**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

# **AMENDMENTNO.****1 TO**

** **

**FORM 10-Q/A**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended September 30, 2003**

 

**CommissionFile Number 000-30229**

 

----

 

**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 ApolloDrive, Chelmsford, Massachusetts 01824**

(Address of principal executive offices,including zip code)

 

**(978) 614-8100**

(Registrant’s telephone number, includingarea code)

 

----

 

Indicate by check mark whether the Registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days. Yes ý  No o

 

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

 

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

 

 

----

 

**EXPLANATORYNOTE**

 

As reported in our 2003 Annual Report on Form 10-K/Afiled with the Securities and Exchange Commission (SEC) on July 28, 2004,we have restated our consolidated financial statements for the years ended December 31,2002 and 2001 and the nine months ended September 30, 2003. We alsoreported in our 2003 Annual Report on Form 10-K/A that we anticipated amendingour previously filed quarterly reports for each of the first three quarters of2003. This Amendment No. 1 on Form 10-Q/A to our Quarterly Report onForm 10-Q for the quarter ended September 30, 2003, filed with theSEC on November 10, 2003, is being filed for the purpose of restating ourcondensed consolidated financial statements and related disclosures for thethree and nine months ended September 30, 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 on Form 10-K/A filed with the SEC on July 28, 2004.

 

This Amendment No. 1 on Form 10-Q/A doesnot reflect events occurring after the filing of the original Quarterly Reporton Form 10-Q on November 10, 2003, or modify or update the disclosurepresented in the original Quarterly Report on Form 10-Q, except to reflectthe revisions as described above.

 

**SONUSNETWORKS, INC.**

**AMENDMENTNO.****1 ON FORM 10-Q/A**

**QUARTERENDED SEPTEMBER 30, 2003**

 

**TABLE OFCONTENTS**

 
| **PART I—FINANCIAL  INFORMATION** |                                                                                                                               |
|----------------------------------------|------------------------------------------------------------------------------------------------------------------------------------|
|                                   |                                                                                                                               |   |
| Item 1:                                | Financial Statements                                                                                                               |   |
|                                   | Condensed  Consolidated Balance Sheets as of September 30, 2003 (unaudited) and  December 31, 2002                       | 3 |
|                                   | Condensed  Consolidated Statements of Operations for the Three and Nine Months Ended  September 30, 2003 and 2002 (unaudited) | 4 |
|                                   | Condensed  Consolidated Statements of Cash Flows for the Nine Months Ended  September 30, 2003 and 2002 (unaudited)           | 5 |
|                                   | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                                  | 6 |
| Item  2:                               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                        | 28 |
| Item 4:                                | Controls and Procedures                                                                                                            | 36 |
|                                   |                                                                                                                               |   |
| **PART II—OTHER  INFORMATION**    |                                                                                                                                    |
|                                   |                                                                                                                               |   |
| Item 6:                                | Exhibits  and Reports on Form 8-K                                                                                                  | 38 |
|                                   | Signatures                                                                                                                         | 39 |

 

2

----

 

**PART I—FINANCIAL INFORMATION**

 

## **Item 1:Financial Statements**

##  

**SONUSNETWORKS, INC.**

**Condensed Consolidated Balance Sheets**

**(Inthousands, except share data)**

 
| ** **                                                                                                                                                                                                           | ** ** | **September 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                           | ** ** | **(As Restated)**            | ** ** | ** **                  | ** ** |
| ** **                                                                                                                                                                                                           | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| **Current  assets:**                                                                                                                                                                                                 |       |                         |       |                        |       |
| Cash and  cash equivalents                                                                                                                                                                                           |       | $                            | 255,059    |                        | $          | 57,278 |   |
| Marketable  securities                                                                                                                                                                                               |       | 45,875                       |       | 60,860                      |       |
| Accounts  receivable, net                                                                                                                                                                                            |       | 8,336                        |       | 4,622                       |       |
| Inventory,  net                                                                                                                                                                                                      |       | 16,422                       |       | 10,449                      |       |
| Other  current assets                                                                                                                                                                                                |       | 7,487                        |       | 3,516                       |       |
| Total  current assets                                                                                                                                                                                                |       | 333,179                      |       | 136,725                     |       |
| **Property  and equipment,** net                                                                                                                                                                                     |       | 6,933                        |       | 11,546                      |       |
| **Purchased  intangible assets,** net                                                                                                                                                                                |       | 3,004                        |       | 4,810                       |       |
| **Other  assets**                                                                                                                                                                                                    |       | 299                          |       | 436                         |       |
|                                                                                                                                                                                                                 |       | $                            | 343,415    |                        | $          | 153,517 |   |
|                                                                                                                                                                                                                 |       |                         |       |                        |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                       | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| **Current  liabilities:**                                                                                                                                                                                            |       |                         |       |                        |       |
| Accounts  payable                                                                                                                                                                                                    |       | $                            | 2,909      |                        | $          | 3,625 |   |
| Accrued  expenses                                                                                                                                                                                                    |       | 17,470                       |       | 16,489                      |       |
| Accrued  restructuring expenses                                                                                                                                                                                      |       | 845                          |       | 2,331                       |       |
| Current  portion of deferred revenue                                                                                                                                                                                 |       | 72,819                       |       | 51,728                      |       |
| Current  portion of long-term liabilities                                                                                                                                                                            |       | 1,329                        |       | 1,606                       |       |
| Total  current liabilities                                                                                                                                                                                           |       | 95,372                       |       | 75,779                      |       |
| **Long-term deferred revenue,** less current portion.                                                                                                                                                           |       | 12,344                       |       | 8,024                       |       |
| **Long-term  liabilities,** less current portion                                                                                                                                                                     |       | 1,822                        |       | 3,293                       |       |
| **Convertible  subordinated note**                                                                                                                                                                                   |       | 10,000                       |       | 10,000                      |       |
| **Commitments  and contingencies**(Note 9)                                                                                                                                                                      |       |                         |       |                        |       |
| **Stockholders’  equity:**                                                                                                                                                                                      |       |                         |       |                        |       |
| Preferred  stock, $0.01 par value; 5,000,000 shares authorized, none issued and outstanding                                                                                                                          |       | —                       |       | —                      |       |
| Common  stock, $0.001 par value; 600,000,000 shares authorized, 246,319,973 and 206,866,358  shares issued and 244,023,063 and 204,599,548 shares outstanding at September 30,  2003 and December 31, 2002 |       | 246                          |       | 207                         |       |
| Capital in  excess of par value                                                                                                                                                                                      |       | 1,040,518                    |       | 853,560                     |       |
| Accumulated  deficit                                                                                                                                                                                                 |       | (815,463                     | )          | (793,426                    | )          |
| Deferred  compensation                                                                                                                                                                                               |       | (1,157                       | )          | (3,659                      | )          |
| Treasury  stock, at cost; 2,296,910 and 2,266,810 common shares at September 30, 2003  and December 31, 2002                                                                                               |       | (267                         | )          | (261                        | )          |
| Total  stockholders’ equity                                                                                                                                                                                     |       | 223,877                      |       | 56,421                      |       |
|                                                                                                                                                                                                                 |       | $                            | 343,415    |                        | $          | 153,517 |   |

