Company was able to estimate the
aggregate severance benefits the Company would be providing in
connection with the reduction in workforce. The Company recorded
a restructuring charge related to the reduction in workforce and
excess facilities of approximately $14.1 million in the
second quarter of 2001. This charge includes $3.2 million
of severance payments and other employee related costs for
approximately 90 employees and 20 contractors, and an accrual of
$10.9 million for losses associated with excess facility
space.

In July 2001, the Company announced an additional
reduction of approximately 27% of its workforce. Additionally,
the Company announced a further reduction of approximately 50%
of the Companys remaining workforce in September 2001 in
order to align its cost structure with its anticipated revenues.
The Company recorded a restructuring charge related to these
reductions in workforce and excess facilities and equipment of
approximately $37.0 million in the third quarter of 2001.
This charge includes $5.7 million of severance payments and
other employee related costs for approximately 290 employees,
and $31.3 million for excess facility space. For the three
and nine months ended September 30, 2001, the Company made
payments of $6.4 million and $8.8 million for
severance and other costs against the restructuring reserve.

13



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


The following table summarizes the activity in
the restructuring accrual for 2001 (in thousands):

|                                            |  |               |        |           |  |                |        |       |  |   |      |   |  |   |        |  
|------------------------------------------- |  | ------------- | ------ | --------- |  | -------------- | ------ | ----- |  | - | ---- | - |  | - | ------ | -
|                                            |  |               |        |           |  | Other Employee |        |      
|                                            |  | Facility      |        | Severance |  | Termination    |        |      
|                                            |  | Closure Costs |        | Costs     |  | Costs          |        | Total
|                                            |  |               |        |           |  |                |        |      
|Restructuring reserve:                      |  |               |        |           |  |                |        |       |  |   |      |   |  |   |        |  
|Balance at January 1, 2001                  |  | $             |       |           |  | $              |       |       |  | $ |     |   |  | $ |       |  
|Accrued and expensed in Q2, 2001            |  |               | 10,902 |           |  |                | 2,600  |       |  |   | 639  |   |  |   | 14,141 |  
|Charged against accrual in Q2, 2001         |  |               | (592   | )         |  |                | (1,623 | )     |  |   | (120 | ) |  |   | (2,335 | )
|                                            |  |               |        |           |  |                |        |       |  |   |      |   |  |   |        |  
|Balance at June 30, 2001                    |  |               | 10,310 |           |  |                | 977    |       |  |   | 519  |   |  |   | 11,806 |  
|Accrued and expensed in Q3, 2001            |  |               | 31,347 |           |  |                | 5,587  |       |  |   | 107  |   |  |   | 37,041 |  
|Charged against accrual in Q3, 2001         |  |               | (756   | )         |  |                | (5,629 | )     |  |   | (40  | ) |  |   | (6,425 | )
|                                            |  |               |        |           |  |                |        |       |  |   |      |   |  |   |        |  
|Balance at September 30, 2001               |  | $             | 40,901 |           |  | $              | 935    |       |  | $ | 586  |   |  | $ | 42,422 |  
|                                            |  |               |        |           |  |                |        |       |  |   |      |   |  |   |        |  
|Short-term portion of restructuring accrual |  |               | 6,751  |           |  |                | 935    |       |  |   | 586  |   |  |   | 8,272  |  
|Long-term portion of restructuring accrual  |  |               | 34,150 |           |  |                |       |       |  |   |     |   |  |   | 34,150 |  
|                                            |  |               |        |           |  |                |        |       |  |   |      |   |  |   |        |  
|Total restructuring accrual                 |  | $             | 40,901 |           |  | $              | 935    |       |  | $ | 586  |   |  | $ | 42,422 |  
|                                            |  |               |        |           |  |                |        |       |  |   |      |   |  |   |        |  

At September 30, 2001, the remaining
restructuring accrual was approximately $42.4 million. The
remaining $42.4 million accrual is expected to be paid out
through February 2011 as follows (in thousands):

|           |  |                  |       |                  |  |   |        | 
|---------- |  | ---------------- | ----- | ---------------- |  | - | ------ | 
|           |  | Employee Related |       | Facility Closure
|Year       |  | Commitments      |       | Commitments     
|           |  |                  |       |                 
|2001       |  | $                | 1,521 |                  |  | $ | 1,688  | 
|2002       |  |                  |      |                  |  |   | 7,004  | 
|2003       |  |                  |      |                  |  |   | 5,197  | 
|2004       |  |                  |      |                  |  |   | 4,835  | 
|2005       |  |                  |      |                  |  |   | 3,365  | 
|Thereafter |  |                  |      |                  |  |   | 18,812 | 
|           |  |                  |       |                  |  |   |        | 
|           |  | $                | 1,521 |                  |  | $ | 40,901 | 
|           |  |                  |       |                  |  |   |        | 

8.     MERGER
COSTS

In August 2000, the Company acquired ACT
Networks, Inc., a leading provider of multi-service access and
voice/ data integration products that enable the convergence of
voice, video and data onto one managed network (the
Enterprise Products). In accordance with a plan that
existed at the time of the acquisition, the Company established
accruals for merger related restructuring costs. At
September 30, 2001, $2.8 million in accruals related
to the ACT acquisition remained. These accruals include costs of
exiting non-cancelable operating leases for the Calabasas,
California manufacturing facility of $3.8 million as
recorded at the date of the acquisition. During the three months
ended September 30, 2001, the Company revised upwards its
estimates of the likely sublease income from this facility and
therefore recorded a reduction in the accrual of
$1.0 million. This has been reflected as an offset to the
restructuring expense recorded in the three months ended
September 30, 2001. The Company has outsourced the
manufacturing of the Enterprise Products to a contract
manufacturer and ceased production at the Calabasas facility at
the end of the second quarter of 2001. As of September 30,
2001, the Company was disposing of the remaining manufacturing
equipment.

14



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


9.     CUSTOMER
ADVANCES

As of September 30, 2001, the Company
received funds totaling $20.9 million from certain
customers in the Asia-Pacific region. These payments are
currently recorded as customer advances. These advances consist
of funds received from customers and the Company now believes
that these funds may be subject to refund, because (i) the
Company is aware of a purported return right with respect to
certain products, (ii) the customer has not accepted
possession of certain products or (iii) the funds may be
subject to the payment of a guaranty obligation purportedly
entered into by the Company for a loan to a customer, which the
Company believes was used to purchase the Companys
products.

10.     RELATED PARTY
TRANSACTIONS

Transactions With Management and
Others

On April 25, 2000, AginfoLink USA, Inc.
(AginfoLink) borrowed $250,000, pursuant to a
promissory note, from Matthew Chiang, in his individual
capacity, who was a non-officer employee of the Company at the
time. Mr. Chiang served as President of the Companys
Asia-Pacific regional office from January 2001 to
September 2001. The Company believes that William Pape, a
director of the Company, holds a minority equity interest in
AginfoLink and serves on the board of directors of AginfoLink.
In the promissory note, AginfoLink agreed to repay the loan
principal, as well as accrued and unpaid interest, on
May 31, 2000. AginfoLink has informed the Company that it
has taken the necessary steps to tender payment of the
outstanding amount under this loan.

Note Receivable from a Leasing
Company

In January 2001, the Company advanced
$5.0 million to Clarent Finance, LLC (Clarent
Finance), a leasing company, for a six-year, eleven
percent junior subordinated debenture. The interest shall be
accrued and due by November 30, 2008. The principal is
repayable in 16 equal quarterly payments of $312,500 each,
commencing January 2005, and is due in full by November 30,
2008.

The Company entered into a remarketing agreement
with Clarent Finance in January 2001 to provide for the
remarketing of certain equipment manufactured by the Company,
purchased by Clarent Finance and leased to the Companys
customers. Under the terms of the remarketing agreement, if
remarketing proceeds are insufficient to equal the remaining
defaulted lessee obligation, the Company is obligated to either
pay the remaining lessee obligation to Clarent Finance or apply
the shortage as a credit on the next equipment lease purchase in
the program. At September 30, 2001, finance receivables for
Clarent Finance totaled $1.6 million.

As a result of its remarketing obligations to
Clarent Finance, the Company defers the recognition of all
revenue and thereby establishes a liability for all amounts to
be earned from leasing arrangements with Clarent Finance. At
September 30, 2001, the Companys recorded liability
approximated its obligation under the remarketing agreement. As
of September 30, 2001 operating expenses for Clarent
Finance had been immaterial.

On March 29, 2002 the Company purchased
Clarent Finance for $275,000 in the form of forgiveness of a
receivable. The Company received approximately $3.4 million
in cash and a lease portfolio of $1.8 million (of which the
Company had previously recorded a liability under the
remarketing agreement of $1.5 million as of
September 30, 2001) and extinguished a note owed to the
Company of $5.0 million.

15



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


Transactions Related to Asia-Pacific
Region

The Company entered into various transactions
with entities that, as a result of the investigation, the
Company now believes are controlled by Matthew Chiang or members
of his immediate family. Mr. Chiang was employed by the
Company as a Marketing Director of the Asia-Pacific region from
July 1997 to June 1999, a Director, Product and Market Strategy
from July 1999 to December 2000 and the Companys Vice
President and General Manager of the Asia Pacific region and
served as the President of its Asia-Pacific regional office from
January 2001 to September 2001. The entities believed to be
controlled by Mr. Chiang or members of his immediate family
are Great MinCom Communication Corporation (which the Company
believes is also known as Great MinCom Products Corporation and
collectively, Great MinCom) and Articula Corporation
(Articula). The Company believes that
Mr. Chiang may have had a direct or indirect material
interest in each of the transactions between the Company, Great
MinCom and Articula. The Company believes that Jerry Chang, who
was a director of the Company from July 1996 to September 2001,
the Companys President from July 1996 to April 2001, Chief
Executive Officer from July 1996 to July 2001 and Chief
Strategist from July 2001 to September 2001, may have an
indirect financial interest in Articula.

During the year ended December 31, 2000, the
Company sold products with an aggregate value of approximately
$4.1 million to Great MinCom.

In December 2000 and March 2001, transfers of
Company funds of $6.0 million and $7.0 million,
respectively, were made to Great MinCom, with the funds intended
for use as bid deposits in connection with certain proposed
transactions in the Asia Pacific region (the Bid
Deposits). As a result of the investigation, the Company
has now determined that personnel in the Asia-Pacific region
improperly reported that the second transfer to Great MinCom
occurred in the second quarter of 2001 when the second transfer
actually occurred in the first quarter of 2001, resulting in a
$7.0 million overstatement of the Companys cash
balance at March 31, 2001.

In June 2001, the Company and Great MinCom
entered into a Confirmation Agreement pursuant to which Great
MinCom agreed to return the funds advanced as Bid Deposits to
the Company by December 31, 2001, unless Great MinCom
secured contracts for the proposed transactions relating to the
Bid Deposits, in which case Great MinCom agreed to return the
funds advanced as Bid Deposits after completion of the
transactions. As a result of the investigation, the Company now
believes that the funds advanced as Bid Deposits were not used
for their intended purpose and are not recoverable.

From April to July 2001, an additional
$43.0 million was transferred by the Asia-Pacific regional
office to Great MinCom and Articula in violation of the
Companys financial control procedures. After transfer of
these funds, the Company received promissory notes in exchange
for the cash. These promissory notes are: a promissory note from
Articula in the amount of $3.0 million (bearing interest of
4.15% per annum from May 3, 2001); a promissory note from
Great MinCom in the amount of $2.4 million (bearing
interest of 4.15% per annum from May 21, 2001); and a
convertible promissory note from Articula and Great MinCom in
the amount of $37.6 million (bearing interest of 5.0% per
annum from July 25, 2001 and due in January 2002). At the
same time as the execution of the $37.6 million convertible
promissory note, the Company entered into a Strategic Partner
Agreement with Articula and Great MinCom as of July 25,
2001, pursuant to which Articula and Great MinCom, among other
things, agreed to provide sales and marketing support to the
Company and to use the Company as their exclusive supplier of
VoIP products.

None of the amounts covered by the two promissory
notes executed in May 2001 and the promissory note executed in
July 2001 had been repaid as of the date of this filing. As a
result of the investigation, the Company has now determined that
$36.5 million had been transferred prior to the end of the
second quarter of 2001 but not reported to the appropriate
Company personnel, resulting in a $36.5 million
overstatement of the cash balance for the quarterly period ended
June 30, 2001.

16



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


An aggregate of $3.0 million of the funds
transferred to Articula and Great MinCom by the Companys
Asia-Pacific regional office was intended for use as partial
payment for the Companys obligations under: a Joint
Marketing Agreement dated as of April 4, 2001 between the
Company and Articula pursuant to which the Company agreed to pay
Articula $3.0 million; and a Consulting Services Agreement
dated as of May 10, 2001 between the Company and Great
MinCom pursuant to which the Company agreed to pay Great MinCom
$1.1 million. In connection with the Consulting Services
Agreement, Great MinCom agreed to assist the Company with the
development of channel partner relationships for network design
and system integration.

Principal of approximately $43.0 million
plus accrued interest is outstanding under the various
promissory notes as of September 30, 2001. As a result of
the investigation and restatement the Company has now determined
that a significant portion of the funds related to the
$43.0 million, as well as the $13.0 million in Bid
Deposits mentioned above and the $11.0 million from the
guaranty noted below, may have been used by third parties to
purchase the Companys products from the Companys
customers. As a result, the Company reversed all revenue
associated with the products original sale and expensed
the associated inventory in the same period that the revenue was
originally recognized because it is not believed to be
recoverable and, for accounting purposes only, recorded any
payment associated with the reversed revenue transactions as a
reduction in the notes receivable balances. Remaining notes
receivable balances of approximately $8.2 million were
provided for by charges to other expense during the third
quarter of 2001 due to the doubtful probability of collection.
Although accounted for as described above, as of the date of
this filing, the notes remain outstanding and unpaid. The
Company reserves its rights to pursue collection of the entire
principal balance plus accrued interest for each of the loans
and the Bid Deposit amounts, in addition to other remedies or
actions available to the Company.

D-Link Corporation (D-Link), a
distributor and supplier to the Company, claims that on
July 3, 2001 the Company executed a guaranty of
Articulas repayment of an $11.0 million loan from
D-Link to Articula. The purported guaranty was not reported to
the appropriate personnel in the Company by the executive who
signed the guaranty in violation of the Companys
procedures. The Company now believes that, as of the date of
this filing, Articula had repaid $2.0 million of the amount
purportedly guarantied by the Company. The Company has recorded
a liability of $9.0 million (in customer advances) in its
September 30, 2001 financials as a result of this purported
guaranty.

During May through July 2001, Mr. Chiang,
the President of the Companys Asia-Pacific regional
office, received from the Company cash advances or effected
loans in violation of the Companys policies in the amount
of approximately $1.1 million, all of which is outstanding,
but fully reserved for, as of September 30, 2001.
Mr. Chiang also effected loans and investments from the
Asia-Pacific regional office in violation of the Companys
financial control policies, in the amount of approximately
$703,000, some of which directly or indirectly benefited
Mr. Chiang. These transactions were not reported to the
appropriate personnel in the Company and the amounts remain
outstanding, but fully reserved for, as of September 30,
2001. The Company now believes that these loans and investments
resulted in the payments of Company funds to customers who used
Company funds for the purchase of Company products. The Company
has reversed all revenue associated with the original recording
of revenue of such products and expensed the associated
inventory in the same period that the revenue was originally
recognized.

