**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**AMENDMENT NO. 1 ON**

 

**FORM 10-Q/A**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended March 31,2003**

 

**Commission File Number 000-30229**

 

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**SONUSNETWORKS, INC.**

(Exact name of Registrant as specified in itscharter)

 
| **DELAWARE**                                                    | ** ** | **04-3387074**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) | ** ** | (I.R.S. employer identification no.) |
|                                                            | ** ** |                                 |
| **250 Apollo Drive, Chelmsford, Massachusetts  01824**          |
| (Address of principal executive offices,  including zip code)   |
| ** **                                                      |       |                                 |
| **(978) 614-8100**                                         |
| (Registrant’s telephone number, including  area code)      |

 

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Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the Registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes ý  No o

 

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

 

As of April 30, 2003, there were 225,193,886 shares of $0.001 parvalue per share, common stock outstanding.

 

 

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**EXPLANATORY NOTE**

 

As reported in our 2003 Annual Report on Form 10-K/A filed withthe Securities and Exchange Commission (SEC) on July 28, 2004, we haverestated our consolidated financial statements for the years ended December 31,2002 and 2001 and the nine months ended September 30, 2003.  We also reported in our 2003 Annual Report onForm 10-K/A that we anticipated amending our previously filed quarterlyreports for each of the first three quarters of 2003.  This Amendment No. 1 on Form 10-Q/Ato our Quarterly Report on Form 10-Q for the quarter ended March 31,2003, filed with the SEC on May 9, 2003, is being filed for the purpose ofrestating our condensed consolidated financial statements and relateddisclosures for the quarters ended March 31, 2003 and 2002 under Item 1 ofPart I; and restating Items 2 and 4 of Part I as well as Item 6 of Part II,consistent with the restatement-related adjustments described in our 2003Annual Report filed on Form 10-K/A with the SEC on July 28, 2004.

 

This Amendment No. 1 on Form 10-Q/Adoes not reflect events occurring after the filing of the original QuarterlyReport on Form 10-Q on May 9, 2003, or modify or update thedisclosure presented in the original Quarterly Report on Form 10-Q, exceptto reflect the revisions as described above.

 

**SONUS NETWORKS, INC.**

**AMENDMENT NO. 1 ON FORM 10-Q/A**

**QUARTER ENDED MARCH 31, 2003**

 

**TABLE OF CONTENTS**

 
| **PART I—FINANCIAL INFORMATION** |                                                                                                                  |
|--------------------------------------------|-----------------------------------------------------------------------------------------------------------------------|
|                                       |                                                                                                                  |   |
| Item 1:                                    | Financial Statements                                                                                                  |   |
|                                       | Condensed Consolidated Balance Sheets as of  March 31, 2003 (unaudited) and December 31, 2002               | 3 |
|                                       | Condensed Consolidated Statements of  Operations for the Three Months Ended March 31, 2003 and 2002  (unaudited) | 4 |
|                                       | Condensed Consolidated Statements of Cash  Flows for the Three Months Ended March 31, 2003 and 2002 (unaudited)  | 5 |
|                                       | Notes to Condensed Consolidated Financial  Statements (unaudited)                                                     | 6 |
| Item 2:                                    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           | 25 |
| Item 4:                                    | Controls  and Procedures                                                                                              | 32 |
|                                       |                                                                                                                  |   |
| **PART II—OTHER INFORMATION**    |                                                                                                                  |
|                                       |                                                                                                                  |   |
| Item 6:                                    | Exhibits  and Reports on Form 8-K                                                                                | 34 |
|                                       | Signatures                                                                                                            | 35 |

 

2

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**PART I—FINANCIALINFORMATION**

 

## **Item 1: Financial Statements**

##  

**SONUS NETWORKS, INC.**

**Condensed Consolidated Balance Sheets**

**(In thousands, except share data)**

 
| ** **                                                                                                                                                                                                       | ** ** | **March 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                                                       | ** ** | **(As Restated)**       | ** ** | ** **                 | ** ** |
| ** **                                                                                                                                                                                                       | ** ** | **(Unaudited)**         | ** ** | ** **                 | ** ** |
| **Assets**                                                                                                                                                                                                       | ** ** | ** **              | ** ** | ** **                 | ** ** |
| **Current  assets:**                                                                                                                                                                                             |       |                    |       |                       |       |
| Cash and cash equivalents                                                                                                                                                                                        |       | $                       | 45,636     |                       | $          | 57,278 |   |
| Marketable securities                                                                                                                                                                                            |       | 61,010                  |       | 60,860                     |       |
| Accounts receivable, net                                                                                                                                                                                         |       | 4,754                   |       | 4,622                      |       |
| Inventory, net                                                                                                                                                                                                   |       | 12,970                  |       | 10,449                     |       |
| Other current assets                                                                                                                                                                                             |       | 5,172                   |       | 3,516                      |       |
| Total current assets                                                                                                                                                                                             |       | 129,542                 |       | 136,725                    |       |
| **Property  and equipment,** net                                                                                                                                                                                 |       | 9,617                   |       | 11,546                     |       |
| **Purchased  intangible assets,** net                                                                                                                                                                            |       | 4,208                   |       | 4,810                      |       |
| **Other  assets**                                                                                                                                                                                                |       | 415                     |       | 436                        |       |
|                                                                                                                                                                                                             |       | $                       | 143,782    |                       | $          | 153,517 |   |
|                                                                                                                                                                                                             |       |                    |       |                       |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                    | ** ** | ** **              | ** ** | ** **                 | ** ** |
| **Current  liabilities:**                                                                                                                                                                                        |       |                    |       |                       |       |
| Accounts payable                                                                                                                                                                                                 |       | $                       | 2,706      |                       | $          | 3,625 |   |
| Accrued expenses                                                                                                                                                                                                 |       | 13,902                  |       | 16,489                     |       |
| Accrued restructuring expenses                                                                                                                                                                                   |       | 1,513                   |       | 2,331                      |       |
| Current portion of deferred revenue                                                                                                                                                                              |       | 56,105                  |       | 51,728                     |       |
| Current portion of long-term liabilities                                                                                                                                                                         |       | 1,527                   |       | 1,606                      |       |
| Total current liabilities                                                                                                                                                                                        |       | 75,753                  |       | 75,779                     |       |
| **Long-term deferred  revenue,** less  current portion                                                                                                                                                      |       | 7,263                   |       | 8,024                      |       |
| **Long-term  liabilities,** less current portion                                                                                                                                                                 |       | 2,660                   |       | 3,293                      |       |
| **Convertible  subordinated note**                                                                                                                                                                               |       | 10,000                  |       | 10,000                     |       |
| **Commitments  and contingencies**(Note 9)                                                                                                                                                                       |       |                    |       |                       |       |
| **Stockholders’  equity:**                                                                                                                                                                                  |       |                    |       |                       |       |
| Preferred stock, $0.01 par value; 5,000,000  shares authorized, none issued and outstanding                                                                                                                      |       | —                  |       | —                     |       |
| Common stock, $0.001 par value; 600,000,000  shares authorized, 207,429,547 and 206,866,358 shares issued and 205,162,737  and 204,599,548 shares outstanding at March 31, 2003 and December 31,  2002 |       | 207                     |       | 207                        |       |
| Capital in excess of par value                                                                                                                                                                                   |       | 853,961                 |       | 853,560                    |       |
| Accumulated deficit                                                                                                                                                                                              |       | (803,133                | )          | (793,426                   | )          |
| Deferred compensation                                                                                                                                                                                            |       | (2,668                  | )          | (3,659                     | )          |
| Treasury stock, at cost; 2,266,810 common  shares at March 31, 2003 and December 31, 2002                                                                                                              |       | (261                    | )          | (261                       | )          |
| Total stockholders’ equity                                                                                                                                                                                  |       | 48,106                  |       | 56,421                     |       |
|                                                                                                                                                                                                             |       | $                       | 143,782    |                       | $          | 153,517 |   |

 

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

 

3

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**SONUS NETWORKS, INC.**

**Condensed Consolidated Statements ofOperations**

**(In thousands, except per share data)**

**(Unaudited and As Restated)**

 
| ** **                                                  | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                  | ** ** | **2003**                              | ** ** | **2002** | ** ** |
|                                                        |       |                                  |       |   |   |
| **Revenues:**                                               |       |                                  |       |   |   |
| Product                                                     |       | $                                     | 3,517      |   | $ | 13,119 |   |
| Service                                                     |       | 5,692                                 |       | 7,389 |   |
| Total revenues                                              |       | 9,209                                 |       | 20,508 |   |
| **Cost of  revenues** (1):                                  |       |                                  |       |   |   |
| Product                                                     |       | 1,538                                 |       | 6,938 |   |
| Service                                                     |       | 2,555                                 |       | 2,985 |   |
| Write-off of inventory and purchase  commitments            |       | —                                |       | 6,865 |   |
| Total cost of revenues                                      |       | 4,093                                 |       | 16,788 |   |
| **Gross  profit**                                           |       | 5,116                                 |       | 3,720 |   |
| **Operating  expenses:**                                    |       |                                  |       |   |   |
| Research and development (1)                                |       | 7,705                                 |       | 14,931 |   |
| Sales and marketing (1)                                     |       | 3,971                                 |       | 7,459 |   |
| General and administrative (1)                              |       | 1,839                                 |       | 2,587 |   |
| Stock-based compensation                                    |       | 924                                   |       | 6,799 |   |
| Amortization of purchased intangible assets                 |       | 602                                   |       | 1,190 |   |
| Restructuring charges, net                                  |       | —                                |       | 4,752 |   |
| Total operating expenses                                    |       | 15,041                                |       | 37,718 |   |
| **Loss  from operations**                                   |       | (9,925                                | )          | (33,998 | ) |
| Interest expense                                            |       | (130                                  | )          | (139 | ) |
| Interest income                                             |       | 381                                   |       | 592 |   |
| **Loss before income  taxes**                               |       | (9,674                                | )          | (33,545 | ) |
| Provision for income taxes                                  |       | 33                                    |       | 22 |   |
| **Net loss**                                                |       | $                                     | (9,707     | ) | $ | (33,567 | ) |
|                                                        |       |                                  |       |   |   |
| **Basic  and diluted net loss per share**                   |       | $                                     | (0.05      | ) | $ | (0.18 | ) |
|                                                        |       |                                  |       |   |   |
| **Shares  used in computing net loss per share**(Note 3(p)) |       | 198,703                               |       | 187,173 |   |

 

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

 
| Cost of revenues           |   | $   | 12     |   | $      | 118   |   |
|----------------------------|--------|-----|--------|--------|--------|-------|--------|
| Research and development   |   | 377 |   | 3,562  |   |
| Sales and marketing        |   | 405 |   | 2,072  |   |
| General and administrative |   | 130 |   | 1,047  |   |
|                       |   | $   | 924    |   | $      | 6,799 |   |

 

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

 

4

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**SONUS NETWORKS, INC.**

**Condensed Consolidated Statements of CashFlows**

**(In thousands)**

**(Unaudited and As Restated)**

 
| ** **                                                                   | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **2003**                              | ** ** | **2002** | ** ** |
|                                                                         |       |                                  |       |   |   |
| **Cash  flows from operating activities:**                                   |       |                                  |       |   |   |
| Net loss                                                                     |       | $                                     | (9,707     | ) | $ | (33,567 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                  |       |   |   |
| Depreciation and amortization                                                |       | 2,885                                 |       | 4,113 |   |
| Write-off of inventory                                                       |       | —                                |       | 6,865 |   |
| Stock-based compensation                                                     |       | 924                                   |       | 6,799 |   |
| Amortization of purchased intangible assets                                  |       | 602                                   |       | 1,190 |   |
| Changes in current assets and liabilities:                                   |       |                                  |       |   |   |
| Accounts receivable                                                          |       | (132                                  | )          | 4,181 |   |
| Inventory                                                                    |       | (2,521                                | )          | 8,265 |   |
| Other current assets                                                         |       | (1,656                                | )          | (290 | ) |
| Accounts payable                                                             |       | (919                                  | )          | (7,717 | ) |
| Accrued expenses                                                             |       | (3,694                                | )          | (5,972 | ) |
| Deferred revenue                                                             |       | 3,616                                 |       | (857 | ) |
| Net cash used in operating activities                                        |       | (10,602                               | )          | (16,990 | ) |
| **Cash  flows from investing activities:**                                   |       |                                  |       |   |   |
| Purchases of property and equipment                                          |       | (956                                  | )          | (1,021 | ) |
| Maturities of marketable securities                                          |       | 3,647                                 |       | 10,340 |   |
| Purchases of marketable securities                                           |       | (3,797                                | )          | (2,973 | ) |
| Other assets                                                                 |       | 21                                    |       | (84 | ) |
| Net cash (used in) provided by investing  activities                         |       | (1,085                                | )          | 6,262 |   |
| **Cash  flows from financing activities:**                                   |       |                                  |       |   |   |
| Sale of common stock in connection with  employee stock purchase plan        |       | 447                                   |       | 2,304 |   |
| Proceeds from exercise of stock options                                      |       | 21                                    |       | 63 |   |
| Payments of long-term liabilities                                            |       | (423                                  | )          | (143 | ) |
| Repurchase of common stock                                                   |       | —                                |       | (94 | ) |
| Net cash provided by financing activities                                    |       | 45                                    |       | 2,130 |   |
| **Net  decrease in cash and cash equivalents**                               |       | (11,642                               | )          | (8,598 | ) |
| **Cash and  cash equivalents, beginning of period**                          |       | 57,278                                |       | 49,069 |   |
| **Cash and  cash equivalents, end of period**                                |       | $                                     | 45,636     |   | $ | 40,471 |   |
|                                                                         |       |                                  |       |   |   |
| **Supplemental  disclosure of cash flow information:**                       |       |                                  |       |   |   |
| Cash paid during the period for interest                                     |       | $                                     | 12         |   | $ | 20 |   |

 

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

 

5

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**SONUS NETWORKS, INC.**

**Notes to Condensed Consolidated FinancialStatements**

**(Unaudited)**

 

**(1) Description of Business**

 

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

 

**(2) Restatement of ConsolidatedFinancial Statements**

 

As reported in Sonus’ 2003 Annual Report on Form 10-K/A filed withthe SEC on July 28, 2004, Sonus has restated its consolidated financialstatements for the years ended December 31, 2002 and 2001 and the ninemonths ended September 30, 2003. Sonus also reported in its 2003 Annual Report on Form 10-K/A thatit anticipated amending its previously filed quarterly reports for each of thefirst three quarters of 2003.  Sonus hasfiled this Amendment No. 1 on Form 10-Q/A to its Quarterly Report on Form 10-Qfor the quarter ended March 31, 2003, filed with the SEC on May 9,2003, for the purpose of restating its condensed consolidated financialstatements and related disclosures for the quarters ended March 31, 2003and 2002. Amounts disclosed with respect to the December 31, 2002 balance sheethave previously been restated in our Form 10-K/A filed with the SEC on July 28,2004 and are not reported as restated herein.