Indebtedness of Management

As described in Transactions Related to
Asia-Pacific Region, Mr. Chiang, a former executive
of the Company, and certain entities affiliated with
Mr. Chiang are currently indebted to the Company.

17



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


11.     LINE OF
CREDIT

In June 2001 the Company obtained a
$10.0 million line of credit with a financial institution
to provide working capital for the Company. The entire balance
had been borrowed and remained outstanding at September 30,
2001. The interest rate on this credit facility is variable and
is equal to the prime rate (6.0% at September 30, 2001).
Under the terms of this arrangement, the Company must maintain a
restricted cash balance of $10.0 million until the line is
converted to a receivables backed facility. The line of credit
expires on June 30, 2002. As of the date of the filing of
this report, there is no outstanding balance under this line of
credit.

12.     STOCKHOLDERS
EQUITY

In January 2001, the Company increased the
aggregate number of shares of common stock authorized for
issuance under the 1999 Amended and Restated Equity Incentive
Plan (the 1999 Plan) by 987,966 or 2.5% of the
Companys outstanding shares, measured as of that date.
This increase was in accordance with the provisions of the 1999
Plan. On June 7, 2001, the Companys stockholders
approved an amendment to the 1999 Plan to increase the number of
shares authorized for issuance by 1,000,000 shares from
17,780,431 shares to 18,780,431.

On February 14, 2001, the Company cancelled
approximately 2.9 million outstanding options under an
Option Cancellation and Regrant program (the
Program) for employees. Replacement options to
purchase approximately 635,000 shares of common stock were
granted to employees on February 15, 2001 at the fair
market value of $13.625 per share. These shares vested in full
on August 15, 2001 and will expire on November 15,
2001 if they are unexercised. In addition, the Company granted
replacement options to purchase approximately
916,000 shares of common stock to employees on
August 17, 2001 at the fair market value of $6.30 per share
under the Program. The options granted on August 17, 2001
vest ratably each month over a 24-month period, have a 10-year
term and are subject to variable accounting.

In February 2001, the Company adopted a Share
Purchase Rights Plan designed to guard against abusive takeover
tactics.

13.     SEGMENTS OF
AN ENTERPRISE AND RELATED INFORMATION

The Company operates in one industry segment. The
Company designs, develops and sells Internet protocol telephony,
or IP telephony systems. Net revenue for non-U.S. location is
substantially the result of export sales from the U.S.

Net revenue by geographic region based on
customer location are as follows (in thousands):

|                                  |                                |                    |   |                   |        |      |   |            |        |  |   |        |        |  |   |        |        | 
|--------------------------------- | ------------------------------ | ------------------ | - | ----------------- | ------ | ---- | - | ---------- | ------ |  | - | ------ | ------ |  | - | ------ | ------ | 
|                                  |                                |                    |   |                  
|                                  |                                | Three Months Ended |   | Nine Months Ended
|                                  |                                | September 30,      |   | September 30,    
|                                  |                                |                    |   |                  
|                                  |                                | 2001               |   | 2000              |        | 2001 |   | 2000      
|                                  |                                |                    |   |                   |        |      |   |           
|                                  |                                |                    |   | (Restated)        |        |      |   | (Restated)
|Net revenue by geographic region: |                                |                    |   |                   |        |      |   |            |        |  |   |        |        |  |   |       
|                                  | United States                  |                    | $ | 5,219             |        |      | $ | 10,610     |        |  | $ | 17,218 |        |  | $ | 24,844 |       
|                                  | Other Americas                 |                    |   | 873               |        |      |   | 4,319      |        |  |   | 3,597  |        |  |   | 7,996  |       
|                                  | Europe, Middle East and Africa |                    |   | 9,604             |        |      |   | 6,018      |        |  |   | 22,720 |        |  |   | 16,562 |       
|                                  | Asia Pacific                   |                    |   | 3,042             |        |      |   | 6,274      |        |  |   | 13,821 |        |  |   | 21,295 |       
|                                  |                                |                    |   |                   |        |      |   |            |        |  |   |        |        |  |   |       
|                                  |                                | Total              |   | $                 | 18,738 |      |   | $          | 27,221 |  |   | $      | 57,356 |  |   | $      | 70,697 | 
|                                  |                                |                    |   |                   |        |      |   |            |        |  |   |        |        |  |   |       

18



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


14.     INCOME
TAXES

The provision for income taxes of $405,000 and
$730,000 for the three and nine months ended September 30,
2001 consists of foreign income taxes provided on the profits
attributable to the Companys foreign operations. The
Companys effective tax rates differed from the combined
federal and state statutory rates due primarily to acquisition
charges that were non-deductible for tax purposes.

15.     NET LOSS PER
SHARE

Basic and diluted net loss per share is computed
by dividing net loss by the weighted average number of common
shares outstanding during the period less outstanding shares
subject to a right of repurchase by the Company. Outstanding
shares subject to repurchase are not included in the
computations of basic and diluted net loss per share until the
time-based vesting restrictions have lapsed.

The following table sets forth the computation of
basic and diluted net loss per share (in thousands, except per
share amounts):

|                                     |                                     |                                                          |       |                   |        |      |       |            |        |   |        |          |        |   |       |         |        | 
|------------------------------------ | ----------------------------------- | -------------------------------------------------------- | ----- | ----------------- | ------ | ---- | ----- | ---------- | ------ | - | ------ | -------- | ------ | - | ----- | ------- | ------ | 
|                                     |                                     |                                                          |       |                  
|                                     |                                     | Three Months Ended                                       |       | Nine Months Ended
|                                     |                                     | September 30,                                            |       | September 30,    
|                                     |                                     |                                                          |       |                  
|                                     |                                     | 2001                                                     |       | 2000              |        | 2001 |       | 2000      
|                                     |                                     |                                                          |       |                   |        |      |       |           
|                                     |                                     |                                                          |       | (Restated)        |        |      |       | (Restated)
|Numerator:                           |                                     |                                                          |       |                   |        |      |       |            |        |   |        |          |        |   |       |        
|                                     | Net loss                            |                                                          | $     | (263,224          | )      |      | $     | (53,508    | )      |   | $      | (406,162 | )      |   | $     | (62,381 | )     
|                                     |                                     |                                                          |       |                   |        |      |       |            |        |   |        |          |        |   |       |        
|Denominator:                         |                                     |                                                          |       |                   |        |      |       |            |        |   |        |          |        |   |       |        
|                                     | Weighted average shares outstanding |                                                          |       | 40,813            |        |      |       | 36,482     |        |   |        | 40,165   |        |   |       | 33,826  |       
|                                     | Less shares subject to repurchase   |                                                          |       |                  |        |      |       |           |        |   |        |         |        |   |       | (63     | )     
|                                     |                                     |                                                          |       |                   |        |      |       |            |        |   |        |          |        |   |       |        
|                                     |                                     | Denominator for basic and diluted net loss per
    share |       |                   | 40,813 |      |       |            | 36,482 |   |        |          | 40,165 |   |       |         | 33,763 | 
|                                     |                                     |                                                          |       |                   |        |      |       |            |        |   |        |          |        |   |       |        
|Basic and diluted net loss per share |                                     | $                                                        | (6.45 | )                 |        | $    | (1.47 | )          |        | $ | (10.11 | )        |        | $ | (1.85 | )      
|                                     |                                     |                                                          |       |                   |        |      |       |            |        |   |        |          |        |   |       |        

In periods with a net loss, the Company excludes
outstanding stock options and shares subject to repurchase from
the calculation of diluted net loss per common share because all
such securities are anti-dilutive. The total number of shares
excluded from the calculations of diluted net loss per share
were 1,317,000 and 2,100,000 for the three and nine months ended
September 30, 2001, and 5,121,000 and 5,921,000 for the
three and nine months ended September 30, 2000.

16.     COMPREHENSIVE
LOSS

The Companys total comprehensive loss is as
follows (in thousands):

|                                   |                                       |                    |          |                   |  |      |         |            |   |   |          |      |   |   |         |      |  
|---------------------------------- | ------------------------------------- | ------------------ | -------- | ----------------- |  | ---- | ------- | ---------- | - | - | -------- | ---- | - | - | ------- | ---- | -
|                                   |                                       |                    |          |                  
|                                   |                                       | Three Months Ended |          | Nine Months Ended
|                                   |                                       | September 30,      |          | September 30,    
|                                   |                                       |                    |          |                  
|                                   |                                       | 2001               |          | 2000              |  | 2001 |         | 2000      
|                                   |                                       |                    |          |                   |  |      |         |           
|                                   |                                       |                    |          | (Restated)        |  |      |         | (Restated)
|Net loss                           |                                       | $                  | (263,224 | )                 |  | $    | (53,508 | )          |   | $ | (406,162 | )    |   | $ | (62,381 | )   
|Other comprehensive income (loss): |                                       |                    |          |                   |  |      |         |            |   |   |          |      |   |   |         |     
|                                   | Translation adjustments               |                    |          | 90                |  |      |         | (116       | ) |   |          | (544 | ) |   |         | (137 | )
|                                   | Unrealized gain (loss) on investments |                    |          | 30                |  |      |         | 9          |   |   |          | 9    |   |   |         | (20  | )
|                                   |                                       |                    |          |                   |  |      |         |            |   |   |          |      |   |   |         |     
|Comprehensive loss                 |                                       | $                  | (263,104 | )                 |  | $    | (53,615 | )          |   | $ | (406,697 | )    |   | $ | (62,538 | )   
|                                   |                                       |                    |          |                   |  |      |         |            |   |   |          |      |   |   |         |     

19



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


17.     COMMITMENTS

At September 30, 2001 the Company had
operating lease commitments of approximately $72.5 million
that are due and payable through 2011. At September 30,
2001, the Company had expensed approximately $37.2 million
that had been accrued as part of our restructuring and merger
related accruals.

18.     LITIGATION

Beginning in July 2001, the Company and certain
of its current and former officers and directors were named as
defendants in several class action shareholder complaints filed
in the United States District Court for the Southern District of
New York, collectively captioned In re Clarent Corp. Initial
Public Offering Securities Litigation. These lawsuits
purport to bring suit on behalf of all purchasers of the
Companys common stock between July 1, 1999 and
December 6, 2000. In these actions, the plaintiffs allege
that the Company, certain of its officers and directors and the
underwriters of its initial public offering (IPO)
violated the federal securities laws because the Companys
IPO registration statement and prospectus purportedly contained
untrue statements of material fact or omitted material facts
regarding the compensation to be received by, and the stock
allocation practices of, the IPO underwriters. The plaintiffs
further allege that the prospectus relating to the
Companys secondary offering was false and misleading for
the same reasons. The plaintiffs seek unspecified monetary
damages and other relief. Similar complaints were filed in the
same Court against hundreds of other public companies that
conducted IPOs of their common stock since the late 1990s (the
IPO Lawsuits). On August 8, 2001, the IPO
Lawsuits were consolidated for pretrial purposes before United
States Judge Shira Scheindlin of the Southern District of New
York. Judge Scheindlin held an initial case management
conference on September 7, 2001, at which time she ordered,
among other things, that the time for all defendants to respond
to any complaint be postponed until further order of the Court.
Thus, the Company has not been required to answer any of the
complaints, and no discovery has been served on the Company. In
accordance with Judge Scheindlins orders at further status
conferences in March and April, the appointed lead
plaintiffs counsel filed amended, consolidated complaints
in the IPO Lawsuits on April 19, 2002. However, Judge
Scheindlin does not expect any of the defendants to file motions
to dismiss the amended, consolidated complaints until at least
summer of 2002.

In September and October 2001, a series of
securities law class action complaints were filed in the United
States District Court for the Northern District of California
against the Company and certain of its current and former
executive officers and directors. The plaintiffs in each of
these actions allege, among other things, violations of the
Securities Exchange Act of 1934, as amended, due to the filing
with the SEC of allegedly false financial statements concerning
the Companys results of operations for the second, third
and fourth quarters of 2000, and the first and second quarters
of 2001. The original complaints seek unspecified monetary
damages and other relief. In November 2001, the court entered an
order consolidating these actions into a single action, and in
December 2001 appointed a lead class plaintiff. A consolidated
complaint has not yet been filed. No discovery has taken place
and no trial date has been set.

In October and November 2001, four shareholder
derivative actions were filed against the Company, three in the
Delaware Chancery Court and one in California Superior Court. In
November 2001, the three Delaware shareholder derivative actions
were consolidated into a single action. The plaintiffs in these
actions claim to be suing on the Companys behalf and name
various of the Companys current and former officers and
directors as defendants. The complaints assert several claims,
including breach of fiduciary duties, corporate waste, abuse of
control, unjust enrichment, usurpation of corporate
opportunities and mismanagement, resulting from, among other
things, the Companys reporting of allegedly false
financial statements concerning the Companys results of
operations for the second, third and fourth quarters of 2000 and
the first and second quarters of 2001, the Companys
alleged failure to disclose information regarding the
Companys operations and the defendants alleged
failure to implement and maintain adequate internal financial
controls.

20



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


The complaints seek unspecified monetary damages
and other relief. The plaintiff in the California action has
commenced discovery against the defendants. However, the Company
is seeking a protective order relating to certain of the
discovery requests. Discovery has not commenced in the Delaware
action. On March 23, 2002, the Companys Board of
Directors formed a special litigation committee of the Board of
Directors to investigate the plaintiffs allegations. No
trial date has been set in either action.

On December 31, 2001, D-Link Corporation
(D-Link), a distributor and supplier to the Company,
filed two complaints in California Superior Court in which
D-Link asserted various breach of contract claims against the
Company. D-Link seeks damages of approximately
$19.0 million plus interest with respect to these alleged
breaches of contracts. On March 5, 2002 the court
consolidated the two actions. The Company has filed a
cross-complaint against D-Link alleging breach of contract and
breach of warranty. The Company has answered D-Links
complaints, denying all material allegations and asserting
various affirmative defenses. Discovery has commenced with
respect to both of the D-Link complaints, but a trial date has
not been set.

In December 2001, the Company received letters
from Bright Oceans Corporation (HK) Limited (Bright
Oceans) in which Bright Oceans asserted possible claims
against the Company. Bright Oceans claimed that it purchased
products from the Company on purchase orders subject to a right
of return. Bright Oceans seeks recovery of $4.6 million
plus interest and expenses based on its purported right of
return.

On April 12, 2002, a civil complaint for
violations of the federal securities laws was filed against the
Company and certain of its officers and directors in the United
States District Court for the District of Minnesota entitled
Ahlstrom, et al. v. Clarent Corporation, et al. The
plaintiffs in this action include Irwin L. Jacobs and a number
of investors apparently affiliated with him. Plaintiffs allege
that the defendants intentionally issued false financial reports
for the Company between March 2001 and August 2001 in violation
of Sections 10(b) and 20(a) of the Securities Exchange Act
of 1934 and similar provisions of Minnesota law. The Company
currently believes that this litigation will be coordinated or
consolidated for most pre-trial purposes with the other
securities law class action matters currently pending against
the Company. This matter is at an early stage. No response to
the complaint has yet been filed, and no discovery has taken
place.

On April 26, 2002, certain former
shareholders of PEAK Software Solutions, Inc.
(PEAK), some of whom are current employees of the
Company, including a key employee of the Company, filed a
lawsuit against the Company in Colorado state court. The
complaint alleges claims for common law fraud, securities fraud
and breach of contract relating to the Companys
acquisition of PEAK in July 2000. The complaint does not specify
the damages sought. The complaint has not yet been served and no
response has been filed.