 

6

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The following summarizes the effects of the restatement adjustments onvarious line items of Sonus’ condensed consolidated statements of operationsfor the three months ended March 31, 2003 and 2002.

 

**Condensed Consolidated Statements ofOperations**

**(In thousands, except per share data)**

**(Unaudited)**

 
| ** **                                                 | ** ** | **Three Months Ended March 31, 2003** | ** ** | **Three Months Ended March 31, 2002** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                 | ** ** | **As Reported**                            | ** ** | **Adjustments**                            | ** ** | **As Restated** | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| **Revenues:**                                              |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Product                                                    |       | $                                          | 11,127     |                                       | $          | (7,610 | ) | $ | 3,517 |   | $ | 15,387 |   | $ | (2,268 | ) | $ | 13,119 |   |
| Service                                                    |       | 4,892                                      |       | 800                                        |       | 5,692 |   | 5,771 |   | 1,618 |   | 7,389 |   |
|                                                       |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Total revenues                                             |       | 16,019                                     |       | (6,810                                     | )          | 9,209 |   | 21,158 |   | (650 | ) | 20,508 |   |
| **Cost of  revenues:**                                     |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Product                                                    |       | 3,230                                      |       | (1,692                                     | )          | 1,538 |   | 6,868 |   | 70 |   | 6,938 |   |
| Service                                                    |       | 2,935                                      |       | (380                                       | )          | 2,555 |   | 3,007 |   | (22 | ) | 2,985 |   |
| Write-off (benefit) of inventory and  purchase commitments |       | (735                                       | )          | 735                                        |       | — |   | 9,434 |   | (2,569 | ) | 6,865 |   |
|                                                       |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Total cost of revenues                                     |       | 5,430                                      |       | (1,337                                     | )          | 4,093 |   | 19,309 |   | (2,521 | ) | 16,788 |   |
|                                                       |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| **Gross  profit**                                          |       | 10,589                                     |       | (5,473                                     | )          | 5,116 |   | 1,849 |   | 1,871 |   | 3,720 |   |
| **Operating  expenses:**                                   |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Research and development                                   |       | 7,702                                      |       | 3                                          |       | 7,705 |   | 14,615 |   | 316 |   | 14,931 |   |
| Sales and marketing                                        |       | 5,274                                      |       | (1,303                                     | )          | 3,971 |   | 8,407 |   | (948 | ) | 7,459 |   |
| General and administrative                                 |       | 1,080                                      |       | 759                                        |       | 1,839 |   | 1,466 |   | 1,121 |   | 2,587 |   |
| Stock-based compensation                                   |       | 894                                        |       | 30                                         |       | 924 |   | 5,743 |   | 1,056 |   | 6,799 |   |
| Amortization of purchased intangible assets                |       | 271                                        |       | 331                                        |       | 602 |   | 406 |   | 784 |   | 1,190 |   |
| Restructuring charges (benefit), net                       |       | —                                     |       | —                                     |       | — |   | (12,141 | ) | 16,893 |   | 4,752 |   |
|                                                       |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Total operating expenses                                   |       | 15,221                                     |       | (180                                       | )          | 15,041 |   | 18,496 |   | 19,222 |   | 37,718 |   |
| ** **                                                 |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| **Loss  from operations**                                  |       | (4,632                                     | )          | (5,293                                     | )          | (9,925 | ) | (16,647 | ) | (17,351 | ) | (33,998 | ) |
| Interest expense                                           |       | (130                                       | )          | —                                     |       | (130 | ) | (139 | ) | — |   | (139 | ) |
| Interest income                                            |       | 381                                        |       | —                                     |       | 381 |   | 592 |   | — |   | 592 |   |
| **Loss  before income taxes**                              |       | (4,381                                     | )          | (5,293                                     | )          | (9,674 | ) | (16,194 | ) | (17,351 | ) | (33,545 | ) |
| Provision for income taxes                                 |       | —                                     |       | 33                                         |       | 33 |   | — |   | 22 |   | 22 |   |
| ** **                                                 |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| **Net loss**                                               |       | $                                          | (4,381     | )                                          | $          | (5,326 | ) | $ | (9,707 | ) | $ | (16,194 | ) | $ | (17,373 | ) | $ | (33,567 | ) |
|                                                       |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| **Basic  and diluted net loss per share**                  |       | $                                          | (0.02      | )                                          | $          | (0.03 | ) | $ | (0.05 | ) | $ | (0.09 | ) | $ | (0.09 | ) | $ | (0.18 | ) |
|                                                       |       |                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| **Shares  used in computing net loss per share**           |       | 198,703                                    |       | —                                     |       | 198,703 |   | 186,057 |   | 1,116 |   | 187,173 |   |

 

7

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The following summarizes the effects of the restatement adjustments onvarious line items of Sonus’ condensed consolidated balance sheet as of March 31,2003.

 

**Condensed Consolidated Balance Sheet**

**March 31, 2003**

**(In thousands)**

**(Unaudited)**

 
| ** **                                            | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
|-------------------------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| **Assets**                                            | ** ** | ** **      | ** ** | ** **      | ** ** | ** **      | ** ** |
| **Current  assets:**                                  |       |            |       |            |       |            |       |
| Cash and cash equivalents                             |       | $               | 45,226     |            | $          | 410             |       | $ | 45,636 |   |
| Marketable securities                                 |       | 61,010          |       | —          |       | 61,010          |       |
| Accounts receivable, net                              |       | 2,454           |       | 2,300           |       | 4,754           |       |
| Inventory, net                                        |       | 11,287          |       | 1,683           |       | 12,970          |       |
| Other current assets                                  |       | 4,488           |       | 684             |       | 5,172           |       |
| Total current assets                                  |       | 124,465         |       | 5,077           |       | 129,542         |       |
| **Property  and equipment,** net                      |       | 9,226           |       | 391             |       | 9,617           |       |
| **Purchased  intangible assets,** net                 |       | 903             |       | 3,305           |       | 4,208           |       |
| **Other  assets**                                     |       | 494             |       | (79             | )          | 415             |       |
|                                                  |       | $               | 135,088    |            | $          | 8,694           |       | $ | 143,782 |   |
| ** **                                            |       |            |       |            |       |            |       |
| **Liabilities and Stockholders’ Equity**         |       |            |       |            |       |            |       |
| **Current  liabilities:**                             |       |            |       |            |       |            |       |
| Accounts payable                                      |       | $               | 3,451      |            | $          | (745            | )          | $ | 2,706 |   |
| Accrued expenses                                      |       | 30,389          |       | (16,487         | )          | 13,902          |       |
| Accrued restructuring expenses                        |       | 1,513           |       | —          |       | 1,513           |       |
| Current portion of deferred revenue                   |       | 31,831          |       | 24,274          |       | 56,105          |       |
| Current portion of long-term liabilities              |       | 1,527           |       | —          |       | 1,527           |       |
|                                                  |       |            |       |            |       |            |       |
| Total current liabilities                             |       | 68,711          |       | 7,042           |       | 75,753          |       |
| **Long-term  deferred revenue,** less current portion |       | —          |       | 7,263           |       | 7,263           |       |
| **Long-term  liabilities,** less current portion      |       | 2,660           |       | —          |       | 2,660           |       |
| **Convertible  subordinated notes**                   |       | 10,000          |       | —          |       | 10,000          |       |
| **Commitments  and contingencies**                    |       |            |       |            |       |            |       |
| **Stockholders’  equity:**                       |       |            |       |            |       |            |       |
| Preferred stock                                       |       | —          |       | —          |       | —          |       |
| Common stock                                          |       | 207             |       | —          |       | 207             |       |
| Capital in excess of par value                        |       | 858,514         |       | (4,553          | )          | 853,961         |       |
| Accumulated deficit                                   |       | (802,249        | )          | (884            | )          | (803,133        | )          |
| Deferred compensation                                 |       | (2,494          | )          | (174            | )          | (2,668          | )          |
| Treasury stock, at cost                               |       | (261            | )          | —          |       | (261            | )          |
| Total stockholders’ equity                       |       | 53,717          |       | (5,611          | )          | 48,106          |       |
|                                                  |       | $               | 135,088    |            | $          | 8,694           |       | $ | 143,782 |   |

 

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

 

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***Revenue Adjustments***

 

*Deferral of product revenue*

 

Sonus has deferred revenues of $36.7 million previously reportedin 2001 and the first quarter of 2002 from a particular customer transaction.The amount of $27.5 million was subsequently recognized in the secondquarter of 2002, while the remainder was allocated to maintenance revenue andrecognized over the period the services are provided. This transaction involveda complex multiple element arrangement that required significant analysis withrespect to the facts surrounding the transaction and technical accountinganalysis to determine when revenue should be recognized. Sonus previouslyrecognized revenue in 2001 under this contractual arrangement upon delivery andacceptance of certain product and software releases. As a result of acomprehensive review and analysis of this arrangement, and based on theapplication of complex revenue recognition guidance, Sonus has now determinedthat there was insufficient support to establish vendor specific objectiveevidence of fair value (VSOE) with respect to certain undelivered softwarereleases and Sonus has determined the existence of certain previouslyunidentified specified software releases. As a result, Sonus has deferredproduct revenues associated with products and software releases shipped to thiscustomer in 2001 and the first quarter of 2002 until the second quarter of2002, when all software releases under the arrangement were delivered.

 

In the fourth quarter of 2002, Sonus amended its arrangement with thiscustomer to include, among other items, certain additional future softwarereleases. Sonus previously recognized revenue from this arrangement in thefourth quarter of 2002 and in each of the first three quarters of 2003 upon deliveryof the products and software releases. Upon review and analysis of thearrangement, Sonus has determined that, based on a technical analysis ofsoftware revenue recognition rules, that VSOE was not established for certainundelivered software releases. As a result, Sonus has deferred revenues of$16.2 million associated with products and software releases shipped tothis customer during the fourth quarter of 2002 and the first three quarters of2003, including the deferral of $6.1 million of products and software releasesshipped during the first quarter of 2003. Sonus recognized $10.9 millionof those revenues in the fourth quarter of 2003 when the final software releasespecified in the amendment was delivered to the customer, and the remainingamount was deferred and allocated to maintenance services and estimateddiscounts on future purchases.

 

*Maintenance revenue*

 

A number of Sonus’ customer transactions involve multiple elements,including the delivery of product and maintenance services as part of a bundledoffering. Statement of Position (SOP) 97-2, *SoftwareRevenue Recognition*, requires maintenance revenue to be recognizedover the period services are provided. Based on Sonus’ review and analysis,Sonus identified certain circumstances in which it offered maintenance servicesat no additional charge or at discounted rates to certain customers but did notseparate the fair value for the maintenance from product revenue. This resultedin revenue associated with the value of the undelivered maintenance servicesnot being recognized over the service period. In the restated financialstatements, Sonus has recognized maintenance revenue ratably over the period inwhich the maintenance services were provided based on the deferral of theapplicable VSOE of maintenance services. In such cases, Sonus has reclassifiedmaintenance services from product revenue to service revenue for the applicableperiods presented. Based on Sonus’ review and analysis, Sonus also identifiedcertain circumstances in which insufficient value was allocated to maintenance.In such cases, Sonus has reclassified additional amounts from product revenueto service revenue for the applicable periods presented. In connection with therecognition of the deferred product revenue described above in the secondquarter of 2002 and the fourth quarter of 2003, a significant portion of theproduct revenue was allocated to the value of undelivered maintenance servicesand deferred over the five-year period in which the maintenance services areprovided.

 

*Delivery*

 

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

 

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delivered product.