The Company intends to defend itself vigorously
against these allegations. However, the ultimate outcome of
these matters cannot presently be determined.

19.     SUBSEQUENT
EVENTS

On January 29, 2002, the Company was
notified that its securities would be delisted by Nasdaq
effective January 30, 2002 as a result of (i) its
failure to file its Quarterly Report on Form 10-Q for the
quarter ended September 30, 2001, (ii) the failure of
its annual report on Form 10-K for the fiscal year ended
December 31, 2000 to contain audited financial statements
because its auditor, Ernst & Young LLP, informed the Company
that its financial statements for the year ended
December 31, 2000 should no longer be relied upon as a
result of the matters which gave rise to the need for a special
investigation, and for which the investigation and resulting
restated financial statements were not complete, rendering the
Companys financial statements unaudited at that time, and
(iii) public interest concerns related to the protection of
the Companys investors.

In February 2002 the Company commenced a further
reduction of its worldwide workforce by approximately 190 people
to approximately 180 employees. This action is expected to
result in a charge of approximately $3.0 million during the
first quarter of 2002.

21



---



##### Table of Contents



CLARENT CORPORATION


NOTES TO UNAUDITED CONDENSED
CONSOLIDATED

FINANCIAL STATEMENTS 
(Continued)


In January 2002, the Company engaged Regent
Pacific Management Corporation, an international firm that
specializes in the recovery and restructuring of
under-performing companies and appointed Gary J. Sbona of Regent
Pacific as chief executive officer. Mr. Sbona has also
joined the Companys board of directors and has been
appointed the chairman of the board. On March 9, 2002, the
Company appointed James B. Weil of Regent Pacific as president.

On March 29, 2002 the Company purchased
Clarent Finance, LLC for $275,000 in the form of forgiveness of
a receivable. The Company received approximately
$3.4 million in cash and a lease portfolio of
$1.8 million, of which the Company had previously recorded
a liability under a remarketing agreement of $1.5 million,
and extinguished a note owed to the Company of $5.0 million.

22



---



##### Table of Contents








|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF
    FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion in
conjunction with our Unaudited Condensed Consolidated Financial
Statements and related Notes. Certain statements contained in
this Quarterly Report on Form 10-Q/A, including, without
limitation, statements containing the words believe,
anticipate, estimate,
expect, and words of similar import, constitute
forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. You should not
place undue reliance on these forward-looking statements. Our
actual results could differ materially from those anticipated in
these forward-looking statements for many reasons, including the
risks faced by us described below and elsewhere in this
Quarterly Report, and in other documents we file with the SEC.

Overview

Clarent Corporation is a leading provider of
softswitch and Internet Protocol (IP) communications
solutions that take advantage of the flexibility and universal
reach of IP networks, the most prominent of which is the public
network known as the Internet. Our software platform and
softswitch solutions, in conjunction with our hardware, or
equipment provided by others, enable service providers to
deliver simultaneous transmission of voice, fax and data over IP
networks.

Our customers include service providers, system
integrators, resellers and enterprises. Service provider
customers include traditional local, international and wholesale
long distance telecommunication companies, as well as next
generation service providers, including Internet Service
Providers (ISPs), Application Service Providers
(ASPs), web-to-phone providers and others employing
Internet-based business models.

We sell our products both through distributors
and our direct sales force. We have sales and support personnel
based in a number of countries and locations throughout the
United States.

Our operations and prospects have been and we
expect will be significantly affected by the developments
leading to and relating to the restatement of our 2001 and 2000
financial statements. The circumstances necessitating the
restatement, and the impact on us, can be described in the
following general categories:

Revenue
Restatement:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We discovered that our revenue had been
    overstated for certain periods because revenue from sales in the
    Asia-Pacific region had been recognized in situations where
    customers had indirectly received our funds from third parties,
    by means of arrangements effected through unauthorized acts of
    our employees. These arrangements were entered into in violation
    of our procedures and were not reported to the appropriate
    personnel within the Company.                                                                                                              
|
| |  | Revenue also had been overstated for certain
    periods because revenue had been recognized from certain sales
    in the Asia-Pacific region where customers now claim to have
    return rights or that we have repurchase obligations. We now
    believe that certain of our personnel may have entered into
    agreements with customers in the Asia-Pacific region purporting
    to provide such return rights or repurchase obligations. These
    agreements were entered into in violation of our procedures and
    were not reported to the appropriate personnel within the
    Company.
|
| |  | We have restated revenue for certain periods
    because, based on current information and actual payment
    history, it now appears that certain customers may not have been
    creditworthy at the time of purchase.                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | Revenue also had been overstated for certain
    periods because of transactions involving the sale of products
    over which we continued to have some control until a subsequent
    period.                                                                                                                                                                                                                                                                                                                                                                                                        

Impact on
Expenses:



| |   |                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In connection with the restatement, we have
    adjusted certain accruals and reserves related to accounts
    receivable, warranty and inventory and have made
    reclassification entries. We also recorded additional

23



---



##### Table of Contents



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | losses in the form of restructuring and asset
    impairments in the third quarter of 2001. These losses resulted
    from what we now know was an over-expansion of our operating
    capacity and operating expenses as well as the overall downturn
    in the telecommunications industry. We increased our operating
    capacity based on forecasts that included revenue levels that we
    now know, based on the discovery of financial irregularities,
    were overstated, but which we believed at the time were
    appropriate.
|
| |  | We also determined that expenses were understated
    because certain payments or loans made from the Asia-Pacific
    regional office were effected in violation of our procedures and
    were not reported to the appropriate personnel within the
    Company. We believe that such payments or loans are not
    recoverable.                                                                                                                                                                                                           

Financial
Condition:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our cash position was overstated in the
    March 31, 2001 and June 30, 2001 financial statements
    because personnel in the Asia Pacific region transferred cash in
    violation of the our policies and procedures. These cash
    transfers were not reported to the appropriate personnel within
    the Company. As a result, the cash transfers were accounted for
    in improper periods. As of September 30, 2001, in the
    aggregate, there was no direct material impact on our cash
    position as a result of the improper recording of these
    transactions, including the cash transfers, although we had
    recorded liabilities of approximately $24 million
    associated with the irregularities giving rise to the
    restatement. As of the date of filing of this report, our cash
    position has been materially impacted by several factors, as
    discussed below.
|
| |  | The unauthorized transactions with third parties
    that appear to have used our funds to purchase our products had
    a material impact on our financial condition because of the
    expense of the inventory for which we will probably not be able
    to recover any value and the associated distribution costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | Our primary source of liquidity is our operating
    cash flows, which have been disrupted by the activities giving
    rise to, and the impact of, the restatement as well as the
    downturn in demand for telecommunications equipment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | We suffered substantial operating losses due to
    the activities necessitating the restatement because we
    over-expanded our operating capacity and operating expenses in
    2000 and the first two quarters of 2001. We increased our
    operating capacity based on forecasts that included revenue
    levels that we now know, based on the discovery of
    irregularities, were overstated, but which we believed at the
    time were appropriate.                                                                                                                                                                                                                                                                                                                                                                                                                                         

To address the activities discovered in our
investigation, we have implemented remedial actions, including
the prompt termination of employees who appear to have been
involved in activities relating to the irregularities, closure
of our Asia-Pacific regional headquarters, and the adoption of
new and more stringent subsidiary cash control and expense
approval policies, such as new banking and internal reporting
procedures, improved controls over sales representatives and
sales orders and hiring and payroll procedures, and new and more
stringent credit approval policies.

We direct you to refer to Note 1 of Notes to
Unaudited Condensed Consolidated Financial Statements for more
current information regarding the restatement.

Critical Accounting Policies

In the ordinary course of business, we have made
a number of estimates and assumptions relating to the reporting
of results of operations and financial condition in the
preparation of our financial statements in conformity with
accounting principles generally accepted in the United States of
America. Actual results could differ significantly from those
estimates if our assumptions are incorrect. We believe that the
following discussion addresses our most critical accounting
policies. Such policies are most important to the portrayal of
our financial condition and results and require
managements most difficult, subjective and complex

24



---



##### Table of Contents



judgments, often as a result of the need to make
estimates about the effect of matters that are inherently
uncertain.


Revenue
Recognition

We derive our revenues from sale of our hardware,
licenses of our software and the sale of professional services
and technical support. Our product sales, including our license
arrangements, do not provide for a right of return. Our license
arrangements are perpetual licenses. We sell our products
primarily through a direct sales force and distributors.

We sell our hardware and software in bundled
units and recognize revenue in accordance with Statement of
Position 97-2, Software Revenue Recognition(SOP 97-2), as amended by SOP 98-9, and generally
recognize revenue when all of the following criteria are met as
set forth in SOP 97-2:



| |   |                                              
| | - | ---------------------------------------------
| |  | persuasive evidence of an arrangement exists,
|
| |  | delivery has occurred,                       
|
| |  | the fee is fixed or determinable and         
|
| |  | collectibility is probable.                  

We define each of the four criteria above as
follows:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Persuasive evidence of an arrangement exists.Our policy is to confirm each sale
    with a written contract or purchase order, which is signed by
    both the customer and us.                                                                                                                                                                                                                                                        
|
| | Delivery has occurred.Delivery has occurred when products
    have been shipped to the customer.                                                                                                                                                                                                                                                                                                                                       
|
| | The fee is fixed or determinable.We do not provide customers the right
    to refund any portion of their purchases. If an arrangement is
    not considered fixed or determinable, revenue is recognized as
    payments become due.                                                                                                                                                                                                  
|
| | Collectibility is probable.Collectibility is assessed on a
    customer-by-customer basis. Customers are subjected to a credit
    review process, which evaluates the customers financial
    positions and ultimately their ability to pay. If we determine
    from the outset of an arrangement that collectibility is not
    probable based upon our credit review process, revenue is
    recognized on a cash-collected basis.

We allocate revenue on arrangements involving
multiple elements to each element based on the relative fair
value of each element. Our determination of fair value of each
element in multiple-element arrangements is based on
vendor-specific objective evidence, or VSOE. We limit our
assessment of VSOE for each element to the price charged when
the same element is sold separately. We have determined that we
have sufficient VSOE to allocate revenue to maintenance and
technical support services and professional services. We sell
our professional services separately, and have established VSOE
on this basis. VSOE for maintenance and technical support
service is determined based upon the customers annual
renewal rates for these elements. Accordingly, assuming all
other revenue recognition criteria are met, we recognize revenue
from product sales upon delivery using the residual method in
accordance with SOP 98-9. We defer fees for maintenance and
technical support services and recognize them ratably over the
term of the support period.

Our professional services generally are not
deemed essential to the functionality of the software. Our
products are fully functional upon delivery and implementation
and do not require any significant modification or alteration.
Customers purchase our professional services to facilitate the
adoption of our technology and dedicate personnel to participate
in the services being performed, but they may also decide to use
their own resources or appoint other professional service
organizations to provide these services. Products are billed
separately and independently from professional services, which
are generally billed on a time-and-materials basis. We generally
recognize revenue from professional services as we perform the
services.

Deferred revenues generally result from the
following: deferred technical support, cash received for
professional services not yet rendered and product revenues
deferred relating to arrangements where we have

25



---



##### Table of Contents



received cash and are required to deliver either
unspecified additional products or specified upgrades for which
we do not have VSOE.


Inventories

We record inventory write-downs for inventory
obsolescence, for inventory in excess of requirements for six to
nine months based on changes in forecasted demand, and for
products which have reached the end of their life-cycle. We
evaluate forecasted demand on a regular basis, evaluating
product mix and sales history as well as projections for sales
prepared by our sales force.

Impairment of
Goodwill, Intangibles and Property and Equipment

We have evaluated the carrying value of certain
long-lived assets and acquired intangibles, consisting primarily
of goodwill and tangible fixed assets, recorded on our balance
sheet at September 30, 2001. Pursuant to accounting rules,
the majority of goodwill is recorded based on stock prices at
the time acquisition agreements were executed and announced.
Goodwill and intangible assets are generally evaluated on an
individual acquisition, market, or product basis whenever events
or changes in circumstances indicate that such assets are
impaired or the estimated useful lives are no longer appropriate.

Periodically, we review our goodwill and other
intangible assets for impairment based on estimated future
undiscounted cash flows attributable to the assets in accordance
with SFAS No. 121. In the event such cash flows are not
expected to be sufficient to recover the recorded value of the
assets, we write down the assets to their estimated fair values
based on the expected discounted future cash flows attributable
to the assets.

The values we assign to the assets resulting from
the impairment analysis are based upon established valuation
techniques provided by an independent firm. These valuation
techniques are based on subjective estimates of duration of cash
flow periods, annual growth rates, discount rates, and terminal
values.

Allowance for
Doubtful Accounts

Our customers are primarily telecommunication
service providers and enterprises, as well as distributors who
sell to these customers. Throughout 2001, the telecommunication
industry has experienced a significant downturn, which has
adversely impacted our customers. We record an allowance for
doubtful accounts based on estimates of collectability of our
accounts receivable balances. We specifically analyze our
accounts receivable and historical bad debts, customer
credit-worthiness, current economic trends, and changes in our
customer payment terms when evaluating the adequacy of the
allowance for doubtful accounts. We have, from time to time,
experienced material differences between our estimated allowance
for doubtful accounts and actual results. If the financial
condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional
allowances may be required. The allowance for doubtful accounts
represents our best estimate, but changes in circumstances
relating to accounts receivable may result in a requirement for
additional allowances in the near future.

Restructuring
Liabilities

We have estimated and accrued restructuring
liabilities based on historical data on prior costs for such
activities, together with assumptions on timeframes for such
activities and specific actions necessary to complete such
transitions. In connection with our 2001 restructuring
activities, we recorded restructuring charges of
$51.2 million, of which approximately $42.2 million is
related to facility closure costs. This $42.2 million
charge consists primarily of lease obligations net of expected
sublease income. Our expected sublease income is based on
information provided by independent real estate brokers. This
estimate considers the timing and amount of future subleases of
the properties. We currently have 307,000 square feet of excess
facilities. Future restructuring costs incurred to exit
facilities could vary from historical costs, assumptions on
timeframes for subleasing facilities could change or it may be
determined that different actions are necessary than those
actions assumed to be necessary at the time of our original
estimates, any of which could result in actual restructuring
costs to exit certain facilities differing from our estimates.
Any significant difference between our estimated restructuring
liabilities and actual experience, or changes in our estimate,
would be

26



---



##### Table of Contents



reflected in our reported operating expenses in
the period we determine that there is such a difference or that
we need to change our estimates.