 

*Customer acceptance*

 

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

 

*Summary*

 

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

 
| ** **                            | ** ** | **Three months ended  March 31, 2003** | ** ** | **Three months ended  March 31, 2002** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Revenues, as previously reported      |       | $                                           | 16,019     |                                        | $          | 21,158 |   |
| Revenue Restatement Adjustments:      |       |                                        |       |                                        |       |
| Deferral of product revenue           |       | (6,095                                      | )          | (3,415                                      | )          |
| Maintenance revenue                   |       | 651                                         |       | (1,684                                      | )          |
| Delivery                              |       | (311                                        | )          | 955                                         |       |
| Customer acceptance                   |       | (1,065                                      | )          | 2,761                                       |       |
| Other                                 |       | 10                                          |       | 733                                         |       |
| Total Revenue Restatement Adjustments |       | (6,810                                      | )          | (650                                        | )          |
| Revenues, as restated                 |       | $                                           | 9,209      |                                        | $          | 20,508 |   |

 

***Expense Adjustments***

 

*Accrued expenses*

 

During Sonus’ review and analysis, Sonus identified several accruedexpense accounts that required adjustment to be in accordance with Statement ofFinancial Accounting Standards (SFAS) No. 5, *Accounting for Contingencies*. Accounting for accruedexpenses requires estimates and judgments, which can be complex. Sonus adjustedaccrual balances as the result of: (1) using more appropriate businessassumptions to estimate certain liabilities, such as warranty reserves and post-shipmentobligations to customers; (2) in those instances lacking availablefoundation or support for recorded balances at the time the original accrualwas established, using currently known information, including actualdisbursements and contemporaneous documentation in order to record theappropriate balances, such as royalties and professional fees; and (3) appropriatelyclassifying certain balance sheet items, such as customer deposits to deferredrevenues.

 

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

 
| ** **                                                 | ** ** | **March 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Accrued expense adjustments—increase/(decrease)  for: |       |                    |       |                       |       |
| Employee compensation and related costs                    |       | $                       | (968       | )                          | $          | 208 |   |
| Professional fees                                          |       | (1,443                  | )          | (1,239                     | )          |
| Royalties                                                  |       | 1,634                   |       | 1,492                      |       |
| Warranty reserve                                           |       | (3,274                  | )          | (3,385                     | )          |
| Post-shipment obligations to customers                     |       | (2,527                  | )          | (2,527                     | )          |
| Customer deposits                                          |       | (7,058                  | )          | (7,240                     | )          |
| Other                                                      |       | (2,851                  | )          | (4,199                     | )          |
| Total accrued expense adjustments                          |       | $                       | (16,487    | )                          | $          | (16,890 | ) |

 

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*Restructuring expense and benefits*

 

In connection with Sonus’ review and analysis, Sonus determined that arestructuring benefit of $16,557,000 for a lease renegotiation originallyrecorded in the first quarter of 2002 should have been recorded in 2001.  In addition, Sonus increased 2002 expenses by$336,000. The effect of these adjustments was to adjust the restructuring itemfrom a benefit of $12,141,000 to an expense of $4,752,000 in the three monthsended March 31, 2002.

 

***Valuation ofIntangibles***

 

During 2001, Sonus acquired two companies, telecomtechnologies, inc. (TTI) and Linguateq, Inc. (Linguateq). Sonusaccounted for the TTI acquisition as a purchase in accordance with AccountingPrinciples Board (APB) No. 16, *BusinessCombinations,* and for Linguateq as a purchase in accordance withSFAS No. 141, *Business Combinations*.As part of Sonus’ re-examination of these acquisitions, Sonus hired anindependent third party appraiser. In connection with the TTI acquisition re-appraisal,Sonus has re-examained the total consideration paid, net liabilities assumed,and certain assumptions and calculations supporting the original appraisal ofthe identified intangible assets acquired from TTI. These assumptions includedthe customer turnover rate, the gross and operating margin percentages andinconsistencies in the profit assumptions used to value in-process research anddevelopment compared to other identified intangible assets. The results ofthese changes to the purchase price and related allocation for the TTIacquisition are as follows, in thousands:

 
| **Purchase  Price of TTI**         | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
|------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| Fair market value of shares issued |       | $               | 527,613    |            | $          | (612            | )          | $ | 527,001 |   |
| Liabilities assumed                |       | 21,184          |       | (1,375          | )          | 19,809          |       |
| Acquisition expenses               |       | 5,833           |       | (67             | )          | 5,766           |       |
| Total                              |       | $               | 554,630    |            | $          | (2,054          | )          | $ | 552,576 |   |

 

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

 
| **Purchase  Price Allocation of TTI**                    | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
|----------------------------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| Tangible assets                                          |       | $               | 8,296      |            | $          | 1,096           |       | $ | 9,392 |   |
| Intangible assets:                                       |       |            |       |            |       |            |       |
| Workforce                                                |       | 3,000           |       | 3,900           |       | 6,900           |       |
| Developed technology                                     |       | 11,900          |       | 2,100           |       | 14,000          |       |
| Customer relationships                                   |       | 17,400          |       | 6,800           |       | 24,200          |       |
| In-process research and development                      |       | 40,000          |       | 800             |       | 40,800          |       |
| Deferred compensation related to unvested  stock options |       | 22,600          |       | —          |       | 22,600          |       |
| Goodwill                                                 |       | 451,434         |       | (16,750         | )          | 434,684         |       |
| Total                                                    |       | $               | 554,630    |            | $          | (2,054          | )          | $ | 552,576 |   |

 

In connection with the revised appraisals, Sonus has determined thatthe useful life of the TTI customer relationships and goodwill should be fiveyears, compared to three years as previously reported. The impact toamortization expense as a result of the change in estimated useful lives andvaluation of intangibles was an increase of $331,000 and $784,000 for the threemonths ended March 31, 2003 and March 31, 2002.

 

***Stock-basedCompensation***

 

Sonus identified items in the calculation of stock-based compensationand related items that required adjustments to the stockholders’ equity section ofits balance sheet, and stock-based compensation expense. These items pertain toerrors involving the amortization and recapture of deferred compensation, the2002 exchange of outstanding employee stock options, and intrinsic valuecharges for restricted stock and stock options grants and modifications.

 

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Sonus previously adopted the accelerated method of amortizing alldeferred compensation defined under Financial Accounting Standards Board (FASB)Financial Interpretation No. (FIN) 28, *Accountingfor Stock Appreciation Rights and Other Variable Stock Option or Award Plans*.In the event of forfeiture of a stock-based award, FIN 44, *Accounting for Certain Transactions involving StockCompensation, an interpretation of APB Opinion No. 25*, requiresthat compensation expense be adjusted to recapture the compensation expensepreviously recorded related to unvested stock-based awards, in the period offorfeiture. Sonus previously had not recorded recapture of any such excesscompensation expense upon the forfeiture of a stock-based award upon employeetermination. As a result, Sonus has decreased stock-based compensation by$50,000 for the three months ended March 31, 2003 and $523,000 for thethree months ended March 31, 2002, in these restated financial statements,which includes the recapture of excess compensation expense related to theitems discussed in the following two paragraphs.

 

Sonus also determined that option grants made to certain newly hiredemployees had intrinsic value on the start date of the new employee. AccountingPrinciples Board (APB) Opinion No. 25, *Accountingfor Stock Issued to Employees,* requires that such intrinsic value berecorded as deferred stock-based compensation and amortized over the vestingperiod. Previously, Sonus had not recorded any deferred stock-basedcompensation expense for these grants, and Sonus is now recording an adjustmentof $1,215,000 to deferred compensation and additional paid-in-capital in 2001.As a result and under our policy of amortization under FIN 28, Sonus hasincreased stock-based compensation expense by $29,000 for the three monthsended March 31, 2003 and $146,000 for the three months ended March 31,2002, in these restated financial statements.

 

Sonus recorded employee deferred stock-based compensation prior to itsinitial public offering and in connection with its acquisition of TTI, andestablished a policy to amortize these amounts on an accelerated method underFIN 28. Sonus determined as a result of its review and analysis that the deferredstock-based compensation related to one category of employees was incorrectlyamortized using the straight-line method and has made adjustments toconsistently apply the FIN 28 method. As a result, Sonus increased stock-basedcompensation by $35,000 for the three months ended March 31, 2003 anddecreased such compensation by $57,000 for the three months ended March 31,2002, in these restated financial statements.

 

Sonus has determined that it improperly calculated deferred stock-basedcompensation and the related amortization associated with the restricted stockissued under the TTI Retention Plan. As a result, Sonus has recorded anincrease to stock-based compensation expense for the three months ended March 31,2003 of $16,000 and an increase for the three months ended March 31, 2002of $1,459,000 to reflect the amortization of deferred stock-based compensationthat should have been recorded.

 

Sonus also determined that it improperly calculated stock-basedcompensation expense for any intrinsic value associated with the modificationof certain stock options and restricted stock to accelerate the vesting of aportion or all of these awards in connection with certain employeeterminations. These adjustments resulted in increases in stock-basedcompensation expense of $31,000 for the three months ended March 31, 2002.

 

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

 
| ** **                                                                             | ** ** | **Three months ended  March 31, 2003** | ** ** | **Three months ended  March 31, 2002** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| Stock-based Compensation Adjustments—increase/(decrease)  for:                    |       |                                        |       |                                        |       |
| Recapture of compensation expense in  connection with employee terminations            |       | $                                           | (50        | )                                           | $          | (523 | ) |
| Amortization related to the intrinsic value  of options granted to new employees       |       | 29                                          |       | 146                                         |       |
| Adjusted amortization under accelerated  method prescribed by FIN 28              |       | 35                                          |       | (57                                         | )          |
| Amortization related to restricted stock  issued in connection with TTI Retention Plan |       | 16                                          |       | 1,459                                       |       |
| Charge for modification in connection with  employee terminations                      |       | —                                      |       | 31                                          |       |
| Total Stock-based Compensation Restatement  Adjustments                                |       | $                                           | 30         |                                        | $          | 1,056 |   |

 

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As described in Note 3 (l) to Sonus’ condensed consolidatedfinancial statements, Sonus calculated the fair value of its stock options andthe options under its employee stock purchase plan for disclosure purposes asrequired under SFAS No. 123, *Accountingfor Stock-Based Compensation.*These calculations depend, among otherfactors, on the characteristics of Sonus’ 2000 Employee Stock Purchase Plan(ESPP) and options with intrinsic value at the grant date. Sonus’ calculationdid not properly consider these two items.

 

***Inventory Reserves***

 

As of March 31, 2003 and March 31, 2002 Sonus’ originallyreported excess, obsolete and evaluation reserve balances were $17,904,000 and$17,130,000. Sonus has determined that its excess, obsolete and evaluationreserve balances were not consistently calculated and, as a result of itsreview of its reserves and consideration of contemporaneous facts andcircumstances, Sonus reduced its reserves and reduced cost of product revenuesby $803,000 and $192,000 as of and for the three months ended March 31,2003 and 2002.

 

***Other Balance SheetAdjustments***

 

Sonus identified certain customer checks received by it prior to theend of fiscal year 2002 and the quarter ended March 31, 2003, which weredeposited after the reporting period and not recorded in the period received.Accordingly, Sonus has increased its cash and cash equivalents and deferredrevenue balances by $410,000 and $6,971,000 as of March 31, 2003 and December 31,2002.

 

Sonus previously did not record deferred revenue for product shipmentsand related services for which customers had been invoiced but for which norevenue was recognized and for which payment had not been collected. In thisrestatement, customer billings for which Sonus has a contractual right toinvoice and collectibility is probable have been recorded as accountsreceivable on the balance sheet, with a corresponding increase to deferredrevenue. Accounts receivable and deferred revenue have increased by $1,938,000and $90,000 at March 31, 2003 and December 31, 2002.

 

Sonus previously reported customer deposits as accrued liabilities. Inconnection with Sonus’ review and analysis, Sonus has determined that it shouldreport customer deposits as deferred revenue rather than accrued expenses.Accordingly, deferred revenue has increased and accrued liabilities havedecreased by $7,058,000 and $7,240,000 as of March 31, 2003 and December 31,2002.

 

***Other Statement ofOperations Adjustments***

 

As described in Note 3 (p) to Sonus’ condensed consolidated financialstatements, Sonus calculated the weighted average common shares outstandingutilized in the determination of loss per share in accordance with the treasurystock method as required under SFAS No. 148, *Earnings Per Share*. Sonus’ calculation did not properlyconsider certain activity and, accordingly, Sonus has modified the weightedaverage common shares outstanding for the three months ended March 31,2002.

 

**(3) Summary of Significant AccountingPolicies**

 

The accompanying condensed consolidated financial statements reflectthe application of certain significant accounting policies as described in thisnote and elsewhere in the accompanying condensed consolidated financialstatements and notes.

 

***(a) Basis ofPresentation and Principles of Consolidation***

 

The accompanying unaudited condensed consolidated financial statementshave been prepared by Sonus and reflect all adjustments, consisting only ofnormal recurring adjustments that in the opinion of management are necessaryfor a fair

 

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statement of the results for the interim periods. The unauditedcondensed consolidated financial statements have been prepared in accordancewith the regulations of the Securities and Exchange Commission (SEC), and omitor condense certain information and footnote disclosures pursuant to existingSEC rules and regulations. Results for the interim period are notnecessarily indicative of results to be expected for any other interim periodor the entire fiscal year. These statements should be read in conjunction withthe consolidated financial statements and related notes included in Sonus’ AnnualReport on Form 10-K/A for the year ended December 31, 2003 filed withthe SEC on July 28, 2004.

 

The accompanying condensed consolidated financial statements includethe accounts of Sonus and its wholly owned subsidiaries. All materialintercompany transactions and balances have been eliminated.