Results of Operations

The following table presents certain consolidated
statement of operations data for the periods indicated as a
percentage of total net revenue:

|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |      |     |   
|-------------------------------------- | ------------------------------------------------------------------------------ | ------------------------ | ------ | ----------------- | ------ | ---- | ---- | ---------- | ---- | -- | ---- | ---- | ---- | -- | --- | ---- | --- | --
|                                       |                                                                                |                          |        |                  
|                                       |                                                                                | Three Months Ended       |        | Nine Months Ended
|                                       |                                                                                | September 30,            |        | September 30,    
|                                       |                                                                                |                          |        |                  
|                                       |                                                                                | 2001                     |        | 2000              |        | 2001 |      | 2000      
|                                       |                                                                                |                          |        |                   |        |      |      |           
|                                       |                                                                                |                          |        | (Restated)        |        |      |      | (Restated)
|As a percentage of net revenue:        |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|                                       | Product and software                                                           |                          |        | 82                | %      |      |      | 85         | %    |    |      | 79   | %    |    |     | 86   | %  
|                                       | Service                                                                        |                          |        | 18                |        |      |      | 15         |      |    |      | 21   |      |    |     | 14   |    
|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|                                       |                                                                                | Total net revenue        |        |                   | 100    |      |      |            | 100  |    |      |      | 100  |    |     |      | 100 |   
|Cost of revenue:                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|                                       | Product and software                                                           |                          |        | 202               |        |      |      | 52         |      |    |      | 148  |      |    |     | 43   |    
|                                       | Service                                                                        |                          |        | 18                |        |      |      | 8          |      |    |      | 21   |      |    |     | 8    |    
|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|                                       |                                                                                | Total cost of revenue    |        |                   | 220    |      |      |            | 60   |    |      |      | 169  |    |     |      | 51  |   
|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|Gross profit (loss)                    |                                                                                |                          | (120   | )                 |        |      | 40   |            |      |    | (69  | )    |      |    | 49  |     
|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|Operating expenses:                    |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|                                       | Research and development                                                       |                          |        | 79                |        |      |      | 31         |      |    |      | 80   |      |    |     | 26   |    
|                                       | Sales and marketing                                                            |                          |        | 95                |        |      |      | 56         |      |    |      | 118  |      |    |     | 54   |    
|                                       | General and administrative                                                     |                          |        | 42                |        |      |      | 19         |      |    |      | 35   |      |    |     | 15   |    
|                                       | Amortization of deferred compensation and other
    stock compensation charges |                          |        | 10                |        |      |      | 6          |      |    |      | 11   |      |    |     | 6    |    
|                                       | Amortization of goodwill and other intangibles                                 |                          |        | 49                |        |      |      | 22         |      |    |      | 48   |      |    |     | 9    |    
|                                       | Impairment of goodwill and other intangibles                                   |                          |        | 529               |        |      |      |           |      |    |      | 173  |      |    |     |     |    
|                                       | Restructuring and merger related costs                                         |                          |        | 192               |        |      |      | 5          |      |    |      | 87   |      |    |     | 2    |    
|                                       | Impairment of property and equipment                                           |                          |        | 217               |        |      |      |           |      |    |      | 70   |      |    |     |     |    
|                                       | Purchased in-process research and development                                  |                          |        |                  |        |      |      | 116        |      |    |      |     |      |    |     | 44   |    
|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|                                       |                                                                                | Total operating expenses |        |                   | 1,213  |      |      |            | 255  |    |      |      | 622  |    |     |      | 156 |   
|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|                                       | Loss from operations                                                           |                          |        | (1,333            | )      |      |      | (215       | )    |    |      | (691 | )    |    |     | (107 | )  
|Other income (expense), net            |                                                                                |                          | (70    | )                 |        |      | 18   |            |      |    | (16  | )    |      |    | 19  |     
|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|Loss before provision for income taxes |                                                                                |                          | (1,403 | )                 |        |      | (197 | )          |      |    | (707 | )    |      |    | (88 | )   
|Provision for income taxes             |                                                                                |                          | (2     | )                 |        |      |     |            |      |    | (1   | )    |      |    |    |     
|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     
|                                       |                                                                                | Net loss                 |        |                   | (1,405 | )%   |      |            | (197 | )% |      |      | (708 | )% |     |      | (88 | )%
|                                       |                                                                                |                          |        |                   |        |      |      |            |      |    |      |      |      |    |     |     

Net Revenue

Net revenue decreased 31% to $18.7 million
in the three-months ended September 30, 2001 from
$27.2 million in the three months ended September 30,
2000. Net revenue for the nine months ended September 30,
2001 decreased by 19% to $57.4 million from
$70.7 million for the same period in 2000. The decrease in
product and software sales of 34% to $15.4 million in the
three months ended September 30, 2001 from
$23.2 million in the three months ended September 30,
2000 and the decrease of 26% to $45.0 million in the nine
months ended September 30, 2001 from $61.1 million in
the nine months ended September 30, 2000 was primarily
attributable to the continuing weakness of global economic
conditions, including, in particular,

27



---



##### Table of Contents



the downturn of the telecommunications market,
resulting in a significant decline in capital expenditures by
our customers offset in part by revenues from a suite of
products acquired from ACT Networks in August 2000. Service
revenue from maintenance and support decreased by 17% to
$3.3 million in the three months ended September 30,
2001 from $4.0 million in the same period in 2000.


The decrease in service revenue is attributable
to decreases in the sale of new support contracts resulting from
decreased hardware and software sales. Service revenue from
maintenance and support increased by 29% to $12.3 million
in the nine months ended September 30, 2001 from
$9.6 million in the same period in the prior year. This
increase in service revenue is attributable to the renewal of
support contracts with existing customers in the earlier part of
2001. One customer, Grintek Telecom, accounted for 17% of net
revenues for the nine months ended September 30, 2001. No
other customer individually accounted for 10% or more of net
revenue during the nine months ended September 30, 2001. In
subsequent quarters we expect revenues to substantially decline
as a result of several factors including the downturn in the
telecommunications market, as well as the activities giving rise
to and the impact of the restatement.

Cost of Revenue

Cost of revenue increased approximately 151% and
168% to $41.2 million and $96.8 million in the three
and nine months ended September 30, 2001 from
$16.4 million and $36.1 million in the three and nine
months ended September 30, 2000. Product and software costs
increased by 166% and 181% to $37.8 million and
$85.0 million in the three and nine months ended
September 30, 2001 from $14.2 million and
$30.2 million, respectively, in the three and nine months
ended September 30, 2000. Service costs increased by 58%
and 99% to $3.4 million and $11.7 million in the three
and nine months ended September 30, 2001 from
$2.2 million and $5.9 million in the same periods in
2000, due to the increases in technical support personnel to
service an anticipated increased customer base.

Gross margin decreased to a negative 120% and a
negative 69% for the three and nine months ended
September 30, 2001 compared to a gross margin of 40% and
49% for the corresponding periods in 2000. A significant portion
of the drop in gross margin for the three and nine months ended
September 30, 2001 was attributable to a charge of
$24.9 million and $31.0 million, respectively, for the
write-down of excess and obsolete inventories. The excess
inventories resulted from our significant reduction in
forecasted demand, which we revised in connection with the
restatement of our financial statements. For the nine months
ended September 30, 2001, the decrease in gross margin also
resulted partially from $18.8 million of product costs
associated with products shipped to certain customers in the
Asia-Pacific region for which revenue was not recognizable
because we now believe that these customers indirectly used
Company funds for the purchase of our products and, to a lesser
degree, because certain customers purportedly had return rights
for such products. We believe that such products, once delivered
to the customer, will probably not be recoverable.

Our gross margin has also been affected by
significant erosion in the average selling prices of our
products due to a number of factors, including competitive
pricing pressures and rapid technological changes that we expect
to continue in the future. We expect gross margin to be
adversely affected by increases in material or labor costs,
costs related to maintaining higher inventory balances, changes
in product mix, changes in the geographical mix of customers and
changes in the channels of distribution. We expect to continue
to increase the percentage of sales to distributors, which may
result in lower gross margins.

Research and Development Expenses

Research and development expenses increased 75%
and 151% to $14.8 million and $46.0 million in the
three and nine months ended September 30, 2001 from
$8.4 million and $18.3 million in the three and nine
months ended September 30, 2000. Research and development
expenses increased as a percentage of revenue to 79% and 80% for
the three and nine months ended September 30, 2001 from 31%
and 26% for the three and nine months ended September 30,
2000, respectively. The increase in research and development
expenses both in absolute dollars and as a percentage of revenue
from period to period is primarily attributable to increases in
the number of research and development employees to an average
of 272 for the nine months ended September 30, 2001, from
130 for the nine months ended September 30, 2000, and to
the significant decrease

28



---



##### Table of Contents



in net revenue. We expect research and
development expenses to decrease in absolute dollars going
forward as a result of reductions in workforce implemented
during the third quarter and expense reductions planned for
future periods.


Sales and Marketing Expenses

Sales and marketing expenses increased 17% and
77% to $17.9 million and $67.5 million in the three
and nine months ended September 30, 2001, from
$15.3 million and $38.1 million in the three and nine
months ended September 30, 2000. The absolute dollar
increase in sales and marketing expenses was primarily
attributable to an increase in personnel and related expenses
required to implement our sales and marketing strategy and
increased public relations and other promotional expenses. Sales
and marketing expense as a percentage of revenue increased to
95% and 118% for the three and nine months ended
September 30, 2001, from 56% and 54% in the three and nine
months ended September 30, 2000. The increase in sales and
marketing costs as a percentage of revenue from period to period
is attributable to the significant decrease in revenue combined
with increased expenses. The increase in expense during the nine
months ended September 30, 2001 was also attributable to an
increase in personnel and related expenses required to build the
infrastructure to support a larger organization based on
anticipated higher current period revenue and higher revenue
growth. We expect sales and marketing expenses to decrease in
absolute dollars going forward as a result of reductions in
workforce implemented during the third quarter and expense
reductions planned for future periods.

General and Administrative Expenses

General and administrative expenses increased 56%
and 94% to $8.0 million and $20.2 million in the three
and nine months ended September 30, 2001 from
$5.1 million and $10.4 million in the three and nine
months ended September 30, 2000. General and administrative
expenses as a percentage of revenue increased to 42% and 35% for
the three and nine months ended September 30, 2001 from 19%
and 15% for the three and nine months ended September 30,
2000. The absolute dollar increase in general and administrative
expenses during the three and nine months ended
September 30, 2001 was largely attributable to an increase
in personnel and related expenses required to build the
infrastructure to support a larger organization based on
anticipated higher current period revenue and higher revenue
growth. General and administrative employee headcount averaged
132 for the nine months ended September 30, 2001 as
compared to 80 for the nine months ended September 30,
2000. The increase in general and administrative expenses as a
percentage of revenue from period to period is attributable to
the significant decrease in revenue combined with increased
expenses. We expect our general and administrative expenses to
decrease going forward in absolute dollars as a result of
reductions in workforce implemented during the third quarter and
expense reductions planned for future periods.

Amortization of Deferred
Compensation

For the three and nine months ended
September 30, 2001, amortization of deferred compensation
was $1.9 million and $6.0 million as compared to
$1.8 million and $4.1 million in the three and nine
months ended September 30, 2000. Amortization of deferred
compensation resulted from the grant of stock options to
purchase common stock at prices below the deemed fair value as
well as the assumption of stock options through acquisition at
prices below the deemed fair value of our common stock. The
deferred compensation is being amortized using the graded method
over the vesting period of the stock options.

On February 14, 2001, we cancelled
approximately 2.9 million outstanding options under an
Option Cancellation and Regrant program (the
Program) for employees. Replacement options to
purchase approximately 635,000 shares of common stock were
granted to employees on February 15, 2001 at the fair
market value of $13.625 per share. These shares vested in full
on August 15, 2001 and expired unexercised on
November 15, 2001. In addition, we granted replacement
options to purchase approximately 916,000 shares of common
stock to employees on August 17, 2001 at the fair market
value of $6.30 per share under the Program. The options granted
on August 17, 2001 vest ratably each month over a 24-month
period and have a 10-year term.

29



---



##### Table of Contents



Amortization of Goodwill and Other
Intangibles

Exclusive of amortization of developed
technology, which is charged to cost of revenue, amortization of
goodwill and other intangibles for the three and nine months
ended September 30, 2001 was $9.1 million and
$27.3 million as compared to $6.0 million and
$6.5 million for the three and nine months ended
September 30, 2000. The goodwill and purchased intangible
assets were the result of three purchase business combinations.
One purchase was completed in the fourth quarter of 1999 and two
in the third quarter of 2000. The value of the purchased
intangible assets was determined using independent valuations
for both the PEAK and ACT Networks acquisitions in 2000.

Impairment Charges

We have evaluated the carrying value of certain
long-lived assets and acquired intangibles, consisting primarily
of goodwill, intangibles and fixed assets, recorded on our
balance sheet at September 30, 2001, in accordance with
Statement of Financial Accounting Standards (SFAS) 121.

Due to circumstances created by the significant
downturn in the telecommunications market and the effects of
financial irregularities and the restatement, we recorded an
impairment charge during the quarter ended September 30,
2001 against the goodwill and intangibles associated with our
acquisitions of PEAK Software and ACT Networks, as well as our
property and equipment. In accordance with our policy,
undiscounted cash flows indicated that the assets were impaired.
We calculated the impairment charge by comparing the expected
discounted future cash flows to the carrying amount of our
long-lived assets. The cash flow periods used were
4.25 years using annual growth rates of 10% to 25%, the
discount rate used was 27 percent and the terminal values
were estimated based upon a sales market multiple of 1.2. The
assumptions supporting the estimated future cash flows,
including the discount rate and estimated terminal values
reflect managements best estimates. The discount rate was
based upon our weighted average cost of capital as adjusted for
the risks associated with its operation. This resulted in a
$99.1 million write-down of goodwill and other intangibles,
as well as a $40.5 million write-down of property and
equipment for the quarter ended September 30, 2001.

Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards
Board (FASB) issued Statement of Financial
Accounting Standards No. 141, Business
Combinations (SFAS 141). SFAS 141
requires the purchase method of accounting for all business
combinations and eliminates the pooling-of-interests method for
business combinations initiated after June 30, 2001.
SFAS 141 also includes guidance on the initial recognition
and measurement of goodwill and other intangible assets arising
from business combinations completed after June 30, 2001.
The Company does not expect the adoption of SFAS 141 to
have a material effect on its financial conditions or results of
operations.

In July 2001, the FASB issued SFAS 142,
Goodwill and Other Intangible Assets
(SFAS 142). SFAS 142 discontinues
amortization of goodwill and intangible assets deemed to have
indefinite lives and requires such assets to be reviewed at
least annually for impairment. SFAS 142 also includes
provisions on the identification of intangible assets,
reclassification of certain intangibles from previously reported
goodwill, and reassessment of the useful lives of existing
intangibles. The Company will apply SFAS 142 beginning in
the first quarter of 2002. The Company does not expect the
adoption of SFAS 142 to have a material effect on its
financial conditions or results of operations.

In July 2001, the FASB issued SFAS 143,
Accounting for Asset Retirement Obligations
(SFAS 143) which addresses accounting and
reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement
costs. SFAS 143 is effective for fiscal years beginning
after June 15, 2002. The Company is currently assessing the
impact of this new standard, and as such, it is possible that
its adoption could have a material effect on its financial
condition or results of operations.

30



---



##### Table of Contents



In August 2001, the FASB issued SFAS 144,
Impairment or Disposal of Long-Lived Assets
(SFAS 144) which is effective for fiscal years
beginning after December 15, 2001. SFAS 144 supersedes
SFAS 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of and
provides a single accounting model for impairment of long-lived
assets. The Company is currently assessing the impact of this
new standard, and as such, it is possible that its adoption
could have a material effect on its financial condition or
results of operations.

Status of R&D Projects Acquired from ACT
Networks

The projected results with respect to the
research and development projects acquired from ACT Networks
have not been achieved. The remaining $10.7 million in
developed technology acquired from ACT Networks was written-off
as part of the impairment of intangible assets in the third
quarter of 2001.