 

***(b) Use ofEstimates and Judgments***

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting periods. Significant estimates relied upon in preparing thesefinancial statements include revenue recognition for multiple elementarrangements, allowances for doubtful accounts, estimated fair value ofinvestments, including whether any decline in such fair value isother-than-temporary, expected future cash flows used to evaluate therecoverability of long-lived assets, estimated fair values of long-lived assetsused to record impairment charges related to intangible assets, restructuringand other related charges, contingencies associated with revenue contracts,contingent liabilities, and recoverability of Sonus’ net deferred tax assetsand related valuation allowance. Although Sonus regularly assesses theseestimates, actual results could differ materially from these estimates. Changesin estimates are recorded in the period in which they become known. Sonus basesits estimates on historical experience and various other assumptions that itbelieves to be reasonable under the circumstances. Actual results may differfrom Sonus’ estimates if past experience or other assumptions do not turn outto be substantially accurate.

 

***(c) CashEquivalents and Marketable Securities***

 

Cash equivalents are stated at cost plus accrued interest, whichapproximates market value, and have maturities of three months or less at thedate of purchase.

 

Marketable securities are classified as held-to-maturity, as Sonus hasthe intent and ability to hold to maturity. Marketable securities are reportedat amortized cost. Cash equivalents and marketable securities are invested inhigh-quality credit instruments, primarily U.S. Government obligations andcorporate obligations.  Currentmarketable securities have remaining contractual maturities of less than oneyear as of the balance sheet date. There have been no material gains or losses todate.

 

***(d) Concentrationsof Credit and Off-Balance Sheet Risk, Significant Customers and LimitedSuppliers***

 

The financial instruments that potentially subject Sonus toconcentrations of credit risk are cash, cash equivalents, marketable securitiesand accounts receivables. Sonus has no off-balance sheet concentrations such asforeign exchange contracts, options contracts or other foreign hedgingarrangements. Sonus’ cash and cash equivalent holdings are diversified amongfour financial institutions.

 

For the three months ended March 31, 2003 and 2002, two and fourcustomers each contributed 10% or more of Sonus’ revenues, representing anaggregate of 40% and 60% of total revenues. The following customers contributed10% or more of Sonus’ revenues in the three months ended March 31, 2003and 2002:

 
| ** **                     | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|
| **Customer:**                  | ** ** | **2003**                              | ** ** | **2002** | ** ** |
| ** **                     | ** ** | **(As Restated)**                     | ** ** | **(As Restated)** | ** ** |
| Global Crossing                |       | 29                                    | %          | 10 | % |
| Nissho Electronics Corporation |       | 11                                    |       | * |   |
| IDT Corporation                |       | *                                     |       | 12 |   |
| XO Communications              |       | *                                     |       | 12 |   |
| Touch America                  |       | *                                     |       | 26 |   |

 

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*                                         Representsless than 10% of revenues.

 

As of March 31, 2003 and December 31, 2002, three and threecustomers each accounted for more than 10% of Sonus’ accounts receivable balance,representing an aggregate of 76% and 78% of the total accounts receivable.Sonus performs ongoing credit evaluations of its customers and generally doesnot require collateral on accounts receivable. Sonus maintains allowances for potential credit losses and such losseshave been within management’s expectations.

 

International revenues, primarily attributable to Asia and Europe, were26% and 24% of total revenues for the three months ended March 31, 2003and 2002.

 

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

 

***(e) AccountsReceivable***

 

Accounts receivable consist of the following, in thousands:

 
| ** **                      | ** ** | **March 31,  2003** | ** ** | **December 31,  2002** | ** ** |
|---------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **(As Restated)**        | ** ** | ** **                  | ** ** |
| Earned accounts receivable      |       | $                        | 2,959      |                        | $          | 4,873 |   |
| Unearned accounts receivable    |       | 1,938                    |       | 90                          |       |
| Accounts receivable, gross      |       | 4,897                    |       | 4,963                       |       |
| Allowance for doubtful accounts |       | (143                     | )          | (341                        | )          |
| Accounts receivable, net        |       | $                        | 4,754      |                        | $          | 4,622 |   |

 

Unearned accounts receivable represent products shipped to customerswhere Sonus has a contractual right to bill the customer and collectibility isprobable prior to satisfying Sonus’ revenue recognition criteria. The allowancefor doubtful accounts is based on Sonus’ detailed assessment of thecollectibility of specific customer accounts.

 

***(f) Inventory***

 

Inventory consists of the following, in thousands:

 
| ** **                                             | ** ** | **March 31,  2003** | ** ** | **December 31,  2002** | ** ** |
|--------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **(As Restated)**        | ** ** | ** **                  | ** ** |
| On-hand final assemblies and finished goods  inventory |       | $                        | 16,072     |                        | $          | 12,292 |   |
| Unearned inventory                                     |       | 10,704                   |       | 10,441                      |       |
| Evaluation inventory                                   |       | 3,295                    |       | 6,022                       |       |
| Inventory, gross                                       |       | 30,071                   |       | 28,755                      |       |
| Excess, obsolete and evaluation reserve                |       | (17,101                  | )          | (18,306                     | )          |
| Inventory, net                                         |       | $                        | 12,970     |                        | $          | 10,449 |   |

 

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

 

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

 

***(g) Propertyand Equipment***

 

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

 

***(h) PurchasedIntangible Assets***

 

Purchased intangible assets of $4,208,000 as of March 31, 2003 and$4,810,000 as of December 31, 2002 are carried at cost less accumulatedamortization. Amortization is computed over the estimated useful lives of therespective assets. Sonus expects that the remaining amount of purchasedintangible assets will be fully amortized by December 2004.

 

***(i) DeferredRevenue***

 

Deferred revenue consists of the following, in thousands:

 
| ** **                        | ** ** | **March 31,  2003** | ** ** | **December 31,  2002** | ** ** |
|-----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(As Restated)**        | ** ** | ** **                  | ** ** |
| Maintenance and support contracts |       | $                        | 23,953     |                        | $          | 24,832 |   |
| Customer deposits                 |       | 37,477                   |       | 34,830                      |       |
| Unearned revenue                  |       | 1,938                    |       | 90                          |       |
| Total deferred revenue            |       | 63,368                   |       | 59,752                      |       |
| Less current portion              |       | (56,105                  | )          | (51,728                     | )          |
|                              |       | $                        | 7,263      |                        | $          | 8,024 |   |

 

Maintenance and support contracts are recognized ratably over the lifeof the service contract. Customer deposits represent payments received inadvance of revenue recognition. Unearned revenue represents billings for whichpayment has not been received and revenue recognition criteria have not beenmet.

 

***(j) RevenueRecognition***

 

Sonus recognizes revenue from product sales when persuasive evidence ofan arrangement exists, delivery has occurred, the sales price is fixed ordeterminable and collectibility of the related receivable is probable underordinary payment terms. When Sonus has future obligations, including a requirementto deliver additional elements which are essential to the functionality of thedelivered elements or for which vendor specific objective evidence of fairvalue (VSOE) does not exist or customer acceptance is required, Sonus defersrevenue recognition and related costs until those obligations are satisfied.The ordering pattern and sales lead times associated with customer orders mayvary significantly from period to period.

 

Many of Sonus’ sales are generated from complex contractualarrangements which require significant revenue recognition judgments,particularly in the case of multiple element arrangements. When a sale involvesmultiple elements, such as products, maintenance or professional services,Sonus allocates the entire sales price to each respective

 

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element based on VSOE or using the residual method when VSOE cannot beestablished for a single delivered element in the arrangement. Sonus thenrecognizes revenue on each element in accordance with its policies for revenuerecognition related to each element. Sonus determines VSOE based upon the pricecharged when the same element is sold separately. If Sonus cannot establishVSOE for each undelivered element, it defers revenue recognition on the entirearrangement until the earlier of the establishment of VSOE or delivery of theundelivered element.

 

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

 

Maintenance and support services are recognized ratably over the lifeof the maintenance and support service period, which typically is one year whenthe services are sold separately and up to five years when the fees for theservices are bundled with the product fees as part of a multiple elementarrangement. Maintenance and support services include telephone support andunspecified rights to product upgrades and enhancements. Maintenance andsupport VSOE represents a consistent percentage of the sales prices charged tocustomers. The application of judgment could affect the continued determinationof maintenance and support VSOE and Sonus’ ability to recognize revenue usingthe residual method.

 

Installation service revenues are generally recognized at the time ofthe related product revenue recognition as installation is typically completeby such time. Professional services are typically recognized as the servicesare performed.

 

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

 

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

 

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

 

***(k) SoftwareDevelopment Costs***

 

Sonus accounts for its software development costs in accordance withStatement of Financial Accounting Standards (SFAS) No. 86, *Accounting for the Costs of Computer Software to BeSold, Leased or Otherwise Marketed*. Accordingly, the costs for thedevelopment of new software and substantial enhancements to existing softwareare expensed as incurred until technological feasibility has been established,at which time any additional costs would be capitalized. Sonus has determinedthat technological feasibility is established at the time a working model ofthe software is completed. Because Sonus believes its current process fordeveloping software is essentially completed concurrently with theestablishment of technological feasibility, no costs have been capitalized todate.

 

***(l) Stock-BasedCompensation***

 

SFAS No. 123, *Accounting forStock-Based Compensation*. SFAS No. 123 provides that companiesmay account for stock-based compensation under either the fair value-basedmethod of accounting under SFAS No. 123 or the intrinsic value-basedmethod provided by Accounting Principles Board (APB) No. 25, *Accounting for Stock Issued to Employees*.Sonus uses the intrinsic value-based method of APB No. 25 to account forall of its employee stock-based compensation

 

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plans and uses the fair value method of SFAS No. 123 to accountfor all non-employee stock-based compensation. Sonus follows FASBInterpretation (FIN) No. 28, *Accountingfor Stock Appreciation Rights and Other Variable Stock Option or Award Plans*and amortizes the intrinsic value for all awards as measured under APB No. 25on an accelerated basis. SFAS No. 123, as amended by SFAS No. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure—an amendment of FASB Statement No. 123*, requirescompanies following APB No. 25 to make pro forma disclosure in the notesto the financial statements using the measurement provisions of SFAS No. 123.

 

Sonus has computed the pro forma disclosures required under SFAS No. 123for stock options granted to employees and shares purchased under the 2000Employee Stock Purchase Plan (ESPP) using the Black-Scholes option-pricingmodel. In valuing the stock options granted, Sonus used an assumed risk-freeinterest rate of 3% for the three months ended March 31, 2003 and 2002;volatility of 137% for the three months ended March 31, 2003, and 150% forthe three months ended March 31, 2002; and an expected life of four tofive and three to five years for the three months ended March 31, 2003 and2002, with the assumption that dividends will not be paid. In valuing the ESPP,Sonus used an assumed risk-free interest rate of 1.2 - 4.7% for the threemonths ended March 31, 2003, and of 1.9 – 6.8% for the three months ended March 31,2002; volatility of 137-150% for the three months ended March 31, 2003,and 80-150% for the three months ended March 31, 2002; and an expectedlife ranging from six months to two years, with the assumption that dividendswill not be paid. The pro forma information is as follows (in thousands, exceptper share data):

 
| ** **                                                                                                            | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| ** **                                                                                                            | ** ** | **(As Restated)**                      | ** ** | **(As Restated)** | ** ** |
| **Net  loss—**                                                                                                   |       |                                   |       |   |   |
| As reported                                                                                                           |       | $                                      | (9,707     | ) | $ | (33,567 | ) |
| Plus: Employee stock-based compensation  expense included in net loss under intrinsic value method related to options |       | 817                                    |       | 6,280 |   |
| Less: Employee stock-based compensation  under fair value method                                                      |       | (9,750                                 | )          | (11,963 | ) |
| Pro forma                                                                                                             |       | $                                      | (18,640    | ) | $ | (39,250 | ) |
| ** **                                                                                                            |       |                                   |       |   |   |
| **Basic  and diluted net loss per share—**                                                                       |       |                                   |       |   |   |
| As reported                                                                                                           |       | $                                      | (0.05      | ) | $ | (0.18 | ) |
| Pro forma                                                                                                             |       | $                                      | (0.09      | ) | $ | (0.21 | ) |

 

***(m) ComprehensiveLoss***

 

Sonus applies SFAS No. 130, *ReportingComprehensive Income*. The comprehensive net loss for the threemonths ended March 31, 2003 and 2002 does not differ from the reportedloss.

 

***(n) Fair Value ofFinancial Instruments***

 

The carrying amounts of Sonus’ financial instruments, which includecash equivalents, marketable securities, accounts payable, long-termliabilities and the convertible subordinated note, approximate their fairvalue.

 

***(o) Disclosuresabout Segments of an Enterprise***

 

SFAS No. 131, *Disclosures aboutSegments of an Enterprise and Related Information*, establishedstandards for reporting information regarding operating segments andestablished standards for related disclosures about products and services andgeographic areas. Operating segments are identified as components of anenterprise about which separate discrete financial information is available forevaluation by the chief operating decision maker in making decisions regardingresource allocation and assessing performance. To date, the chief operatingdecision maker has made such decisions and assessed performance at the companylevel.

 

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***(p) Net Loss PerShare***

 

Basic net loss per share is computed by dividing the net loss for theperiod by the weighted average number of shares of unrestricted common stockoutstanding during the period. Diluted net loss per share is computed bydividing the net loss for the period by the weighted average number of sharesof unrestricted common stock and dilutive potential common shares outstandingbased on the average market price of Sonus’ common stock (under the treasurystock method). Dilutive potential common shares consist of restricted commonstock and common stock issuable upon the exercise of stock options andconversion of a convertible subordinated note. There were no dilutive shares of potential common stock for the threemonths ended March 31, 2003 and 2002 as Sonus incurred a net loss in eachperiod.

 

The following table sets forth the computation of shares used incalculating the basic and diluted net loss per share, in thousands:

 
| ** **                                                  | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                  | ** ** | **2003**                               | ** ** | **2002** | ** ** |
| ** **                                                  | ** ** | **(As Restated)**                      | ** ** | **(As Restated)** | ** ** |
| Weighted average common shares outstanding                  |       | 204,953                                |       | 203,341 |   |
| Less weighted average restricted common  shares outstanding |       | (6,250                                 | )          | (16,168 | ) |
| Shares used in basic and diluted net loss  per share        |       | 198,703                                |       | 187,173 |   |

 

Excluded from the shares used in calculating the net loss per share inthe above table are options to purchase shares of common stock and shares ofcommon stock issuable upon conversion of a convertible subordinated noterepresenting an aggregate of 10,725,125 and 22,793,172 shares as of March 31,2003 and 2002, as their effects would have been anti-dilutive.

 

***(q) RecentAccounting Pronouncements***

 

In June 2002, the FASB issued SFAS No. 146, *Accounting for Costs Associated with Exit or DisposalActivities*. SFAS No. 146 addresses the recognition, measurementand reporting of costs associated with exit and disposal activities, includingrestructuring activities that were accounted for in accordance with EmergingIssues Task Force Issue No. 94-3, *LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring*).The scope of SFAS No. 146 includes costs related to terminating a contractthat is not a capital lease, costs to consolidate facilities or relocateemployees, and certain termination benefits provided to employees who areinvoluntarily terminated. SFAS No. 146 is effective for exit or disposalactivities initiated after December 31, 2002. The implementation of thisstatement did not have a material impact on its financial position or resultsof operations.

 

In November 2002, the FASB issued Interpretation No. 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*(FIN No. 45). FIN No. 45 elaborates on the disclosures to be made bya guarantor in its interim and annual financial statements about itsobligations under certain guarantees that it has issued. It also clarifies thata guarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee. The initial recognition and initial measurement provisions of theinterpretation are applicable on a prospective basis to guarantees issued ormodified after December 31, 2002 and the disclosure requirements in thisinterpretation are effective for financial statements of interim or annualperiods ending after December 15, 2002. The FIN No. 45 disclosurerequirements are included in Note 5 to Sonus’ unaudited condensedconsolidated financial statements. The adoption of FIN No. 45 did not havea material impact on Sonus’ financial position or results of operations.

 

In December 2002, the FASB issued SFAS No. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure,* an amendment of SFAS No. 123. SFAS No. 148provides alternative methods of transition for a voluntary change to the fairvalue-based method of accounting for employee stock-based compensation. Thesealternative methods will only impact Sonus if it voluntarily changes to thefair value-based method of accounting for employee stock-based

 

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compensation. SFAS No. 148 also requires companies who account foremployee stock-based compensation under the intrinsic value-based method todisclose additional footnote information in annual financial statements effectivefor fiscal years ending after December 15, 2002 and in financialstatements for interim periods beginning after December 15, 2002. Therequisite disclosure appears in Note 3(l) to Sonus’ unaudited condensedconsolidated financial statements.

 

In January 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities*(FIN No. 46) to clarify the conditions under which assets, liabilities andactivities of another entity should be consolidated into the financialstatements of a company. FIN No. 46 requires the consolidation of avariable interest entity by a company that bears the majority of the risk ofloss from the variable interest entity’s activities, is entitled to receive amajority of the variable interest entity’s residual returns or both. Sonus doesnot have any variable interest entities.

 

***(r) Warranty Reserve***

 

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

 

In addition, certain of Sonus’ customer contracts include provisionsunder which Sonus may be obligated to pay penalties generally for thecontractual period or for the life of the product if its products fail or donot perform in accordance with specifications. Sonus accrues for suchcontingent obligations when the occurrence of such obligation is probable andthe amount of such obligation is reasonably estimable. Sonus has not incurredsignificant costs related to such provisions. Sonus periodically assesses theadequacy of its recorded warranty liabilities and adjusts the amounts asnecessary. Increases in product failures rates, material usage or servicedelivery costs may result in increases to Sonus’ warranty reserve and its grossprofit could be adversely affected.

 

**(4) Restructuring Charges**

 

Commencing in the third quarter of fiscal 2001 and extending throughfiscal 2002, in response to unfavorable business conditions primarily caused bysignificant declines in capital spending by telecommunications serviceproviders, Sonus implemented restructuring plans designed to reduce expensesand align its cost structure with its revised business outlook. Therestructuring plans included worldwide workforce reductions, consolidation ofexcess facilities and the write-off of excess inventory and purchasecommitments.

 

**2002 Restructuring Accrual**

 

The following table summarizes the activity during the three monthsended March 31, 2003 relating to Sonus’ accrual for fiscal 2002restructuring actions, in thousands:

 
| ** **                        | ** ** | **December 31,  2002  Accrual  Balance** | ** ** | **Cash  Payments** | ** ** | **March 31, 2003  Accrual Balance** | ** ** | **Current  Portion** | ** ** | **Long-term  Portion** | ** ** |
|-----------------------------------|------------|-----------------------------------------------|------------|--------------------|------------|------------------------------------------|------------|----------------------|------------|------------------------|------------|
|                              |       |                                          |       |               |       | **(As Restated)**                        |       |                 |       |                   |       |
|                              |       |                                          |       |               |       | ** **                               |       |                 |       |                   |       |
| Workforce reduction               |       | $                                             | 534        |               | $          | (509                                     | )          | $                    | 25         |                   | $          | 25 |   | $ | — |   |
| Consolidation of facilities       |       | 2,214                                         |       | (384               | )          | 1,830                                    |       | 862                  |       | 968                    |       |
| Sub-total                         |       | 2,748                                         |       | (893               | )          | 1,855                                    |       | 887                  |       | 968                    |       |
| Write-off of purchase commitments |       | 340                                           |       | (120               | )          | 220                                      |       | 220                  |       | $                      | —     |   |
| Total                             |       | $                                             | 3,088      |               | $          | (1,013                                   | )          | $                    | 2,075      |                   | $          | 1,107 |   | $ | 968 |   |

 

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Remaining cash expenditures relating to the workforce reductions areexpected to be substantially paid in the second quarter of fiscal 2003. Theremaining cash expenditures relating to the consolidation of excess facilitiesare expected to be paid through 2008. The purchase commitment obligations areexpected to be substantially paid by the end of fiscal 2003.

 

***(a) Workforcereduction***

 

The restructuring actions in fiscal 2002 included a reduction in Sonus’workforce. The affected employees were entitled to severance and other benefitsfor which Sonus recorded a charge of $5,282,000 in fiscal 2002, of which$1,340,000 was recorded in the first quarter. In addition, Sonus recordednon-cash stock-based compensation expense of $381,000 in the first quarter offiscal 2002 related to the write-off of deferred compensation associated withshares and options held by terminated employees.

 

***(b) Consolidationof excess facilities***

 

Sonus recorded a net restructuring charge in the first quarter offiscal 2002 of $3,411,000 for the consolidation of excess facilities, which isincluded on the balance sheet in accrued restructuring expenses and long-termobligations. The accrual for the consolidation of excess facilities wasdetermined assuming no sublease income.

 

***(c) Write-offof inventory and purchase commitments***

 

During the three months ended March 31, 2002, Sonus recordedadditional cost of revenues of $6,865,000 consisting of $4,457,000 for thewrite-off of inventory determined to be excess and obsolete and $2,408,000 formaterials that were committed to be purchased from third party contractmanufacturers and suppliers under purchase commitments, but that were in excessof required quantities. The charge for purchase commitments was recorded on thebalance sheet as accrued restructuring expenses.

 

**2001 Restructuring Accrual**

 

The following table summarizes the activity during the three monthsended March 31, 2003 relating to Sonus’ accrual for fiscal 2001restructuring actions, in thousands:

 
| ** **                                     | ** ** | **December 31,  2002  Accrual  Balance** | ** ** | **Cash  Payments** | ** ** | **March. 31,  2003  Accrual  Balance** | ** ** | **Current  Portion** | ** ** | **Long-Term  Portion** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------|------------|--------------------|------------|----------------------------------------|------------|----------------------|------------|------------------------|------------|
|                                           |       |                                          |       |               |       | **(As Restated)**                      |       |                 |       |                   |       |
|                                           |       |                                          |       |               |       |                                   |       |                 |       |                   |       |
| Consolidation of facilities and other  charges |       | $                                             | 571        |               | $          | (94                                    | )          | $                    | 477        |                   | $          | 406 |   | $ | 71 |   |
|                                                |            |                                               |            |                    |            |                                        |            |                      |            |                        |            |  |  |  |  |  |

 

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

 

In the first quarter of fiscal 2002, Sonus’ TTI subsidiary reduced itslease commitments for previously accrued excess space in its Texas facilitiesin exchange for a one-time payment of $835,000 to the landlord and a guaranteeby Sonus of TTI’s rents owed through April 2003.

 

**(5) Warranty Reserve**

 

The following table summarizes the activity related to product warrantyreserve, included in accrued expenses, during the three months ended March 31,2003, in thousands and as restated:

 
| Balance at December 31, 2002 |   | $      | 1,300  |   |
|-----------------------------------|--------|--------|--------|--------|
| Charges to costs and expenses     |   | — |   |
| Deductions                        |   | — |   |
| Balance at March 31, 2003    |   | $      | 1,300  |   |

 

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**(6) Long-term Liabilities**

 

Long-term liabilities consist of capital leases, borrowings from a bankfor equipment purchases (Note 7) and restructuring expenses (Note 4).Sonus assumed certain capital leases as part of the acquisition of telecomtechnologies, inc. (TTI). The capital leases are due in monthly installmentsexpiring at various dates through March 2005 and accrue interest at annualrates ranging from 4.6% to 34.3%. The future minimum annual payments undercapital leases and amounts due for long-term liabilities, as of March 31,2003, are as follows, in thousands:

 
| **Capital Leases:**                                      |   |   |   |
|----------------------------------------------------------|--------|--------|--------|
| 2003 obligations (nine months)                           |   | $      | 387    |   |
| 2004 obligations                                         |   | 193    |   |
| 2005 obligations                                         |   | 30     |   |
| Total minimum lease payments                             |   | 610    |   |
| Less amount representing interest                        |   | (29    | )      |
| Present value of minimum payments                        |   | 581    |   |
| **Borrowings  under equipment line of credit with bank** |   | 2,567  |   |
| **Long-term  portion of restructuring expenses**         |   | 1,039  |   |
| Total long-term liabilities                              |   | 4,187  |   |
| Less current portion                                     |   | (1,527 | )      |
| Long-term liabilities, net of current  portion           |   | $      | 2,660  |   |

 

The future principal payments on total long-term liabilities, excludingthe capital leases, as of March 31, 2003 are: $825,000 in 2003 (ninemonths); $1,341,000 in 2004; $828,000 in 2005; $195,000 in 2006; $204,000 in2007; and $213,000 in 2008.

 

**(7) Bank Agreement**

 

In January 2002, Sonus established a $10,000,000 equipment line ofcredit and a $20,000,000 working capital line of credit with a bank at the bank’sprime rate. In March 2003, Sonus extended these existing lines of creditat the bank’s prime rate (4.25% at March 31, 2003), available through March 23,2004.  Amounts borrowed under theequipment line were repayable over a 36-month period. For both lines of credit,Sonus had to comply with certain restrictive covenants including maintainingcertain minimum investment balances with the bank, a minimum tangiblestockholders’ equity of $40,000,000 as of March 31, 2003 and a quick ratioof 1.5 to 1.0, as defined in the credit agreement.  Under the agreement, all of Sonus’ assets,except intellectual property, had been pledged as collateral. As of March 31,2003, Sonus had $2,567,000 outstanding under the equipment line of credit(Note 6) and was in compliance with all bank covenants.  Interest expense related to the line ofcredit was $29,000 for the three months ended March 31, 2003.

 

**(8) Convertible Subordinated Note**

 

In May 2001, Sonus completed a private placement of an aggregateprincipal amount of $10,000,000 of a 4.75% convertible subordinated note, due May 1,2006, with a customer. Interest payments are due semi-annually on May 1and November 1 of each year through May 2006. The note may beconverted by the holder into shares of Sonus’ common stock at any time beforeits maturity or prior to its redemption or repurchase by Sonus. The conversionrate is 33.314 shares per each $1,000 principal amount of the note, subject toadjustment in certain circumstances. As of May 1, 2004, Sonus has theoption to redeem all or a portion of the note at 100% of the principal amount.Also, at any time if the market price of Sonus’ common stock exceeds $60.04 pershare for twenty trading days in any thirty trading-day period, Sonus mayredeem this note through the issuance of shares of common stock or for cash. Inthe event of a change of control in Sonus, the holder at its option may requireSonus to redeem the note through the issuance of common stock or cash. Interestexpense related to Sonus’ convertible subordinated note was $119,000 for boththe three months ended March 31, 2003 and 2002.

 

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**(9) Commitments and Contingencies**

 

***(a) Leases***

 

Sonus leases its facilities under operating leases, which expirethrough December 2008. Sonus is responsible for certain real estate taxes,utilities and maintenance costs under these leases. The future minimum paymentsunder operating lease arrangements as of March 31, 2003, are as follows:$3,514,000 in 2003 (nine months); $1,693,000 in 2004; $1,068,000 in 2005;$876,000 in 2006; $261,000 in 2007; and $213,000 in 2008.