The following list provides the information
regarding the status of research and development projects at the
date of acquisition. There has been no change in expected costs
through September 30, 2001 with the exception of the
DynaStar project which was discontinued.

|             |  |                     |     |            |  |                  |     |  |  |                   
|------------ |  | ------------------- | --- | ---------- |  | ---------------- | --- |  |  | ------------------
|             |  | Estimated costs to  |     | Expected   |  |                 
|             |  | complete at time of |     | Costs at   |  | Expected Date of
|             |  | acquisition         |     | Completion |  | Completion      
|             |  |                     |     |            |  |                 
|             |  |                     |     |           
|             |  | (in millions)       |     |           
|NetPerformer |  | $                   | 3.9 |            |  | $                | 3.9 |  |  | Q3 2001 (complete)
|SX-10        |  | $                   | 0.8 |            |  | $                | 0.8 |  |  | Q3 2001 (complete)
|DynaStar     |  | $                   | 0.8 |            |  |                  | n/a |  |  | Discontinued      

Restructuring Costs

On May 14, 2001, we announced a reduction in
workforce of approximately 10% and a streamlining of our
business units to achieve cost savings and operating
efficiencies in accordance with our previously stated goals.
Further, in July 2001, we consolidated two of our three business
units and announced an additional reduction of our workforce of
approximately 27%. In September 2001, we announced further
reductions in workforce, reorganizing our workforce along
functional lines and targeted at eliminating approximately 50%
of our remaining workforce.

We recorded restructuring charges related to the
reductions in workforce and excess facilities and equipment of
approximately $37.0 million in the third quarter of 2001
and $51.2 million for the nine months ended
September 30, 2001. During the three and nine months ended
September 30, 2001, payments of approximately
$6.4 million and $8.8 million in severance and other
costs were made and charged against the accrual. At
September 30, 2001, the remaining restructuring accrual was
approximately $42.4 million of which this amount is
expected to be paid with cash through 2011. As a result of our
significant downsizing in personnel through our restructuring
actions we expect to see a reduction of approximately $8.0 to
$10.0 million per quarter in our operating expense.

Other Income (Expense), Net

Other expense, net was $13.1 million and
$9.1 million in the three and nine months ended
September 30, 2001 as compared to other income, net of
$5.1 million and $13.6 million in the three and nine
months ended September 30, 2000. Other expense for the
first three quarters of 2001 was primarily attributable to
charges for impaired investments and loan reserves net of
interest income earned. Interest income in the first three
quarters of 2001 of $6.3 million, as compared with
$13.6 million in the first three quarters of 2000, reflects
lower cash and investment balances as compared to 2000. Charges
for impaired investments were $6.1 million and
$8.9 million for the three and nine months ended
September 30, 2001. Charges for impaired loans were
$8.2 million for both the three and nine months ended
September 30, 2001. The charges for impaired loans are
based on our determination that the collection of certain loans
to strategic partners and unauthorized personnel loans are not
collectible. We expect interest income to decrease in the
remaining quarter of 2001 as cash resources are invested in
working capital and used to fund operating losses.

31



---



##### Table of Contents



Provision for Income Taxes

The provisions for income taxes of $405,000 and
$730,000 for the three and nine months ended September 30,
2001 and $2,000 and $286,000 for the three and nine months ended
September 30, 2000, consist of foreign income taxes
provided on the profits attributable to the Companys
foreign operations. Our effective tax rates differed from the
combined federal and state statutory rates predominantly as a
result of acquisition charges that were non-deductible for tax
purposes.

Liquidity and Capital Resources

From inception through June 1999, we financed our
operations primarily through private sales of convertible
preferred stock, which totaled $18.9 million in aggregate
net proceeds. During 1999, we completed both an initial and a
secondary public offering, which resulted in net proceeds of
approximately $302.6 million. In addition, we received net
proceeds of $33.3 million from our acquisitions during the
third quarter of 2000.

Net cash used in operating activities was
$139.2 million in the nine months ended September 30,
2001 compared to $4.0 million in the same period of 2000.
The net cash used in operating activities in this period in 2001
was principally the result of the net loss of
$406.1 million, the decrease in accounts payable and
accrued liabilities of $8.4 million, and the decrease in
deferred revenue of $4.5 million. These amounts were
partially offset by adjustments for amortization, depreciation,
and property and equipment asset impairment charges, including
fixed asset goodwill and intangible write-offs, of
$190.8 million, the increase in restructuring and merger
related accruals of $42.1 million, the increase in
investment impairments of $8.9 million, the decrease in
accounts receivable of $12.3 million, the decrease in
inventories of $6.3 million, the decrease in prepaid
expenses and other current assets of $1.1 million, and the
increase in customer advances of $18.3 million.
Amortization expense has increased significantly as a result of
the deferred compensation, goodwill and intangibles related to
two acquisitions completed during the third quarter of 2000. The
decrease in accounts payable and accrued liabilities was
primarily due to decreased inventory levels partially offset by
increased operating expense levels. The decrease in deferred
revenue was the result of a decrease in product revenue. The
decrease in prepaid expenses and other current assets primarily
resulted from a decrease in prepaid promotional costs and
insurance costs. The increase in customer advances resulted from
our receipt of funds from customers that we now believe may be
subject to refund, because of (i) a purported return right,
(ii) the customer not accepting possession of certain
products or (iii) funds being subject to the payment of a
guaranty obligation which we purportedly entered into for a loan
to a customer, which we believe was used to purchase our
products. The decrease in accounts receivables is the result of
decreased sales of new and existing products in the third
quarter of 2001. The decrease in inventory is largely due to the
write down in the carrying value of (i) materials and
finished goods relating to excess and obsolete products and
(ii) finished goods pertaining to customers who have
financed their purchases through a customer leasing program.

Net cash used in operating activities of
$4.0 million in the nine months ended September 30,
2000 was principally the result of the net loss of
$62.4 million, an increase in inventories of
$4.8 million, a decrease in accounts payable and accrued
liabilities of $4.9 million, a decrease in deferred revenue
of $740,000, and an increase in other assets of
$1.3 million. These amounts were partially offset by
adjustments for amortization of deferred compensation, goodwill
and intangibles of $10.9 million, depreciation of
$6.1 million and a charge for purchased in-process research
and development of $31.5 million, and a decrease in
accounts receivable of $8.2 million, an increase in
customer advances of $7.2 million and an increase of
restructuring and merger related accrual of $6.4 million.
Amortization of deferred compensation, goodwill and intangibles
increased significantly as a result of the two acquisitions
completed during the third quarter of 2000. The increase in
accounts receivable was the result of increased sales both
through growth and acquisition.

Net cash from investing activities was
approximately $18.0 million in the first nine months of
2001 as compared to $33.0 million used in investing
activities for the same period in 2000. For 2001,
$65.0 million of cash from investing activities resulted
from the sale and maturity of investments, net of purchases, as
compared to $47.3 million invested in the purchase of
investment securities, net of sales and maturities, during the
same period in 2000. Cash used in investing activities during
the nine months ended September 30, 2001 included
$10.0 million in cash which became restricted to secure our
line of credit, a loan to a leasing company

32



---



##### Table of Contents



of $5.0 million and purchases of property
and equipment and expenditures on leasehold improvements
totaling $32.0 million. These acquisitions included
approximately $10.0 million in software licenses,
approximately $9.0 million in computer equipment and
approximately $8.0 million in furniture and leasehold
improvements. Cash used in investing activities for the nine
months ended September 30, 2000 included purchases of
property and equipment totaling $19.0 million, which was
based on anticipated higher current period revenue and higher
revenue growth.


Net cash from financing activities was
$12.0 million in the nine months ended September 30,
2001 as compared to $5.4 million for the same period in
2000. The cash provided by financing activities during the nine
months ended September 30, 2001 included proceeds from a
line of credit of $10.0 million and $2.0 million in
proceeds from the exercise of employee stock options and
employee stock purchase plans. The proceeds from employee stock
plans accounted for $5.4 million from financing activities
during the first nine months of 2000.

At September 30, 2001, our cash, cash
equivalents and short-term investment balance, exclusive of
restricted cash, was $86.3 million and will be used to fund
our operating leases and our working capital and other capital
expenditures, to fund our commitments under our remarketing
arrangements with Clarent Finance LLC and for our other
commitments and obligations.

As of September 30, 2001, our principal
commitments consisted of obligations outstanding under our
operating leases of $72.5 million (of which
$37.2 million has been accrued as part of our restructuring
and merger related accruals), advances from customers in the
Asia-Pacific region of $20.9 million, including a guaranty
purportedly executed on behalf of the Company with respect to a
strategic partners performance in connection with a
$9.0 million guarantee of a loan, a secured line of credit
of $10.0 million, remarketing obligations with a leasing
company of $2.0 million, and an obligation to a venture
capital management fund of $7.5 million.

The Companys total obligations and
commitments are as follows (in millions):

|                                |       |           |      |             |  |             |      |               |  |   |      |      |  |   |      |      | 
|------------------------------- | ----- | --------- | ---- | ----------- |  | ----------- | ---- | ------------- |  | - | ---- | ---- |  | - | ---- | ---- | 
|Obligations and                 |       | Less than |      |             |  |             |      |              
|Commitments                     |       | 1 year    |      | 1  3 years |  | 4  5 years |      | After 5 years
|                                |       |           |      |             |  |             |      |              
|Operating Leases                |       | $         | 14.7 |             |  | $           | 33.1 |               |  | $ | 13.6 |      |  | $ | 11.1 |     
|Customer Advances               |       |           | 20.9 |             |  |             |     |               |  |   |     |      |  |   |     |     
|Lines of Credit                 |       |           | 10.0 |             |  |             |     |               |  |   |     |      |  |   |     |     
|Remarketing Obligations         |       |           | 0.2  |             |  |             | 1.3  |               |  |   | 0.4  |      |  |   | 0.1  |     
|Venture Capital Management Fund |       |           | 1.9  |             |  |             | 3.8  |               |  |   | 1.8  |      |  |   |     |     
|                                |       |           |      |             |  |             |      |               |  |   |      |      |  |   |      |     
|                                | Total |           | $    | 47.7        |  |             | $    | 38.2          |  |   | $    | 15.8 |  |   | $    | 11.2 | 
|                                |       |           |      |             |  |             |      |               |  |   |      |      |  |   |      |     

We currently have no material commitments for
capital expenditures. In addition, we are subject to various
legal actions that could have a materially adverse impact on our
financial position for which our directors and officers
insurance coverage may not be available. Please refer to the
section entitled Risk Factors that May Impact Future
Operating Results and Item 1 of Part II entitled
Legal Proceedings for further discussion.

At March 31, 2002, our cash, cash
equivalents and short-term investments were approximately
$34 million, which may not be adequate to meet our
operating cash needs through the end of 2002, unless we achieve
increased revenues and further reduce our expenses. To reduce
our expenditures, we restructured in several areas, including
reducing staffing, implementing expense management and
curtailing capital spending. For example, since July 2001, our
headcount decreased by approximately 82%, from approximately
1,018 employees to approximately 180 employees currently.
In addition, we have sustained, and expect to continue to
sustain, substantial expenses arising from the restatement of
our financial statements and related litigation matters. Until
we resolve the claims against us and reduce our commitments, we
expect that our expenses will continue to exceed our revenues
for the foreseeable future. We plan to take further measures to
conserve cash, and to continue to evaluate our strategic
alternatives.

33



---



##### Table of Contents



For the quarter ended September 30, 2001, we
reported revenues of $18.7 million. In quarters subsequent
to the quarter ended September 30, 2001, revenues have
declined substantially. Our revenues have been, and we expect
will continue to be, materially affected by the downturn in
demand for telecommunications equipment and by events causing,
and the impact of, the restatement of our financial statements.
We do not expect demand for our products to recover for the
remainder of 2002, and we expect operating losses and negative
cash flows from operations to continue for the foreseeable
future.

If we are not able to achieve increased revenues
and resolve the claims against us, or if we incur unexpected
expenditures, then we will need to reduce expenses further and
raise additional funds to continue as a going concern. We
continue to evaluate our strategic alternatives, including
financing transactions or a sale of assets. Due to the
unavailability of a public market for our stock as well as our
current stock price, additional funding may not be available to
us on favorable terms or at all. If we raise additional funds
through the issuance of equity securities, the percentage
ownership of our stockholders could be significantly diluted.
Furthermore, these securities may have rights, preferences or
privileges senior to our common stock. If additional funding is
not available when needed, we may be unable to continue as a
going concern and achieve our intended business objectives.

34



---



##### Table of Contents



RISK FACTORS THAT MAY IMPACT FUTURE OPERATING
RESULTS

Factors that have affected our results of
operations in the past and are likely to affect our results of
operations in the future, include the following:

We expect to require additional funds to
continue operations according to our current business
plan.

On March 31, 2002, our cash, cash
equivalents and short term investments was approximately
$34 million, which may not be adequate to meet our
operating cash needs through the end of 2002 based on our
current business plan and results of operations. Our primary
source of capital is our revenue from product and service sales,
which historically has been, and we expect will continue to be,
less than our expenses. As described more fully below, our
revenues have been, and we expect will continue to be,
materially affected by the downturn in demand for
telecommunications equipment and by the events causing, and the
impact of, the restatement of our financial statements. In
addition, we have sustained, and expect to continue to sustain,
substantial expenses relating to the restatement of our
financial statements. As a result, we expect that our expenses
will continue to exceed our revenues for the foreseeable future,
and we will be required to raise additional funds in order to
continue operations according to our current business plan. If
we are not able to raise sufficient capital, we may have to
curtail our operations, which could seriously harm our business,
financial condition and results of operations, and we could have
to cease operations.

We have an accumulated deficit of
approximately $540.8 million and expect to continue to
incur operating losses for the foreseeable future.

As of September 30, 2001, we had an
accumulated deficit of approximately $540.8 million. We
expect to incur operating losses for the foreseeable future, and
these losses may be substantial. Further, we expect to incur
negative operating cash flow in the future. Generally, in the
long term, we expect to continue to invest in our research and
development and sales and marketing organizations, and we have
substantial commitments and expect to incur substantial expenses
related to the activities giving rise to the restatement of our
financial statements. We will need to generate significant
revenue growth to achieve profitability and positive operating
cash flows. Even if we do achieve profitability and positive
operating cash flows, we may not be able to sustain or increase
profitability or positive operating cash flows on a quarterly or
annual basis.

We have experienced operating losses in each year
since inception. The following table shows our operating losses
for the periods indicated:

|               |          |        |  |                                        
|-------------- | -------- | ------ |  | ---------------------------------------
|Operating Loss |          | Period
|               |          |       
|(in thousands) |          |       
|$              | (396,292 | )      |  | Nine months ended September 30, 2001   
|               | (112,402 | )      |  | Year ended December 31, 2000 (restated)
|               | (33,163  | )      |  | Year ended December 31, 1999           
|               | (5,824   | )      |  | Year ended December 31, 1998           
|               | (2,129   | )      |  | Year ended December 31, 1997           

We are currently the target of securities
litigation and may be the target of further actions, which will
be costly and time consuming to defend.