 

***(b) PendingLitigation***

 

In November 2001, a purchaser of Sonus’ common stock filed acomplaint in the federal district court for the Southern District of New Yorkagainst Sonus, two of its officers and the lead underwriters allegingviolations of the federal securities laws in connection with Sonus’ initial publicoffering (IPO) and seeking unspecified monetary damages. The purchaser seeks torepresent a class of persons who purchased Sonus’ common stock between the IPOon May 24, 2000 and December 6, 2000. An amended complaint was filedin April 2002. The amended complaint alleges that Sonus’ registrationstatement contained false or misleading information or omitted to statematerial facts concerning the alleged receipt of undisclosed compensation bythe underwriters and the existence of undisclosed arrangements betweenunderwriters and certain purchasers to make additional purchases in the aftermarket. The claims against Sonus are asserted under Section 10(b) ofthe Securities Exchange Act of 1934 and Section 11 of the Securities Actof 1933 and against the individual defendants under Sections 11 and 15 ofthe Securities Act. Other plaintiffs have filed substantially similar classaction cases against approximately 300 other publicly traded companies andtheir IPO underwriters which, along with the actions against Sonus, have beentransferred to a single federal judge for purposes of coordinated casemanagement. On July 15, 2002, Sonus, together with the other issuers namedas defendants in these coordinated proceedings, filed a collective motion todismiss the consolidated amended complaints on various legal grounds common toall or most of the issuer defendants. The plaintiffs voluntarily dismissed theclaims against the individual defendants, including those Sonus officers namedin the complaint. On February 19, 2003, the court granted a portion of themotion to dismiss by dismissing the Section 10(b) claims againstcertain defendants including Sonus, but denied the remainder of the motion asto the defendants. Accordingly, the case will proceed against Sonus on the Section 11claims. The outcome of the litigation remains uncertain. Sonus intends tocontinue to vigorously defend this action.

 

Beginning in July 2002, several purchasers of Sonus’ common stockfiled complaints in federal district court for the District of Massachusettsagainst Sonus, certain officers and directors and a former officer underSections 10(b) and 20(a) and Rule 10b-5 of the SecuritiesExchange Act of 1934 (Class Action Complaints). The purchasers seek torepresent a class of persons who purchased common stock of Sonus between December 11,2000 and January 16, 2002, and seek unspecified monetary damages. The Class ActionComplaints were essentially identical and alleged that Sonus made false andmisleading statements about its products and business. On March 3, 2003,the plaintiffs filed a Consolidated Amended Complaint. On April 22, 2003,Sonus filed a motion to dismiss the Consolidated Amended Complaint on variousgrounds. The plaintiffs’ opposition to the motion is due on June 6, 2003.Sonus believes the claims in the Consolidated Amended Complaint are withoutmerit and that it has substantial legal and factual defenses, which it intendsto pursue vigorously.

 

On September 30, 2002, a purported shareholder derivative lawsuitwas filed in the superior court of Middlesex County of Massachusetts againstSonus and its directors. The complaint is based on essentially the sameallegations as the Class Action Complaints and alleges that Sonus’directors breached their fiduciary duties. The complaint seeks an unspecifiedamount of compensatory and other damages and relief on behalf of Sonus. AfterSonus submitted a motion to dismiss the complaint on multiple grounds, theplaintiff agreed to dismiss the complaint without prejudice retaining the rightto refile the complaint at a later date. The complaint was dismissed on February 4,2003.

 

**(10) Stockholders’ Equity**

 

***(a) PublicOffering***

 

In April 2003, Sonus completed a public offering of 20,000,000shares of its common stock at $3.05 per share, resulting in net proceeds of$56,730,000 after deducting offering costs of $4,270,000.

 

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***(b) 1997 StockIncentive Plan***

 

On January 1 of each year, the aggregate number of shares ofcommon stock available for issuance under the 1997 Stock Incentive Plan (Plan)shall increase by the lesser of (i) 5% of the outstanding shares on December 31of the preceding year or (ii) an amount determined by the Board ofDirectors. As of March 31, 2003, 110,611,642 shares were authorized and54,864,126 shares were available under the Plan for future issuance.

 

On October 16, 2002, Sonus commenced an offer to exchange(Exchange Offer) outstanding employee stock options granted under the Planhaving an exercise price of $0.67 or more per share for new stock options to begranted by Sonus. Outstanding options granted under the TTI Amended andRestated 1998 Equity Incentive Plan were not eligible for exchange. Also, Sonus’directors, executive officers and non-employees were not eligible toparticipate in the exchange. On November 22, 2002, the Exchange Offerexpired. Outstanding options to purchase 8,973,000 shares of common stock wereaccepted for exchange and cancelled. Sonus expects to issue new options inexchange for such tendered options on or after May 23, 2003 and that theseoptions will be granted with an exercise price equal to the fair market valueof Sonus’ common stock on the date of grant.

 

***(c) 2000Employee Stock Purchase Plan***

 

On January 1 of each year, the aggregate number of shares ofcommon stock available for purchase under the 2000 Employee Stock Purchase Plan(ESPP) shall increase by the lesser of (i) 2% of the outstanding shares onDecember 31 of the preceding year or (ii) an amount determined by theBoard of Directors. As of March 31, 2003, 15,444,567 shares wereauthorized and 2,727,974 shares were available under the ESPP for futureissuance.

 

***(d) Stock-BasedCompensation***

 

Stock-based compensation expenses include the amortization of deferredemployee compensation and other equity-related expenses.

 

In connection with certain employee stock option grants includinggrants related to the TTI acquisition and the issuance of employee restrictedcommon stock between 1999 and 2001, Sonus recorded deferred stock-basedcompensation. This represents the aggregate difference between the exerciseprice or purchase price and the fair value of the common stock on the date ofgrant or sale for accounting purposes. The deferred compensation is recognizedas an expense over the vesting period of the underlying stock options andrestricted common stock based on the accelerated method prescribed by FIN 28.

 

Sonus recorded stock-based compensation of $924,000 and $6,799,000 forthe three months ended March 31, 2003 and 2002.

 

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##  

## **Item 2:**Management’s Discussion and Analysis of Financial Condition and Results ofOperations

##  

*This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contains forward-lookingstatements, which are subject to a number of risks and uncertainties. Theseforward-looking statements are based on our current expectations, assumptions,estimates and projections about our industry and ourselves, and we do notundertake an obligation to update our forward-looking statements to reflectfuture events or circumstances. Our actual results could differ materially fromthose anticipated in these forward-looking statements as a result of variousfactors. This discussion should be read in conjunction with the unauditedcondensed consolidated financial statements and related notes for the periodsspecified. Further reference should be made to our Annual Report on Form 10-Kfor the year ended December 31, 2004 and our Quarterly Report on Form 10-Qfor the quarter ended March 31, 2005, on file with the SEC.*

 

**Overview**

 

We are a leading supplier of packet voice infrastructure solutions forwireline and wireless service providers. Our products are a new generation ofcarrier-class switching equipment and software that enable voice services to bedelivered over packet-based networks.

 

We began shipping product to customers during the fourth quarter offiscal 1999 and recorded our first revenues of $51.8 million in fiscal2000 and revenues of $128.8 million in fiscal 2001 and $93.9 millionin fiscal 2002.  Revenues for the threemonths ended March 31, 2003 were $9.2 million, representing adecrease of 55% from $20.5 million for the same period in fiscal2002.  Significant declines in capitalspending by telecommunications service providers, and financial difficulties,including in some cases bankruptcies, experienced by certain emerging serviceproviders, including some of our customers, caused the reduction in ourrevenues in 2002 and in the first quarter of 2003. In response to theunfavorable economic conditions, commencing in the third quarter of fiscal 2001and continuing through fiscal 2002, we implemented restructuring plans designedto reduce expenses and align our cost structure with our revised businessoutlook. The restructuring plans included worldwide workforce reductions,consolidation of excess facilities and the write-off of excess inventory andpurchase commitments.

 

We sell our products primarily through a direct sales force and, insome markets, through resellers and distributors. Customers’ decisions topurchase our products to deploy in commercial networks involve a significantcommitment of resources and a lengthy evaluation, testing and productqualification process. We believe our revenues and results of operations mayvary significantly and unexpectedly from quarter to quarter as a result of longsales cycles, our expectation that customers will tend to sporadically placelarge orders with short lead times and the application of complex revenuerecognition rules to certain transactions. We expect to recognize revenuesfrom a limited number of customers for the foreseeable future.

 

Since our inception, we have incurred significant losses and, as of March 31,2003, had an accumulated deficit of $803.1 million. Although we achievedprofitability in the second quarter of fiscal 2002, as of March 31, 2003we had not achieved profitability on an annual basis and may incur additionalnet losses in future quarters and years. The quarterly net income in the secondquarter of 2002 was primarily the result of recognizing previously deferredrevenue of $27.5 million from arrangements with a single customer upon thedelivery of certain specified software releases in the second quarter of 2002.We have a lengthy sales cycle for our products and, accordingly, we expect toincur sales and other expenses before we realize the related revenues.

 

**Critical Accounting Policies and Estimates**

 

Our discussion and analysis of our financial condition and results ofoperations are based upon our consolidated financial statements, which havebeen prepared in accordance with accounting principles generally accepted inthe United States. The preparation of these financial statements and relateddisclosures requires management to make judgments, assumptions and estimatesthat affect the amounts reported in the consolidated financial statements andaccompanying disclosures. Management bases its estimates and judgments onhistorical experience, market trends and other factors that are believed to bereasonable under the circumstances. On an on-going basis, we re-evaluate ourestimates for changes in facts and circumstances, and material changes in theseestimates could occur in the future if past experience or other assumptions donot turn out to be substantially accurate. Changes in estimates are recorded inthe period in which they

 

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become known.

 

A summary of those accounting policies, significant judgments andestimates that we believe are most critical to fully understanding andevaluating our financial results is set forth below. This summary should beread in conjunction with our unaudited condensed consolidated financialstatements and the related notes included elsewhere in this Quarterly Report.

 

***Revenue Recognition.***We recognize revenue from product sales whenpersuasive evidence of an arrangement exists, delivery has occurred, the salesprice is fixed or determinable and collectibility of the related receivable is probableunder ordinary payment terms. When we have future obligations, including arequirement to deliver additional elements which are essential to thefunctionality of the delivered elements or for which vendor specific objectiveevidence of fair value (VSOE) does not exist or customer acceptance isrequired, we defer revenue recognition and related costs until thoseobligations are satisfied. The ordering pattern and sales lead times associatedwith customer orders may vary significantly from period to period.

 

Many of our sales are generated from complex contractual arrangementswhich require significant revenue recognition judgments, particularly in thecase of multiple element arrangements. When a sale involves multiple elements,such as products, maintenance or professional services, we allocate the entiresales price to each respective element based on VSOE or using the residualmethod when VSOE cannot be established for a single delivered element in thearrangement. We then recognizes revenue on each element in accordance with ourpolicies for revenue recognition related to each element. We determine VSOEbased upon the price charged when the same element is sold separately. If wecannot establish VSOE for each undelivered element, we defer revenue recognitionon the entire arrangement until the earlier of the establishment of VSOE ordelivery of the undelivered element.

 

In addition, if an arrangement with a customer includes a specifiedupgrade right for which VSOE cannot be established, we defer all revenuerelated to the arrangement until the earlier of the delivery of the specifiedupgrade or the establishment of VSOE for the specified upgrade. We haveconcluded that a specified upgrade right exists if it is included in thecustomer contract or otherwise becomes part of the arrangement with thecustomer. We have concluded that communications with customers in the normalcourse of business regarding customer feature requests and our product plans donot create specified upgrade rights.

 

Maintenance and support services are recognized ratably over the lifeof the maintenance and support service period, which typically is one year whenthe services are sold separately and up to five years when the fees for theservices are bundled with the product fees as part of a multiple elementarrangement. Maintenance and support services include telephone support andunspecified rights to product upgrades and enhancements. Maintenance andsupport VSOE represents a consistent percentage of the sales prices charged tocustomers. The application of judgment could affect the continued determinationof maintenance and support VSOE and Sonus’ ability to recognize revenue usingthe residual method.

 

Installation service revenues are generally recognized at the time ofthe related product revenue recognition as installation is typically completeby such time. Professional services are typically recognized as the servicesare performed.

 

We sell the majority of our products directly to end-users. Forproducts sold through resellers and distributors, we recognize revenue on asell-through method utilizing information provided to us from our resellers anddistributors.

 

We record deferred revenue for product shipped to customers and relatedservices where amounts are billed pursuant to a contractual right andcollection is probable, or collected, in the ordinary course of business if therevenue recognition criteria have not been satisfied. Deferred revenues includecustomer deposits and amounts associated with maintenance contracts Deferredrevenues not expected to be recognized within one year of the balance sheetdate are classified as long-term deferred revenues.

 

We defer recognition of incremental direct costs, such as cost ofgoods, royalties, commissions and third-party installation costs, untilsatisfaction of the criteria for recognition of the related revenue.

 

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***Loss Contingenciesand Reserves.***We are subject to ongoing businessrisks that affect the estimation process of the carrying value of assets, therecording of liabilities and the possibility of various loss contingencies.Under SFAS No. 5, an estimated loss contingency is accrued when it isprobable that a liability has been incurred or an asset has been impaired andthe amount of loss can be reasonably estimated. We regularly evaluate currentinformation available to us to determine whether such amounts should beadjusted and record changes in estimates in the period they become known.

 

***Allowance forDoubtful Accounts.*** We establish billing terms at the time we negotiate purchase agreementswith our customers. We continually monitor timely payments and assess anycollection issues. The allowance for doubtful accounts is based on our detailedassessment of the collectibility of specific customer accounts. While webelieve that our allowance for doubtful accounts is adequate and that thejudgment applied is appropriate, if there is a deterioration of a customer’screditworthiness or actual defaults are higher than our historical experience,the actual results could differ from these estimates. While such credit losseshave historically been within our expectations and the allowances weestablished, we cannot guarantee that we will continue to experience the samecredit loss rates that we have in the past. If the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability tomake payment, additional allowances may be required. We defer revenuerecognition for customers for which we believe collection is less thanprobable. Our failure to accurately estimate the losses for doubtful accounts orreceive payments on a timely basis could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

***Inventory Reserves.***  Inventory purchases and commitments are basedupon estimated future demand for our products. We value inventory at the lowerof cost or net realizable value. We provide inventory reserves based on excessand obsolete inventory determined primarily by future demand forecasts andreturns of deferred product, and record changes to such reserves throughadjustments to cost of revenues. We assess such demand forecasts and returnhistory on at least a quarterly basis. If we record a charge to reduceinventory to its estimated net realizable value, we do not increase itscarrying value due to subsequent changes in demand forecasts or productrepairs. Accordingly, if inventory previously written down to its netrealizable value is subsequently sold, we may realize improved gross profitmargins on those transactions in the period the related revenue is recognized.

 

We also record a full inventory reserve for evaluation equipment at thetime of shipment to our customers as a charge to sales and marketing expense asour experience with this type of inventory indicates it is probable that theinventory will not be realizable. If these evaluation shipments should convertto revenue, we record a benefit to sales and marketing expenses and record thefull cost of revenues in the period of revenue recognition.

 

We have experienced significant changes in our product demand and, as aresult, our required inventory reserves have fluctuated in recent periods. Itis possible that significant changes in required inventory reserves maycontinue to occur in the future if there is a sudden and significant change inthe demand for our products, changes in the amount of customer evaluationinventory or higher risks of inventory obsolescence because of rapidly changingtechnology.

 

***Warranty Reserve.***  Our products are covered by a standardwarranty of 90 days for software and one year for hardware. In addition,certain customer contracts include warranty-type provisions for epidemic orsimilar product failures, generally for the contractual period or the life ofthe product in accordance with published telecommunications standards. Weaccrue for such contingent obligations when the occurrence of such obligationis probable and the amount of such obligation is reasonably estimable. We havenot incurred significant costs related to such obligations. Our customerstypically purchase maintenance and support contracts, which encompass ourwarranty obligations. Our estimates of anticipated rates of warranty claims andcosts are primarily based on historical information and future forecasts.

 

In addition, certain of our customer contracts include provisions underwhich we may be obligated to pay penalties generally for the contractual periodor for the life of the product if its products fail or do not perform inaccordance with specifications. We accrue for such contingent obligations whenthe occurrence of such obligation is probable and the amount of such obligationis reasonably estimable. We have not incurred significant costs related to suchprovisions. We periodically assess the adequacy of our recorded warrantyliabilities and adjusts the amounts as necessary. Increases in product failuresrates, material usage or service delivery costs may result in increases to ourwarranty reserve and our gross profit could be adversely affected.

 

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***Royalty Accrual.***  We accrue for royalty-related technology welicense from vendors based on established royalty rates and usage. In certaincases, we have been contacted by third parties who claim that our productsinfringe on certain intellectual property of the third party. We evaluate theseclaims and accrue for royalties when the amounts are probable and reasonablyestimable. While we believe that the amounts accrued for estimated royaltiesare adequate, the amounts required to ultimately settle royalty obligations maybe different.

 

***Reserve forLitigation and Legal Fees.***  We are subject to various legal claims,including securities litigation and intellectual property claims. We reservefor legal contingencies and legal fees when the amounts are probable andreasonably estimable. Our director and officer liability insurance policiesprovide only limited liability protection relating to the securities classaction and derivative lawsuits against us and certain of our officers anddirectors. We intend to defend these matters vigorously, although the ultimateoutcome of these items is uncertain and the potential loss, if any, may besignificantly higher or lower than the amounts we have previously accrued.

 

***Accounting forIncome Taxes.*** SFAS No. 109, *Accounting forIncome Taxes*, requires the establishment of a valuation allowance toreflect the likelihood of realization of deferred tax assets. Significantmanagement judgment is required in determining our provision for income taxes,our deferred tax assets and liabilities and any valuation allowance recordedagainst our net deferred tax assets. We evaluate all available evidence, suchas recent and expected future operating results by tax jurisdiction, andcurrent and enacted tax legislation and other temporary differences betweenbook and tax accounting, to determine whether it is more likely than not thatsome portion or all of the deferred income tax assets will not be realized.

 

As a result of net operating losses incurred in prior years in mostjurisdictions in which we operate, and uncertainty as to the extent,jurisdiction and timing of profitability in future periods, we have continuedto record a full valuation allowance against deferred tax assets. Theestablishment and amount of the valuation allowance requires significantestimates and judgment and can materially affect our results of operations. Ifthe realization of deferred tax assets in the future is considered more likelythan not, an adjustment to the valuation allowance for the deferred tax assetwould be made. A portion of the release of the valuation allowance willincrease net income in the period such determination was made. Our effectivetax rate may vary from period to period based on changes in estimated taxableincome or loss in each jurisdiction, changes to the valuation allowance, statutoryminimum tax rates or changes to federal, state or foreign tax laws, futureexpansion into areas with varying country, state, and local income tax rates,including statutory minimum tax rates, deductibility of certain costs andexpenses by jurisdiction and as a result of acquisitions.

 

***ThreeMonths Ended March 31, 2003 and 2002***

 

***Revenues.***  Revenues for the three months ended March 31,2003 and 2002 were as follows, in thousands:

 
| ** **     | ** ** | **Three months ended March 31,** | ** ** |
|----------------|------------|---------------------------------------|------------|
| ** **     | ** ** | **2003**                              | ** ** | **2002** | ** ** |
| ** **     | ** ** | **(As Restated)**                     | ** ** | **(As Restated)** | ** ** |
| **Revenues:**  | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Product        |       | $                                     | 3,517      |   | $ | 13,119 |   |
| Service        |       | 5,692                                 |       | 7,389 |   |
| Total revenues |       | $                                     | 9,209      |   | $ | 20,508 |   |

 

Product revenues comprise sales of our voice infrastructure products,including our GSX9000TM Open Services Switch, InsignusTM Softswitch, SonusInsightTM Management System and related product offerings. Product revenues forthe three months ended March 31, 2003 decreased 73% from the same periodin fiscal 2002, primarily as a result of lower demand caused by significantdeclines in capital spending by telecommunications service providers, financialdifficulties experienced by certain emerging service providers, including someof our customers, and as a result of the timing of revenue recognition forcertain customer shipments made in the quarter.

 

Service revenues primarily comprise hardware and software maintenance,network design and other professional

 

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services. Service revenues for the three months ended March 31,2003 decreased 23% from the same period in fiscal 2002. The decrease in servicerevenues was primarily due to a reduction in revenues for product installationsand other professional services. In addition, we completed product deliverableson certain customer arrangements in the first quarter of 2002 for which therelated service revenues were recognized at that time.

 

For the three months ended March 31, 2003 and 2002, two and fourcustomers each contributed 10% or more of our revenues, representing anaggregate of 40% and 60% of total revenues. The following customers contributed10% or more of our revenues in the three months ended March 31, 2003 and2002:

 
| ** **                     | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|
| **Customer:**                  | ** ** | **2003**                              | ** ** | **2002** | ** ** |
| ** **                     | ** ** | **(As Restated)**                     | ** ** | **(As Restated)** | ** ** |
| Global Crossing                |       | 29                                    | %          | 10 | % |
| Nissho Electronics Corporation |       | 11                                    |       | * |   |
| IDT Corporation                |       | *                                     |       | 12 |   |
| XO Communications              |       | *                                     |       | 12 |   |
| Touch America                  |       | *                                     |       | 26 |   |

 

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*                                         Representsless than 10% of revenues.

 

International revenues, primarily to Asia and Europe, were 26% and 24%of revenues for the three months ended March 31, 2003 and 2002.

 

***Cost ofRevenues/Gross Profit.***  Cost of revenues consists primarily ofamounts paid to third party manufacturers for purchased materials and services,manufacturing and professional services personnel and related costs andinventory obsolescence. Cost of revenues and gross profit as a percentage ofrevenues for the three months ended March 31, 2003 and 2002 were asfollows, in thousands except percentages):

 
| ** **                                       | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                       | ** ** | **2003**                              | ** ** | **2002** | ** ** |
| ** **                                       | ** ** | **(As Restated)**                     | ** ** | **(As Restated)** | ** ** |
|                                             |       |                                  |       |   |   |
| **Cost of  revenues:**                           |       |                                  |       |   |   |
| Product                                          |       | $                                     | 1,538      |   | 6,938 |   |
| Service                                          |       | 2,555                                 |       | 2,985 |   |
| Write-off of inventory and purchase  commitments |       | —                                |       | 6,865 |   |
| Total cost of revenues                           |       | $                                     | 4,093      |   | $ | 16,788 |   |
|                                             |       |                                  |       |   |   |
| **Gross profit****(% of respective revenues):**  |       |                                  |       |   |   |
| Product                                          |       | 56                                    | %          | 47 | % |
| Service                                          |       | 55                                    |       | 60 |   |
| Total gross profit                               |       | 56                                    |       | 18 | (1) |
|                                                  |            |                                       |            |  |  |  |  |

 

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(1) Includes the impact of the write-off of inventory and purchasecommitments.

 

The increase in product gross profit as a percentage of productrevenues, excluding the write-offs of inventory and purchase commitments, wasprimarily due to cost reductions resulting from our restructuring actions infiscal 2002. The decrease in service gross profit as a percentage of servicerevenues was primarily due to a higher proportion of fixed costs resulting fromthe decline in total service revenues and a greater mix of lower marginservices.  Our service cost of revenuesis relatively fixed in advance of any particular quarter.

 

During the three months ended March 31, 2002, we included in costof revenues charges of $6.9 million consisting

 

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of $4.5 million for the write-off of inventory determined to be excessand obsolete and $2.4 million for materials that were expected to be purchasedfrom third party contract manufacturers and suppliers under purchase commitments,but which were in excess of required quantities. Remaining cash expenditures of$0.2 million at March 31, 2003 for purchase commitments are included onthe balance sheet as accrued restructuring expenses.

 

***Research andDevelopment Expenses.***  Research and development expenses consistprimarily of salaries and related personnel costs and prototype costs relatedto the design, development, testing and enhancement of our products. Researchand development expenses were $7.7 million for the three months ended March 31,2003, a decrease of $7.2 million, or 48%, from $14.9 million for thesame period in fiscal 2002. This decrease primarily reflects a reduction insalaries and related expenses attributed to restructuring actions and, to alesser extent, reductions in consulting fees, prototype costs and depreciationexpense. Some aspects of our research and development efforts requiresignificant short-term expenditures, the timing of which can cause significantvariability in our expenses.

 

***Sales and MarketingExpenses.*** Sales and marketing expenses consist primarily of salaries and relatedpersonnel costs, commissions, travel and entertainment expenses, promotions,customer evaluations and other marketing and sales support expenses. Sales andmarketing expenses were $4.0 million for the three months ended March 31,2003, a decrease of $3.5 million, or 47%, from $7.5 million for thesame period in fiscal 2002. This decrease primarily reflects a reduction insalaries and related expenses attributed to restructuring actions and, to alesser extent, a decrease in commissions due to decreased revenues and areduction in costs for customer evaluations, travel and entertainment.

 

***General andAdministrative Expenses.***  General and administrative expenses consistprimarily of salaries and related personnel costs for executive andadministrative personnel, recruiting expenses, allowance for doubtful accountsand professional fees. General and administrative expenses were$1.8 million for the three months ended March 31, 2003, a decrease of$748,000, or 29%, from $2.6 million for the same period in fiscal 2002.This decrease primarily reflects reductions in salaries and related expensesattributed to restructuring actions and, to a lesser extent, a reduction inprofessional fees.

 

***Stock-basedCompensation Expenses.***  Stock-based compensation expenses include theamortization of stock compensation charges resulting from the granting of stockoptions, including the telecom technologies, inc. (TTI) stock optionsassumed by us, stock awards to TTI employees under the 2000 Retention Plan andthe sales of restricted common stock. Stock-based compensation expenses were$924,000 for the three months ended March 31, 2003, a decrease of$5.9 million, or 86%, from $6.8 million for the same period in fiscal2002. The decrease is primarily due to lowered deferred compensation balancesresulting from write-offs made in connection with employee terminations and acceleratedrecognition of deferred compensation expense pursuant to FIN 28.

 

On October 16, 2002, we commenced an offer to exchange outstandingemployee stock options for new stock options to be granted on a date that is atleast six months and one day from the expiration date of the exchange offer.The exchange offer expired on November 22, 2002, and outstanding optionsto purchase approximately 8,973,000 shares of common stock were accepted forexchange and cancelled. On May 27, 2003, employees received an option topurchase one share of common stock for each share of common stock under theexchanged options at an exercise price of $4.08 per share, representing thefair market value of our common stock on the date of grant.