Beginning in July 2001, we and certain of our
current and former officers and directors were named as
defendants in several class action shareholder complaints filed
in the United States District Court for the Southern District of
New York, collectively captioned In re Clarent Corp. Initial
Public Offering Securities Litigation. These lawsuits
purport to bring suit on behalf of all purchasers of our common
stock between July 1, 1999 and December 6, 2000. In
these actions, the plaintiffs allege that we, certain of our
officers and directors and the underwriters of our initial
public offering (IPO) violated the federal
securities laws because our IPO registration statement and
prospectus purportedly contained untrue statements of material
fact or omitted material facts regarding the compensation to be
received by, and the stock allocation practices of, the IPO
underwriters. The plaintiffs further allege that the prospectus
relating to our secondary offering was false and misleading for
the same reasons. The plaintiffs seek unspecified monetary
damages and other relief. Similar complaints were filed in the
same Court against hundreds of other public companies that

35



---



##### Table of Contents



conducted IPOs of their common stock since the
late 1990s (the IPO Lawsuits). On August 8,
2001, the IPO Lawsuits were consolidated for pretrial purposes
before United States Judge Shira Scheindlin of the Southern
District of New York. Judge Scheindlin held an initial case
management conference on September 7, 2001, at which time
she ordered, among other things, that the time for all
defendants to respond to any complaint be postponed until
further order of the Court. Thus, we have not been required to
answer any of the complaints, and no discovery has been served
on us. In accordance with Judge Scheindlins orders at
further status conferences in March and April, the appointed
lead plaintiffs counsel filed amended, consolidated
complaints in the IPO Lawsuits on April 19, 2002. However,
Judge Scheindlin does not expect any of the defendants to file
motions to dismiss the amended, consolidated complaints until at
least summer of 2002.


Between September and October 2001, a series of
securities law class action complaints were filed in the United
States District Court for the Northern District of California
against us and certain of our current and former executive
officers and directors. The plaintiffs in each of these actions
allege, among other things, violations of the Securities
Exchange Act of 1934, as amended, due to the filing with the SEC
of allegedly false financial statements concerning our results
of operations for the second, third and fourth quarters of 2000,
and the first and second quarters of 2001. The original
complaints seek unspecified monetary damages and other relief.
In November 2001, the court entered an order consolidating these
actions into a single action, and in December 2001 appointed a
lead class plaintiff. A consolidated complaint has not yet been
filed. No discovery has taken place and no trial date has been
set.

In October and November 2001, four shareholder
derivative actions were filed against us, three in the Delaware
Chancery Court and one in California Superior Court. In November
2001, the three Delaware shareholder derivative actions were
consolidated into a single action. The plaintiffs in these
actions claim to be suing on our behalf and name various of our
current and former officers and directors as defendants. The
complaints assert several claims, including breach of fiduciary
duties, corporate waste, abuse of control, unjust enrichment,
usurpation of corporate opportunities and mismanagement,
resulting from, among other things, our reporting of allegedly
false financial statements concerning our results of operations
for the second, third and fourth quarters of 2000, and the first
and second quarters of 2001, our alleged failure to disclose
information regarding our operations and the defendants
alleged failure to implement and maintain adequate internal
financial controls. The complaints seek unspecified monetary
damages and other relief. The plaintiff in the California action
has commenced discovery against the defendants. However, we are
seeking a protective order relating to certain of the discovery
requests. On March 23, 2002, our Board of Directors formed
a special litigation committee of the Board of Directors to
investigate the plaintiffs allegations. Discovery has not
commenced in the Delaware action. No trial date has been set in
either action.

On April 12, 2002, a civil complaint for
violations of the federal securities laws was filed against us
and certain of our officers and directors in the United States
District Court for the District of Minnesota entitled
Ahlstrom, et al. v. Clarent Corporation, et al. The
plaintiffs in this action include Irwin L. Jacobs and a number
of investors apparently affiliated with him. Plaintiffs allege
that we intentionally issued false financial reports for the
Company between March 2001 and August 2001 in violation of
Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and similar provisions of Minnesota law. We currently
believe that this litigation will be coordinated or consolidated
for most pre-trial purposes with the other securities law class
action matters currently pending against us. This matter is at
an early stage. No response to the complaint has yet been filed,
and no discovery has taken place.

On April 26, 2002, certain former
shareholders of PEAK Software Solutions, Inc.
(PEAK), some of whom are employees of ours,
including one of our key employees, filed a lawsuit against us
in Colorado state court. The complaint alleges claims for common
law fraud, securities fraud and breach of contract relating to
our acquisition of PEAK in July 2000. The complaint does not
specify the damages sought. The complaint has not yet been
served and no response has been filed.

The ultimate outcome of these matters cannot
presently be determined and will require significant commitment
of our financial and management resources and time, which may
seriously harm our business, financial condition and results of
operations. We cannot assure you that any of the allegations
discussed above can be resolved without costly and protracted
litigation, and the outcome may have a materially adverse

36



---



##### Table of Contents



impact upon our financial position, results of
operations and cash flows. No estimate can be made at this time
of the possible loss or possible range of loss associated with
the resolution of these actions.


In addition, securities class action litigation
has often been brought against a company following a decline in
the market price of its securities. The uncertainty of the
currently pending investigation and litigation could lead to
more volatility in our stock price, if and when trading resumes.
We may in the future be the target of securities class action
claims similar to those described above.

We have been and are continuing to
cooperate with regulatory agencies in connection with their
investigations of the actions relating to the restatement of our
financial statements, and we expect the investigations to be
time-consuming and costly and to divert managements time
and attention, and the investigations could result in penalties
against us.

On September 4, 2001, we contacted the
Securities Exchange Commission (the SEC) and the Nasdaq
Marketwatch to inform them of possible accounting and financial
irregularities. Nasdaq commenced and now has completed an
investigation relating to these matters. The Nasdaq
investigation resulted in the delisting of our common stock from
the Nasdaq Stock Market effective January 30, 2002.

We also have been notified that the SEC has
commenced an investigation regarding the events giving rise to
the restatement. Although we are cooperating fully with the SEC
in its investigation, we cannot anticipate actions that may be
taken by the SEC or any other regulatory agencies should they
begin investigations. The SEC has the ability to pursue civil or
criminal penalties against us and our current and former
officers and directors.

Our investigation and our cooperation with the
Nasdaq and SEC investigations have been costly and
time-consuming. Our response to the SECs continuing
investigation will be costly and time-consuming and will divert
managements time and attention from the operation of our
business. The SEC investigation could result in civil or
criminal penalties against us, which could seriously affect our
capital resources. Any of these events could adversely affect
our business, financial position, results of operation and cash
flow.

We are currently engaged in litigation and
other disputes with former distributors and suppliers, which
will be costly and time consuming to defend.

On December 31, 2001, D-Link Corporation
(D-Link), a distributor/supplier to us, filed two
complaints in California Superior Court in which D-Link asserted
various breach of contract claims against us. D-Link seeks
damages of approximately $19.0 million plus interest with
respect to these alleged breaches of contracts. On March 5,
2002 the court consolidated the two actions. We have filed a
cross-complaint against D-Link alleging breach of contract and
breach of warranty. We have answered D-Links complaints,
denying all material allegations and asserting various
affirmative defenses. Discovery has commenced with respect to
both of the D-Link complaints, but a trial date has not been set.

In December 2001, we received letters from Bright
Oceans Corporation (HK) Limited (Bright Oceans) in
which Bright Oceans asserted possible claims against us. Bright
Oceans claimed that it purchased products from us on purchase
orders subject to a right of return that it has now exercised,
and that we are obligated to return Bright Oceans payment.
Bright Oceans seeks recovery of $4.6 million plus interest
and expenses.

The ultimate outcome of these matters cannot
presently be determined and will require significant commitment
of our financial and management resources and time, which may
seriously harm our business, financial condition and results of
operations. We cannot assure you that any of the allegations
discussed above can be resolved without costly and protracted
litigation, and the outcome may have a materially adverse impact
upon our financial position, results of operations and cash
flows. No estimate can be made at this time of the possible loss
or possible range of loss associated with the resolution of
these actions.

In addition, litigation has often been brought
against a company following significant restructurings of
operations that affect its relationships with distributors and
suppliers. We may in the future be the target of other claims
similar to those described above.

37



---



##### Table of Contents



We may not be able to pay our operating
lease commitments of approximately $72.5 million as of
September 30, 2001.

At September 30, 2001, we had operating
lease commitments of approximately $72.5 million that are
due and payable through 2011. These leases relate to
approximately 396,000 square feet of facility space, of which
approximately 307,000 square feet is excess based on our current
operating levels. The excess space is principally in California.

We are currently attempting to sublet the excess
space or renegotiate our lease terms. The market for office
space in California remains depressed, however, and we cannot
guarantee that we will be able to find a sublessee for our
excess office space. In addition, we entered into some of the
leases at times when the demand for office space was
considerably higher than now, and the rental rates under these
leases are likely to be at prices that are higher than the price
for which we will be able to sublease the space. As a result,
even if we can identify a sublessee for our excess office space,
we are likely to remain committed to pay some portion of the
rent. In addition, the lessors of these properties are under no
obligation to renegotiate our leases. If we are unable to sublet
the premises subject to these leases, or are required to
sublease the premises at a loss, and if we are not successful in
renegotiating the lease terms, we will need to raise additional
funds to cover these commitments which, as described above, may
not be possible on terms that are acceptable to us, or at all.

Our strategy to continue operating
according to our current business plan relies heavily on
achieving revenue targets, reducing expenses and effectively
complying with our corrective measures.

Our cash flows have been, and we expect will
continue to be, materially impacted by the downturn in demand
for telecommunications equipment and by the events causing, and
the impact of, the restatement of our financial statements,
which has decreased demand for our products. Although we
implemented remedial measures to address the activities
discovered in our investigation, our ability to achieve our
business plan is dependent on our effective continued execution
of these measures as we operate our business. Additionally, our
ability to meet our revenue targets depends in large part on the
continuing support of our customers and distributors, who may
react adversely to the restatement of our financial statements.
The restatement of our financial statements and the securities
litigation filed against us has resulted in substantial negative
publicity about us, which may cause some of our potential
customers to defer purchases of our products. We may not be able
to retain customers and distributors if they lose confidence in
us, and our distributors may reexamine their willingness to do
business with us. Some of our customers and distributors,
particularly large organizations, may be reluctant to chose us
or continue to use us as a vendor due to concerns over our
weakened financial condition.

In addition, we have incurred, and expect to
continue to incur, substantial expenses relating to the
restatement of our financial statements, regulatory agency
investigations and litigation matters. We also have substantial
operating lease and other commitments, which will require us to
make substantial payments if we cannot renegotiate or otherwise
reduce these commitments. Additionally, achieving our revenue
and expense targets depends on factors that are beyond our
control, such as the condition of the global economy, the status
of capital expenditures in our customers markets and the
outcome of the litigation against us. As a result, we cannot
guarantee that we will be able to achieve the revenue and
expense targets. If we do not achieve these targets, we will
either have to raise additional financing or curtail or cease
our operations.

If we do need to raise additional capital,
there is no guarantee that capital will be available to us on
acceptable terms or at all. If we cannot secure additional
funding on acceptable terms, we may be required to curtail or
cease operations.

We have limited access to the capital markets to
raise additional financing should we need it. Investors recently
have been reluctant to invest in relatively unproven
high-technology companies such as our, and raising capital in
the current market conditions is difficult. In addition, our
ability to obtain additional financing on acceptable terms will
be adversely affected by uncertainties relating to the outcome
of the pending litigation involving us and the regulatory
reviews to which we are subject as well as the effect of the
restatement of our financial statements and the delisting of our
common stock from the Nasdaq Stock Market. As a result, there is
no guarantee that financing will be available on terms that are
acceptable to us, or at all. If

38



---



##### Table of Contents



we are able to consummate a financing
arrangement, there is no guarantee that the amount raised will
be sufficient to meet our future needs.


If we cannot raise needed funds on acceptable
terms, we will have to curtail or cease operations. If we are
required to curtail operations, we may not be able to develop or
enhance our products, take advantage of future opportunities or
respond to competitive pressures or unanticipated requirements.
We also may be required to reduce our planned product offerings
and development and marketing efforts. Any of these effects
could seriously harm our business, financial condition and
results of operations and could adversely affect our continued
viability.

If we are able to raise additional funds, we may
do so from a combination of sources, potentially including debt
and equity issuance, and the sale of assets. If we were to raise
additional funds through the issuance of debt securities, these
securities could have rights, preferences and privileges senior
to those of common stock holders, and the terms of such debt
securities could impose restrictions on our operations. The sale
of additional equity or convertible debt securities would reduce
the ownership percentage of our existing stockholders. New
investors may demand rights, preferences or privileges senior to
those of existing holders of our common stock.

Our indemnification obligations to our
directors and officers in connection with various securities and
other litigation commenced against us, may deplete our cash
resources and affect our ability to operate our business
successfully.

Our Amended and Restated Certificate of
Incorporation provides for the indemnification of our directors
with certain exceptions. In addition, our bylaws provide for the
indemnification of our directors and executive officers as
authorized by law and in accordance with any written
indemnification agreements with our directors and executive
officers. Our bylaws also permit indemnification of officers,
employees and other agents in appropriate situations. We have
entered into indemnity agreements with each of our directors and
current and former executive officers, which provide that we
will indemnify our directors and executive officers to the
fullest extent allowed by law. The indemnity agreements also
provide additional indemnification to our directors and
executive officers in connection with any action, suit or
proceeding, with certain exceptions.

Various securities and other litigation claims
have been filed against several of our current and former
directors and officers. In addition, several of our directors
and officers may incur costs arising from potential
investigation by regulatory agencies, including Nasdaq and the
SEC. The ultimate outcome of these matters cannot be presently
determined and we cannot estimate the possible extent of our
indemnification obligations or the availability of coverage
through our insurance. We have purchased directors and
officers liability insurance to reimburse us for the costs
incurred in connection with our indemnification obligations
described above. For the period from July 1999 through
June 30, 2001, the period in which the claims against us
and certain of our directors and executive officers were
asserted, we had in place directors and officers
liability insurance policies providing an aggregate of
$35.0 million in coverage (the D&O
Policies). The D&O Policies provide coverage, subject
to various exclusions, including claims relating to the
restatement of our financial statements. The D&O Policies
provide that 100% of the costs incurred in defending claims
asserted jointly against us and our directors and executive
officers are allocated to the individuals defense and,
thus, are covered by the policy.

Certain of the insurers of the D&O Policies
have reserved their rights to deny coverage, in whole or in
part, as a result of (i) the activities of certain covered
executives which may be imputed to us, which may result in a
significant limitation of coverage or (ii) the errors or
infirmities in the application process, which may enable the
insurers to rescind the policy. If our insurance coverage is
nonexistent or insufficient to indemnify our directors and
officers to the extent provided in our bylaws and the indemnity
agreements, our financial position, results of operations and
cash flows could be materially adversely affected because we
have not set aside any financial reserves to pay our indemnity
obligations that are denied or not covered by our D&O
Policies.

39



---



##### Table of Contents



Our failure to manage our recent strategic
restructuring effectively could negatively affect our results of
operations.

When we began commercial shipment of our products
in March 1997, we initially experienced a period of rapid growth
and expansion that significantly strained all of our resources.
However, from December 31, 2000 to the filing of this
report, the total number of our employees decreased from
approximately 848 to approximately 180 currently due to
organizational restructuring and related reductions in workforce
arising from reduced revenue expectations. Despite these recent
reductions in workforce, we expect our implementation of
organizational restructuring will place strain on our
management, and operational and financial resources. The success
of our organizational restructuring depends on the ability of
management to utilize reduced resources effectively. We may not
be able to implement our strategic focus on the local access or
our last mile market in an efficient and timely
manner. Delays in streamlining our operations during our
transition to the local access market focus may impair our
ability to accurately forecast sales demand, manage our product
inventory, and record and provide support services to our
customers. Our inability to manage our organizational
restructuring effectively could seriously harm our business,
financial condition and results of operations. Finally, we may
be the target of employment litigation in connection with our
restructuring and reductions in workforce.

If the strategic restructuring of our
organization is not effective, our financial results and
business could suffer.

In response to changes in industry and market
conditions we are restructuring, and may continue to
restructure, our activities to more strategically realign our
resources and improve our operational efficiency. Our
restructuring plan is based on certain assumptions regarding the
cost structure of our business and the nature and severity of
the current industry adjustment which may not prove to be
accurate. Our restructuring plan has involved the implementation
of a number of initiatives to streamline our business and
improve operational efficiency. We cannot assure you that our
restructuring plan will result in sufficient cost reduction or
greater operational efficiency in light of current or future
capital markets and telecommunications industry conditions. We
also cannot assure you that we will not be required to refine,
expand or extend our restructuring plan, or that we will improve
our operational efficiency as a result of our restructuring
plan. In addition, we cannot assure you that we will be able to
successfully utilize our reduced workforce resources effectively
or that our management will be effective during our
restructuring. Current and additional restructuring actions may
result in further cash and/or non-cash charges, which could
adversely affect our business, results of operations and
financial condition. Finally, we may be the target of employment
litigation in connection with our restructuring and reductions
in workforce.

If we are unable to attract or retain key
personnel and qualified employees as a result of uncertainty
about our future and the possible loss of confidence of our
employees, we may not be able to operate our business
successfully.

Our success depends in large part upon our
ability to attract and retain key personnel and qualified
employees, particularly senior management, highly skilled
engineers, sales personnel, marketing personnel and support
personnel, despite our recent workforce reductions. The
competition for such key personnel and qualified employees is
intense. Uncertainty about our future and the possible loss of
confidence of our employees in connection with the restatement
of our historical revenue, multiple lawsuits filed against us,
regulatory review and recent negative publicity could harm our
ability to attract and retain key personnel and qualified
employees, which could materially adversely affect our business,
operating results and financial condition. In addition, we have
effected several reductions in workforce designed to align our
workforce with our anticipated level of business. These
reductions in workforce were targeted at eliminating more than
80% of the workforce we had in early 2001 by early 2002 and
terminating several senior executives.

Our success also depends upon our ability to
attract and retain key executive officers and senior management.
We have recently experienced significant management changes and
several executives either resigned or were terminated in
connection with the financial irregularities investigation and
as a result of reductions in workforce that have been
accompanied by the restructuring of our operations. These
management changes have resulted in transitional difficulties,
and a significant strain on our management systems,

40



---



##### Table of Contents



infrastructure, resources, operational
capabilities and planning and management processes, which will
make it difficult for us to implement our business strategy and
may adversely impact our operating results, financial condition
and our ability to increase revenues or control costs. In
addition, if we are unable to retain our key executive officers,
recruit new key officers or train and manage our workforce, our
business, operating results and financial condition could be
adversely affected.


Competition for technical personnel in the
high-technology industry is intense, despite current economic
conditions. Our future success depends, in large part, on our
ability to attract and retain highly skilled personnel. The loss
of the services of any of our key personnel, the inability to
attract or retain qualified personnel in the future or delays in
hiring required personnel, particularly engineers, sales
personnel and marketing personnel, may seriously harm our
business, financial condition and results of operations. We may
find it more difficult to attract or retain qualified personnel
as a result of our recent reduction in workforce and
restructuring. In addition, if management is unable to utilize
reduced resources effectively, our ability to compete
effectively may be impaired. We will need to expand our sales
operations and marketing operations in order to increase market
awareness of our products and generate increased revenue. New
sales personnel and marketing personnel will require training
and take time to achieve full productivity. In addition, the
design and installation of IP telephony solutions can be
complex. Accordingly, we need highly trained professional
services and customer support personnel. We will need to
continue to increase the number of service and support staff to
support new customers and the expanding needs of existing
customers. Competition for personnel is intense, especially in
the San Francisco Bay Area where we maintain our headquarters.
We cannot be certain that we will successfully attract and
retain additional qualified personnel. In addition, our key
person life insurance policy, covering some of our key
employees, may be insufficient to cover the costs associated
with the loss of one of these employees.

We may not have adequate protection for our
intellectual property, which may make it easier for others to
sell competing products.

We rely on a combination of patent, copyright,
trademark and trade secret laws and restrictions on disclosure
through confidentiality agreements 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. In addition, we
cannot be sure that certain of our former employees have taken
appropriate steps to protect our intellectual property
consistent with our policies. Monitoring unauthorized use of our
products is difficult, and we cannot be certain that the steps
we have taken will prevent misappropriation of our technology.
The laws of some foreign countries do not protect our
proprietary rights to as great an extent as the laws of the
United States, and many United States companies have encountered
substantial infringement problems in these countries, some of
which are countries in which we have sold and continue to sell
products. If we fail to protect our intellectual property rights
adequately, it would be easier for our competitors to sell
competing products.

Our products may infringe on the
intellectual property rights of third parties, which may result
in lawsuits and prohibit us from selling our
products.

We believe there is a risk that third parties
have filed, or will file applications for, or have received or
will receive, patents or obtain additional intellectual property
rights relating to materials or processes that we use or propose
to use. As a result, from time to time, third parties may assert
exclusive patent, copyright, trademark and other intellectual
property rights to technologies that are important to us. In
addition, third parties may assert claims or initiate litigation
against us or our manufacturers, suppliers or customers with
respect to existing or future products, copyrights, trademarks
or other proprietary rights. Any claims against us or customers
that we indemnify against intellectual property claims, with or
without merit, may be time-consuming, result in costly
litigation and diversion of technical and management personnel
or require us to develop non-infringing technology. If a claim
is successful, we may be required to obtain a license or royalty
agreement under the intellectual property rights of those
parties claiming the infringement. If we are unable to obtain
the license or acceptable terms, we may be unable to market our
products. Limitations on our ability to market our products and
delays and costs associated with monetary damages and redesigns
in compliance with an adverse judgment or settlement could harm
our business, financial condition and results of operations.

41



---



##### Table of Contents



Sales to customers based outside the United
States have historically accounted for a significant portion of
our revenue, which exposes us to risks inherent in international
operations.

International sales represented approximately 70%
of revenue for the nine months ended September 30, 2001,
65% of total revenue in 2000 and 54% of total revenue in 1999.
Our international operations are subject to a variety of risks
associated with conducting business internationally any of which
could seriously harm our business, financial condition and
results of operations.

These risks include:



| |   |                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------
| |  | greater difficulty in accounts receivable
    collections;                                                                                    
|
| |  | import or export licensing and product
    certification requirements;                                                                        
|
| |  | tariffs, duties, price controls or other
    restrictions on foreign currencies or trade barriers imposed by
    foreign countries;           
|
| |  | potential adverse tax consequences, including
    restrictions on repatriation of earnings;                                                   
|
| |  | fluctuations in currency exchange rates;                                                                                                      
|
| |  | seasonal reductions in business activity in some
    parts of the world;                                                                      
|
| |  | unexpected changes in regulatory requirements;                                                                                                
|
| |  | burdens of complying with a wide variety of
    foreign laws, particularly with respect to intellectual property
    and license requirements;
|
| |  | difficulties and costs of staffing and managing
    foreign operations;                                                                       
|
| |  | political instability;                                                                                                                        
|
| |  | the impact of recessions in economies outside of
    the United States; and                                                                   
|
| |  | limited ability to enforce agreements,
    intellectual property and other rights in some foreign countries.                                  

Our vendors and suppliers may react
adversely to the restatement of our historical financial
statements and our weakened financial condition, which would
make our continuing viability uncertain.

Our future success depends in large part on the
support of our vendors and suppliers, who may react adversely to
the restatement of our historical financial statements. The
restatement of our historical financial statements and the
securities litigation filed against us has resulted in
substantial negative publicity about us, which has caused some
of our potential customers to defer purchases of our products.
Our vendors and suppliers may reexamine their willingness to do
business with us if they lose confidence in us and our ability
to fulfill our commitments.

The success of our business depends in part on
our ability to enter into contracts with companies and for the
continuing provisions of product and services. Some of these
companies, particularly large organizations, may be reluctant to
chose us or continue to use us as a vendor due to concerns over
our weakened financial condition.

Our common stock is currently not eligible
for trading on any public market, which has adversely affected
the market liquidity and volume of trading of our common stock
and has made it more difficult for us to raise additional
capital.

Our common stock was delisted from the Nasdaq
Stock Market, effective January 30, 2002, based on
Nasdaqs determination that we had violated certain of the
Nasdaq continued listing requirements as a result of
(i) our failure to file our quarterly report on
Form 10-Q for the quarter ended September 30, 2001,
(ii) the failure of our annual report on Form 10-K for
the fiscal year ended December 31, 2000 to contain audited
financial statements because our auditor, Ernst & Young LLP,
informed us that our financial statements for the year ended
December 31, 2000 should no longer be relied upon as a
result of the matters which gave rise to the need for a special
investigation and for which the investigation and resulting
restated financial statements

42



---



##### Table of Contents



were not complete, rendering our financial
statements unaudited at that time, and (iii) public
interest concerns related to the protection of investors. Our
common stock is not currently eligible for trading on any public
market, although private transactions involving our stock are
now quoted on the OTC Market Pink Sheets Electronic Quotation
Service (the Pink Sheets) under the symbol
CLRN. As a result, an investor will likely find it
more difficult to dispose of, or to obtain accurate quotations
for the price of, our common stock. In addition, until we are in
compliance with the public filing requirements of the Securities
Exchange Act of 1934, as amended, the quoting of our common
stock on the Pink Sheets is not eligible to be sponsored by a
market maker, which may make it more difficult for an investor
to acquire or dispose of our common stock in the secondary
market. In addition, if when or our common stock is eligible to
be sponsored by a market maker, our common stock will be subject
to so-called penny stock rules, which impose
additional sales practice and market-making requirements on
broker-dealers who sell and/or make a market in such securities.
Consequently, broker-dealers may be less willing or able to sell
and/or make a market in our common stock and purchasers of our
common stock may have more difficulty selling such common stock
on the Pink Sheets. In all cases, the market liquidity and
volume of trading of our common stock has declined and has made
it more difficult for us to raise additional capital.


We have a limited operating history, which
makes it difficult to evaluate our prospects.

We are an early-stage company in the emerging IP
telephony market. Because of our limited operating history, we
have limited insight into trends that may emerge in our market
and affect our business. The revenue and income potential of the
IP telephony market, and our business in particular, are
unproven. As a result of our limited operating history, we have
limited financial data that you can use to evaluate our
business. You must consider our prospects in light of the risks,
expenses and challenges we might encounter because we are at an
early stage of development in a new and rapidly evolving market.
Unless we generate significant revenue growth, our increasing
expenses will significantly harm our financial position.

Our markets are highly competitive, and we
cannot assure you that we will be able to compete
effectively.

We compete in a new, rapidly evolving and highly
competitive and fragmented market. We expect competition to
intensify in the future. We cannot assure you that we will be
able to compete effectively. We believe that the main
competitive factors in our market are product quality, features,
cost and customer relationships. Our current principal
competitors include Cisco Systems, Inc., Lucent Technologies
Inc., Nortel Networks Corporation, Sonus Networks, Nuera
Communications Inc. and Vocal Tec Communications. Many of our
large competitors have significantly larger market shares (as
measured by ports shipped) and stronger relationships with
service providers than we do. In addition, they may be able to
compete more effectively because they will be able to add IP
telephony features to their existing equipment or bundle these
features as part of a broader solution. We also expect that
other companies may enter our market with better products and
technologies.

We expect our competitors to continue to improve
the performance of their current products and introduce new
products or new technologies. To be competitive, we must
continue to invest significant resources in research and
development, sales, marketing and customer support. We cannot be
sure that we will have sufficient resources to make these
investments or that we will be able to make the technological
advances necessary to be competitive. Increased competition is
likely to result in price reductions, reduced gross margin and
loss of market share. Our failure to compete successfully
against current or future competitors could seriously harm our
business, financial condition and results of operations.

A loss of one or more of our key customers
could cause a significant decrease in our net
revenue.

We have historically derived the majority of our
revenue from a small number of customers. One customer, Grintek
Telecom individually accounted for 26% of our revenue for the
quarter ended September 30, 2001 and 17% for the nine
months ended September 30, 2001. In the fiscal year 2000,
no one customer individually accounted for 10% or more of our
net revenues. In 1999, entities affiliated with AT&T
Corporation accounted for 15% of net revenue and entities
affiliated with Ji Tong Communications accounted for 10% of
net revenue. None of our customers is obligated to purchase
additional products or services. Accordingly, we cannot be
certain that present or future customers will not terminate
their purchasing

43



---



##### Table of Contents



arrangements with us or significantly reduce or
delay their orders. Any termination, change, reduction or delay
in orders could seriously harm our business, financial condition
and results of operations.


Our future ability to generate sales
depends on the interoperability of our products with those of
other vendors.

While our products currently connect to the
traditional telephone system using standard interfaces, an
increasing number of our customers have requested that our
products interoperate with competing IP telephony products from
other vendors. The interoperability standards for IP telephony
equipment are evolving. We have developed only initial
interoperable solutions, but if we are unable to provide or
maintain our customers interoperable solutions with other
vendors products, they may seek vendors who provide
greater product interoperability. This could seriously harm our
business, financial condition and results of operations.

Our inability to introduce new products and
product enhancements could prevent us from increasing
revenue.

We expect that the IP telephony market will be
characterized by rapid technological change. We also expect that
the increased use of IP telephony will require us to rapidly
evolve and adapt our products to remain competitive. The
successful operation of our business depends on our ability to
develop and introduce new products and product enhancements that
respond to technological changes or evolving industry standards
on a timely and cost-effective basis. We cannot be certain that
we will successfully develop and market these types of products
and product enhancements. Our failure to produce technologically
competitive products in a cost-effective manner and on a timely
basis will seriously harm our business, financial condition and
results of operations.

We may not be able to expand our
distribution and direct sales channels, which would harm our
ability to generate revenue.

We are now in the process of converting our
overseas sales organization into distributorships and have
significantly downsized our direct sales force and operating
activities in a number of countries. We believe that our future
success is dependent upon our ability to establish and manage
successful relationships with a variety of domestic and
international distribution partners and key personnel with our
direct sales force. We have agreements with more than 25
distribution partners that accounted for approximately 31% and
24% of net revenue for the three and nine months ended
September 30, 2001, 31% of revenue in the fiscal year 2000
and 16% of revenue in 1999. These distribution agreements
typically may be terminated without cause upon 90 days
notice. We cannot be certain that we will be able to reach
agreement with additional distribution partners on a timely
basis or at all, or that these distribution partners will devote
adequate resources to marketing, selling and supporting our
products. To generate greater revenue from distributors, we must
successfully manage our distributor relationships, which we
cannot guarantee that we will be able to do in the future. Our
inability to generate revenue from distribution partners may
harm our business, financial condition and results of operations.

Our sales cycle is typically long and
unpredictable, causing us to incur expenditures prior to the
receipt of orders.

We incur research and development, and sales and
marketing, including customer support, expenditures prior to
receiving orders for our products from any given customer. The
length of the sales cycle with a particular customer is
influenced by a number of factors, including:



| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | a customers experience with sophisticated
    telecommunications equipment, such as our product;                               
|
| |  | the particular telecommunications market that the
    customer serves; and                                                      
|
| |  | the cost of purchasing our product, including the
    cost of converting from installed equipment, which may be
    significant.