 

***Amortization ofPurchased Intangible Assets.***  In fiscal 2001, we acquired certainintellectual property, in-process research and development and intangibleassets in connection with our acquisitions of TTI and Linguateq. Amortizationof purchased intangible assets was $602,000 for the three months ended March 31,2003, a decrease of $588,000 from $1.2 million for the same period in fiscal2002. The decrease of amortization of purchased intangible assets was due tothe write-off of certain purchased intangibles in fiscal 2002.

 

***RestructuringCharges, net.*** Commencing in the third quarter of fiscal 2001 and extending throughfiscal 2002, in response to unfavorable business conditions primarily caused bysignificant declines in capital spending by telecommunications serviceproviders, we implemented restructuring plans designed to reduce expenses andalign our cost structure with our revised business outlook. The restructuringplans included worldwide workforce reductions, consolidation of excessfacilities and the write-off of excess inventory and purchase commitments.  In the first quarter of fiscal 2002 wereduced our worldwide workforce and recorded a charge of $1.3 million forseverance and other benefits, and also recorded

 

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a net restructuring charge of $3.4 million for the additionalconsolidation of excess facilities, which is included on the balance sheet inaccrued restructuring expenses and long-term obligations.

 

***Interest Income,net.*** Interest income consists of interest earned on our cash balances andmarketable securities. Interest expense consists of interest incurred on aconvertible subordinated note, equipment bank debt and capital leasearrangements. Interest income, net of interest expense, was $251,000 for thethree months ended March 31, 2003, a decrease of $202,000 from $453,000for the same period in fiscal 2002. The decrease primarily reflects a reductionin interest rates and invested balances.

 

***Income Taxes.***  Provision for income taxes recorded was$33,000 for the three months ended March 31, 2003, compared to $22,000 forsame period in fiscal 2002. The income tax provision for all periods isattributable primarily to foreign income taxes and state minimum income taxesin the U.S.

 

**Off-balance Sheet Arrangements**

 

We have no off-balance sheet arrangements that have or are reasonablylikely to have a current or future material effect on our financial condition,changes in financial condition, revenues or expenses, results of operations,liquidity, capital expenditures or capital resources.

 

**Liquidity and Capital Resources**

 

At March 31, 2003, our principal sources of liquidity were ourcash, cash equivalents and marketable securities that totaled$106.6 million.  In April 2003,we completed a public offering of 20,000,000 shares of our common stock at$3.05 per share resulting in net proceeds of approximately $56.7 million afterdeducting an underwriting discount, commissions and offering expenses ofapproximately $4.3 million.

 

Our operating activities used net cash of $10.6 million for thethree months ended March 31, 2003, as compared to $17.0 million forthe same period in fiscal 2002. The decrease in net cash used primarilyreflects a reduction in the net loss, an increase in deferred revenue as aresult of customer payments received prior to meeting revenue recognitioncriteria, and increases in accounts payable and accrued expenses, partiallyoffset by decreases in inventory, accounts receivable and other current assetsand a decrease in non-cash expense items.

 

Net cash used in investing activities was $1.1 million for thethree months ended March 31, 2003 primarily reflects net purchases ofmarketable securities of $150,000 and purchases of property and equipment of$956,000, as compared to net cash provided by investing activities of$6.3 million for the same period in fiscal 2002 which primarily reflectsnet maturities of marketable securities of $7.4 million, partially offsetby purchases of property and equipment of $1.0 million

 

Net cash provided by financing activities was $45,000 for the threemonths ended March 31, 2003, as compared to $2.1 million for the sameperiod in fiscal 2002. The net cash provided by financing activities for thethree months ended March 31, 2003 and 2002 primarily resulted from thesale of common stock in connection with our employee stock purchase planpartially offset by payments on our long-term liabilities.

 

As of March 31, 2003 we had a $10,000,000 equipment line of creditand a $20,000,000 working capital line of credit with a bank available through March 23,2004. The lines of credit were collateralized by all of our assets, exceptintellectual property, and bore interest at the bank’s prime rate. We wererequired to comply with various financial and restrictive covenants. As of March 31,2003, we had $2.6 million outstanding under the equipment line of credit and werein compliance with all bank covenants

 

The following summarizes our future contractual cash obligations as of March 31,2003, in thousands:

 
| ** **                   | ** ** | **Payment Due by Period** | ** ** |
|------------------------------|------------|---------------------------|------------|
| **Contractual  Obligations** | ** ** | **Total**                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Thereafter** | ** ** |
| Long-term debt obligations   |       | $                         | 14,363     |   | $ | 1,664 |   | $ | 2,461 |   | $ | 10,238 |   | $ | — |   |
| Capital lease obligations    |       | 610                       |       | 452 |   | 158 |   | — |   | — |   |
| Operating lease obligations  |       | 7,625                     |       | 4,207 |   | 2,286 |   | 971 |   | 161 |   |
| Total                        |       | $                         | 22,598     |   | $ | 6,323 |   | $ | 4,905 |   | $ | 11,209 |   | $ | 161 |   |

 

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Based on our past performance and current expectations, we believe ourcurrent cash, cash equivalents and marketable securities will be sufficient tomeet our anticipated cash needs for working capital and capital expendituresfor at least 12 months.

 

***RecentAccounting Pronouncements***

 

In June 2002, the FASB issued SFAS No. 146, *Accounting for Costs Associated with Exit or DisposalActivities*. SFAS No. 146 addresses the recognition, measurementand reporting of costs associated with exit and disposal activities, includingrestructuring activities that were accounted for in accordance with EmergingIssues Task Force Issue No. 94-3, *LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring*).The scope of SFAS No. 146 includes costs related to terminating a contractthat is not a capital lease, costs to consolidate facilities or relocateemployees, and certain termination benefits provided to employees who areinvoluntarily terminated. SFAS No. 146 is effective for exit or disposalactivities initiated after December 31, 2002. The implementation of thisstatement did not have a material impact on our financial position or resultsof operations.

 

In November 2002, the FASB issued Interpretation No. 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*(FIN No. 45). FIN No. 45 elaborates on the disclosures to be made bya guarantor in its interim and annual financial statements about itsobligations under certain guarantees that it has issued. It also clarifies thata guarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee. The initial recognition and initial measurement provisions of theinterpretation are applicable on a prospective basis to guarantees issued ormodified after December 31, 2002 and the disclosure requirements in thisinterpretation are effective for financial statements of interim or annualperiods ending after December 15, 2002. The FIN No. 45 disclosurerequirements are included in Note 5 to our unaudited condensedconsolidated financial statements. The adoption of FIN No. 45 did not havea material impact on our financial position or results of operations.

 

In December 2002, the FASB issued SFAS No. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure,* an amendment of SFAS No. 123. SFAS No. 148provides alternative methods of transition for a voluntary change to the fairvalue-based method of accounting for employee stock-based compensation. Thesealternative methods will only impact us if we voluntarily change to the fairvalue-based method of accounting for employee stock-based compensation. SFAS No. 148also requires companies who account for employee stock-based compensation underthe intrinsic value-based method to disclose additional footnote information inannual financial statements effective for fiscal years ending after December 15,2002 and in financial statements for interim periods beginning after December 15,2002. The requisite disclosure appears in Note 3(l) to our unauditedcondensed consolidated financial statements.

 

In January 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities*(FIN No. 46) to clarify the conditions under which assets, liabilities andactivities of another entity should be consolidated into the financialstatements of a company. FIN No. 46 requires the consolidation of avariable interest entity by a company that bears the majority of the risk ofloss from the variable interest entity’s activities, is entitled to receive amajority of the variable interest entity’s residual returns or both. We do nothave any variable interest entities.

 

## **Item 4**:Controls and Procedures

##  

Our management, with the participation of our principal executiveofficer and principal financial officer, has evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934 (the Exchange Act)) as of March 31,2003. Due to the material weaknesses in our internal control over financialreporting (as defined in Rule 13a-15(f) under the Exchange Act)referred to below, we have concluded that our disclosure controls andprocedures were not effective as of March 31, 2003.

 

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An initial evaluation of our disclosure controls and procedures wasperformed shortly following the quarter ended March 31, 2003 by ourmanagement.  Subsequently, in connectionwith the restatement of our consolidated financial statements for the yearsended December 31, 2002 and 2001 and the nine months ended September 30,2003, we discovered material weaknesses applicable to the period covered bythis periodic report.  The materialweaknesses in our internal control over financial reporting are described inItem 9A in our Annual Report on Form 10-K for the year ended December 31,2004, filed with the SEC on March 15, 2005.

 

Since identifying these material weaknesses, we have made changes thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting. The primary such changes aredescribed in Item 4 in our Quarterly Report on Form 10-Q for the quarterended March 31, 2005, filed with the SEC on May 9, 2005, and Item 9Ain our Annual Report on Form 10-K for the year ended December 31,2004.

 

We continue to plan and expect to implement additional changes to ourinfrastructure and related processes that we believe are also reasonably likelyto strengthen and materially affect our internal control over financialreporting.

 

While there have been significant changes in our internal control overfinancial reporting subsequent to March 31, 2003, as described in theabove referenced periodic reports, no change in our internal control overfinancial reporting occurred during the fiscal quarter ended March 31,2003 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

The changes in our internal control over financial reportingimplemented by us to date will not in and of themselves remediate the materialweaknesses, and certain of these remedial measures will require some time to befully implemented or to take full effect. Prior to the remediation of thesematerial weaknesses, there remains risk that the transitional controls, describedbelow, on which we currently rely will fail to be sufficiently effective, whichcould result in material misstatement of our financial position or results ofoperations and require a restatement.

 

We are currently implementing an enhanced controls environment intendedto address the material weaknesses in our internal control over financialreporting and to remedy the ineffectiveness of our disclosure controls andprocedures. While this implementation phase is underway, we are relying onextensive manual procedures, including regular reviews and the significantutilization of outside accounting professionals, to assist us with meeting theobjectives otherwise fulfilled by an effective controls environment. We expectto establish and implement a policy-based system of controls. While we areundertaking the implementation of this new controls environment, there remainsrisk that the transitional controls on which we are currently relying will failto be sufficiently effective. We also note, however, that a control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met. Further,the design of a control system must include an assessment of the costs andrelated risks associated with the control and the purpose for which it wasintended. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesincluding instances of fraud, if any, have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty, and breakdowns can occur because of simple error or mistake.Additionally, controls can be circumvented by the individual acts of some persons,by collusion of two or more people, or by management override of the controls.The design of any system of controls also is based in part upon certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions. Over time, our control systems, as we developthem, may become inadequate because of changes in conditions, or the degree ofcompliance with the policies or procedures may deteriorate. Because of theinherent limitations in a cost-effective control system, misstatements due toerror or fraud may occur and not be detected and could be material and requirea restatement of our financial statements.

 

The certifications of our principal executive officer and principalfinancial officer required in accordance with Rule 13a-14(a) under the ExchangeAct are attached as exhibits to this Amendment to Quarterly Report on Form 10-Q/A.The disclosures set forth in this Item 4 contain information concerning theevaluation of our disclosure controls and procedures, and changes in internalcontrol over financial reporting, referred to in paragraph 4 of thosecertifications. Those certifications

 

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should be read in conjunction with this Item 4 for a more completeunderstanding of the matters covered by the certifications.

 

**PARTII****—OTHERINFORMATION**

 

## **Item 6:**Exhibits and Reports on Form 8-K

##  

(a)                                  Exhibits:

 
| **Exhibit   Number** | ** ** | **Description**                                                                                                                   |
|---------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
|                      |       |                                                                                                                              |
| 10.1#                     |       | Loan Modification Agreement, dated as of March 14, 2003, by and  between the Registrant and Silicon Valley Bank.             |
| 31.1                      |       | Certificate of Sonus Networks, Inc. Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2                      |       | Certificate of Sonus Networks, Inc. Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1                      |       | Certificate of Sonus Networks, Inc. Chief Executive Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2                      |       | Certificate of Sonus Networks, Inc. Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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#                                           Previouslyfiled with Registrant’s Form 10-Q (file No. 000-30229), filed May 9,2003.

 

(b)                                 Reportson Form 8-K:

 

We filed on January 22, 2003, a Current Report on Form 8-Kunder Item 5 (Other Events) reporting our actual financial results for thefourth quarter and fiscal year ended December 31, 2002.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, asamended, the Registrant has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.

 

 
| Dated: June 10, 2005 | SONUS NETWORKS, INC. |
|---------------------------|----------------------|
|                      |                 |
|                      | By:                  |   /s/ Ellen B. Richstone |   |
|                      |                 | Ellen B. Richstone |
| * *                  |                 | *Chief Financial Officer (Principal  Financial Officer)* |
| * *                  | * *             | * * |
|                      |                 |   |
|                      | SONUS NETWORKS, INC. |
|                      |                 |
|                      | By:                  |   /s/ Bradley T. Miller |   |
|                      |                 | Bradley T. Miller |
| * *                  |                 | *Vice President of Finance, Corporate  Controller and Chief Accounting  Officer (Principal Accounting Officer)* |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                   |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                              |
| 10.1#               |       | Loan Modification Agreement, dated as of March 14, 2003, by and  between the Registrant and Silicon Valley Bank.             |
| 31.1                |       | Certificate of Sonus Networks, Inc. Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2                |       | Certificate of Sonus Networks, Inc. Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1                |       | Certificate of Sonus Networks, Inc. Chief Executive Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2                |       | Certificate of Sonus Networks, Inc. Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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#                 Previously filed with Registrant’s Form 10-Q(file No. 000-30229), filed May 9, 2003.

 

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