44



---



##### Table of Contents



Before we receive orders, our customers
typically test and evaluate our products for a period of many
months.

We cannot be certain that the sales cycle for our
products will not lengthen in the future. In addition, the
emerging and evolving nature of the IP telephony market may
cause prospective customers to delay purchase decisions as they
evaluate new technologies, test our products and develop and
implement new systems. As the average order size for our
products grows, the process for approving purchases is likely to
become more complex, leading to potential delays in receipt of
these orders. As a result, our long and unpredictable sales
cycle contributes to the uncertainty of our future operating
results.

Delays in customer orders could have a
negative impact on our results of operations for any given
quarter.

We have historically received a significant
portion of our product orders near the end of a quarter.
Accordingly, a delay in an anticipated receipt or delivery of a
given order past the end of a particular quarter may negatively
impact our results of operations for that quarter. These delays
may become more likely given that we expect that the average
size of our customer orders may increase. As a result, a delay
in the recognition of revenue, even from just one customer, may
have a significant negative impact on our results of operations
for a given period. Additionally, the volatility in capital
markets and in the U.S. economy may cause some customers to
postpone or terminate significant capital expenditures, such as
expenditures on our products. Any delay in sales of our products
could result in a significant decrease in cash flow, which, in
turn, could severely affect our ability to make payments as they
come due and could cause our operating results to vary
significantly from quarter to quarter.

Our dependence on third party manufacturers
may result in product delivery delays.

We license technology that is incorporated into
our products from third party manufacturers, including
AudioCodes, Ltd. and Natural Microsystems. If these vendors fail
to supply us with their components on a timely basis, we could
experience significant delays in shipping our products. Although
we believe there are other sources for this licensed technology,
any significant interruption in the supply or support of any
licensed technology could seriously harm our sales, unless and
until we can replace the functionality provided by this licensed
technology. Also, because our products incorporate software
developed and maintained by third parties, we depend on these
third parties to deliver reliable products, support these
products, enhance their current products, develop new products
on a timely and cost-effective basis, and respond to emerging
industry standards and other technological changes. The failure
of these third parties to meet these criteria could seriously
harm our business, financial condition and results of operations.

Our strategy to outsource assembly and test
functions in the future could delay our ability to deliver our
products on a timely basis.

We assemble and test our products at our
facilities in Redwood City, California and in Manassas,
Virginia. We have outsourced some of our assembly and test
functions.

This outsourcing strategy involves risks,
including the potential absence of adequate capacity and reduced
control over delivery schedules, manufacturing yields, quality
and costs. In the event that any significant subcontractor was
unable or unwilling to continue to manufacture and/or test our
products in the required volumes, we would have to identify and
qualify acceptable replacements. This process could be lengthy,
and we cannot be sure that additional sources would be available
to us on a timely basis. Any delay or increase in costs in the
assembly and testing of products by third-party subcontractors
could seriously harm our business, financial condition and
results of operations.

Our facilities are vulnerable to damage
from earthquakes and other natural disasters.

Some of our assembly facilities are located on or
near known earthquake fault zones and all are vulnerable to
damage from fire, floods, earthquakes, power loss,
telecommunications failures and similar events. If such a
disaster occurs while we still assemble our products in-house,
our ability to assemble, test and ship our products would be
seriously, if not completely, impaired, which would seriously
harm our business, financial condition and results of
operations. We cannot be sure that the insurance we maintain
against fires,

45



---



##### Table of Contents



floods, earthquakes and general business
interruptions will be adequate to cover our losses in any
particular case.


Fluctuations in the values of foreign
currencies could have a negative impact on our
profitability.

Due to our international operations, we incur
expenses in a number of currencies. We do not currently engage
in currency hedging activities to limit the risks of exchange
rate fluctuations. Therefore, fluctuations in the value of
foreign currencies could have a negative impact on the
profitability of our global operations, which would seriously
harm our business, financial condition and results of
operations. All of our sales, including international sales, are
currently denominated in U.S. dollars. However, we do not expect
that future international sales will continue to be denominated
in U.S. dollars. Fluctuations in the value of the U.S. dollar
and foreign currencies may make our products more expensive than
local product offerings.

Our certificate of incorporation and bylaws
and Delaware law contain provisions that could delay or prevent
a change of control of Clarent.

Certain provisions of our certificate of
incorporation and bylaws and Delaware law may discourage, delay
or prevent a merger or acquisition that a stockholder may
consider favorable. These provisions include:



| |   |                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | authorizing the board of directors to issue
    preferred stock;                                                                                                                                      
|
| |  | prohibiting cumulative voting in the election of
    directors;                                                                                                                                       
|
| |  | limiting the persons who may call special
    meetings of stockholders;                                                                                                                               
|
| |  | prohibiting stockholder action by written consent;                                                                                                                                                    
|
| |  | establishing advance notice requirements for
    nominations for election of the board of directors or for
    proposing matters that can be acted on by stockholders at
    stockholder meetings; and
|
| |  | establishing a classified board of directors
    requiring that members of the board of directors be elected in
    different years.                                                                  

In addition, in February 2001, we adopted a
shareholder rights plan which may discourage, delay or prevent a
merger that a stockholder may consider favorable. We are also
subject to certain provisions of Delaware law that could delay,
deter or prevent us from entering into an acquisition, including
Section 203 of the Delaware General Corporation Law, which
prohibits a Delaware corporation from engaging in a business
combination with an interested stockholder unless specific
conditions are met.

We do not intend to pay
dividends.

We have never declared or paid any cash dividends
on our capital stock. We currently intend to retain any future
earnings for funding growth. Therefore, we do not expect to pay
any dividends in the foreseeable future.

46



---



##### Table of Contents






ITEM 3.     QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Financial Market Risk

Our financial market risk includes risks
associated with international operations and related foreign
currencies. We anticipate that international sales will continue
to account for a significant portion of our consolidated
revenue. Our international sales are largely denominated in U.S.
dollars and therefore are not subject to material foreign
currency exchange risk. Expenses of our international operations
are denominated in each countrys local currency and
therefore are subject to foreign currency exchange risk;
however, through September 30, 2001 we have not experienced
any significant negative impact on our operations as a result of
fluctuations in foreign currency exchange rates. We do not
currently engage in any hedging activities or use derivative
financial instruments.

We have an investment portfolio of fixed income
securities, including those classified as cash equivalents, of
approximately $73 million at September 30, 2001. These
securities are subject to interest rate fluctuations and will
decrease in market value if interest rates decrease. The primary
objective of our investment activities is to preserve principal
while at the same time maximizing yields without significantly
increasing risk. We invest primarily in high-quality, short-term
debt instruments such as U.S. government securities and
instruments issued by high quality financial institutions and
companies, including money market instruments and debt issued by
corporations. A hypothetical 100 basis point increase in
interest rates would result in less than a $200,000 decrease
(less than 0.2%) in the fair market value of our
available-for-sale securities.

We have investments in equity and debt securities
of privately held companies for the promotion of business and
strategic objectives of $6.9 million at September 30,
2001. These investments are generally in companies in the
telecommunications industry. We also have invested in a venture
capital management fund. These investments are included in
long-term investments and are accounted for using the cost
method. For investments in which no public market exists, our
policy is to regularly review the operating performance, recent
financing transactions and cash flow forecasts for such
companies in assessing the net realizable values of the
securities of these companies. Impairment losses on equity
investments are recorded when events and circumstances indicate
that such assets are impaired and the decline in value is other
than temporary. During the nine months ended September 30,
2001 we recorded impairment losses of $8.9 million on
investments and realized gains of $1.4 million.

47



---



##### Table of Contents






PART II.

OTHER INFORMATION




ITEM 1.     LEGAL
PROCEEDINGS

Beginning in July 2001, the Company and certain
of its current and former officers and directors were named as
defendants in several class action shareholder complaints filed
in the United States District Court for the Southern District of
New York, collectively captioned In re Clarent Corp. Initial
Public Offering Securities Litigation. These lawsuits
purport to bring suit on behalf of all purchasers of the
Companys common stock between July 1, 1999 and
December 6, 2000. In these actions, the plaintiffs allege
that the Company, certain of its officers and directors and the
underwriters of its initial public offering (IPO)
violated the federal securities laws because the Companys
IPO registration statement and prospectus purportedly contained
untrue statements of material fact or omitted material facts
regarding the compensation to be received by, and the stock
allocation practices of, the IPO underwriters. The plaintiffs
further allege that the prospectus relating to the
Companys secondary offering was false and misleading for
the same reasons. The plaintiffs seek unspecified monetary
damages and other relief. Similar complaints were filed in the
same Court against hundreds of other public companies that
conducted IPOs of their common stock since the late 1990s (the
IPO Lawsuits). On August 8, 2001, the IPO
Lawsuits were consolidated for pretrial purposes before United
States Judge Shira Scheindlin of the Southern District of New
York. Judge Scheindlin held an initial case management
conference on September 7, 2001, at which time she ordered,
among other things, that the time for all defendants to respond
to any complaint be postponed until further order of the Court.
Thus, the Company has not been required to answer any of the
complaints, and no discovery has been served on the Company. In
accordance with Judge Scheindlins orders at further status
conferences in March and April, the appointed lead
plaintiffs counsel filed amended, consolidated complaints
in the IPO Lawsuits on April 19, 2002. However, Judge
Scheindlin does not expect any of the defendants to file motions
to dismiss the amended, consolidated complaints until at least
summer of 2002.

In September and October 2001, a series of
securities law class action complaints were filed in the United
States District Court for the Northern District of California
against the Company and certain of its current and former
executive officers and directors. The plaintiffs in each of
these actions allege, among other things, violations of the
Securities Exchange Act of 1934, as amended, due to the filing
with the SEC of allegedly false financial statements concerning
the Companys results of operations for the second, third
and fourth quarters of 2000, and the first and second quarters
of 2001. The original complaints seek unspecified monetary
damages and other relief. In November 2001, the court entered an
order consolidating these actions into a single action, and in
December 2001 appointed a lead class plaintiff. A consolidated
complaint has not yet been filed. No discovery has taken place
and no trial date has been set.

In October and November 2001, four shareholder
derivative actions were filed against the Company, three in the
Delaware Chancery Court and one in California Superior Court. In
November 2001, the three Delaware shareholder derivative actions
were consolidated into a single action. The plaintiffs in these
actions claim to be suing on the Companys behalf and name
various of the Companys current and former officers and
directors as defendants. The complaints assert several claims,
including breach of fiduciary duties, corporate waste, abuse of
control, unjust enrichment, usurpation of corporate
opportunities and mismanagement, resulting from, among other
things, the Companys reporting of allegedly false
financial statements concerning the Companys results of
operations for the second, third and fourth quarters of 2000 and
the first and second quarters of 2001, the Companys
alleged failure to disclose information regarding the
Companys operations and the defendants alleged
failure to implement and maintain adequate internal financial
controls. The complaints seek unspecified monetary damages and
other relief. The plaintiff in the California action has
commenced discovery against the defendants. However, the Company
is seeking a protective order relating to certain of the
discovery requests. Discovery has not commenced in the Delaware
action. On March 23, 2002, the Companys Board of
Directors formed a special litigation committee of the Board of
Directors to investigate the plaintiffs allegations. No
trial date has been set in either action.

48



---



##### Table of Contents



On December 31, 2001, D-Link Corporation
(D-Link), a distributor and supplier to the Company,
filed two complaints in California Superior Court in which
D-Link asserted various breach of contract claims against the
Company. D-Link seeks damages of approximately
$19.0 million plus interest with respect to these alleged
breaches of contracts. On March 5, 2002 the court
consolidated the two actions. The Company has filed a
cross-complaint against D-Link alleging breach of contract and
breach of warranty. The Company has answered D-Links
complaints, denying all material allegations and asserting
various affirmative defenses. Discovery has commenced with
respect to both of the D-Link complaints, but a trial date has
not been set.

In December 2001, the Company received letters
from Bright Oceans Corporation (HK) Limited (Bright
Oceans) in which Bright Oceans asserted possible claims
against the Company. Bright Oceans claimed that it purchased
products from the Company on purchase orders subject to a right
of return. Bright Oceans seeks recovery of $4.6 million
plus interest and expenses based on its purported right of
return.

On April 12, 2002, a civil complaint for
violations of the federal securities laws was filed against the
Company and certain of its officers and directors in the United
States District Court for the District of Minnesota entitled
Ahlstrom, et al. v. Clarent Corporation, et al. The
plaintiffs in this action include Irwin L. Jacobs and a number
of investors apparently affiliated with him. Plaintiffs allege
that the defendants intentionally issued false financial reports
for the Company between March 2001 and August 2001 in violation
of Sections 10(b) and 20(a) of the Securities Exchange Act
of 1934 and similar provisions of Minnesota law. The Company
currently believes that this litigation will be coordinated or
consolidated for most pre-trial purposes with the other
securities law class action matters currently pending against
the Company. This matter is at an early stage. No response to
the complaint has yet been filed, and no discovery has taken
place.

On April 26, 2002, certain former
shareholders of PEAK Software Solutions, Inc.
(PEAK), some of whom are current employees of the
Company, including a key employee of the Company, filed a
lawsuit against the Company in Colorado state court. The
complaint alleges claims for common law fraud, securities fraud
and breach of contract relating to the Companys
acquisition of PEAK in July 2000. The complaint does not specify
the damages sought. The complaint has not yet been served and no
response has been filed.

The Company intends to defend itself vigorously
against these allegations. However, the ultimate outcome of
these matters cannot presently be determined.

49



---



##### Table of Contents






ITEM 6.     EXHIBITS
AND REPORTS ON FORM 8-K.

(a) The following exhibits are filed as part
of this Form 10-Q:

|      |  |                                                                                                
|----- |  | -----------------------------------------------------------------------------------------------
|10.32 |  | Separation Agreement, dated July 30, 2001,
    by and between the registrant and Peter Bohacek.
|10.33 |  | Offer Letter, dated August 10, 2001, by and
    between the registrant and David Emerson.      

(b) Reports on Form 8-K.

On September 4, 2001, the Company filed a
Current Report on Form 8-K announcing that its previously
reported revenues for the first and second quarters of fiscal
year 2001 may have been materially overstated and that the
Company has formed a special committee to investigate a number
of transactions that place in question the Companys
historical financial results.

50



---



##### Table of Contents



CLARENT CORPORATION






SIGNATURES


Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned thereunto duly
authorized.



| |                     | 
| | ------------------- | 
| | CLARENT CORPORATION | 



| |     |                    | 
| | --- | ------------------ | 
| | By: | /s/ JOHN J. OSHEA | 

| |                                                  | 
| | ------------------------------------------------ | 
| |                                                  | 
| | John J. OShea                                   | 
| | Chief Financial Officer and
    Secretary        | 
| | (Principal Financial and Accounting
    Officer) | 

Date: May 8, 2002

51



---



##### Table of Contents



EXHIBIT INDEX

|                    |  |                                                                                                
|------------------- |  | -----------------------------------------------------------------------------------------------
|Exhibit Description
|                   
|10.32               |  | Separation Agreement, dated July 30, 2001,
    by and between the registrant and Peter Bohacek.
|10.33               |  | Offer Letter, dated August 10, 2001, by and
    between the registrant and David Emerson.