 

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

 

3

----

 

**SONUSNETWORKS, INC.**

**Condensed Consolidated Statements of Operations**

**(Inthousands, except per share data)**

**(Unauditedand As Restated)**

 
| ** **                                                  | ** ** | **Three Months ended   September 30,** | ** ** | **Nine Months ended   September 30,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                  | ** ** | **2003**                                    | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                        |       |                                        |       |                                       |       |   |   |   |   |
| **Revenues:**                                               |       |                                        |       |                                       |       |   |   |   |   |
| Product                                                     |       | $                                           | 14,528     |                                       | $          | 3,498 |   | $ | 26,300 |   | $ | 62,727 |   |
| Service                                                     |       | 7,723                                       |       | 5,660                                      |       | 20,526 |   | 18,714 |   |
| Total  revenues                                             |       | 22,251                                      |       | 9,158                                      |       | 46,826 |   | 81,441 |   |
| **Cost of  revenues**(1):                                   |       |                                        |       |                                       |       |   |   |   |   |
| Product                                                     |       | 5,382                                       |       | 5,034                                      |       | 10,816 |   | 28,610 |   |
| Service                                                     |       | 3,874                                       |       | 2,885                                      |       | 9,798 |   | 8,892 |   |
| Write-off of  inventory and purchase commitments            |       | —                                      |       | —                                     |       | — |   | 6,865 |   |
| Total cost  of revenues                                     |       | 9,256                                       |       | 7,919                                      |       | 20,614 |   | 44,367 |   |
| **Gross  profit**                                           |       | 12,995                                      |       | 1,239                                      |       | 26,212 |   | 37,074 |   |
| **Operating  expenses:**                                    |       |                                        |       |                                       |       |   |   |   |   |
| Research and  development (1)                               |       | 8,036                                       |       | 9,218                                      |       | 24,245 |   | 35,314 |   |
| Sales and  marketing (1)                                    |       | 7,732                                       |       | 4,466                                      |       | 16,179 |   | 21,342 |   |
| General and  administrative (1)                             |       | 842                                         |       | 2,932                                      |       | 4,137 |   | 6,711 |   |
| Stock-based  compensation                                   |       | 1,047                                       |       | 2,228                                      |       | 2,616 |   | 13,945 |   |
| Amortization  of purchased intangible assets                |       | 602                                         |       | 1,173                                      |       | 1,806 |   | 3,553 |   |
| Write-off of  goodwill and purchased intangible assets      |       | —                                      |       | 10,950                                     |       | — |   | 10,950 |   |
| Restructuring  charges, net                                 |       | —                                      |       | 1,007                                      |       | — |   | 6,772 |   |
| Total  operating expenses                                   |       | 18,259                                      |       | 31,974                                     |       | 48,983 |   | 98,587 |   |
| **Loss  from operations**                                   |       | (5,264                                      | )          | (30,735                                    | )          | (22,771 | ) | (61,513 | ) |
| Interest  expense                                           |       | (128                                        | )          | (162                                       | )          | (406 | ) | (437 | ) |
| Interest  income                                            |       | 396                                         |       | 465                                        |       | 1,238 |   | 1,569 |   |
| **Loss  before income taxes**                               |       | (4,996                                      | )          | (30,432                                    | )          | (21,939 | ) | (60,381 | ) |
| Provision  for income taxes                                 |       | 33                                          |       | 22                                         |       | 98 |   | 65 |   |
| **Net loss**                                                |       | $                                           | (5,029     | )                                          | $          | (30,454 | ) | $ | (22,037 | ) | $ | (60,446 | ) |
|                                                        |       |                                        |       |                                       |       |   |   |   |   |
| **Basic  and diluted net loss per share**                   |       | $                                           | (0.02      | )                                          | $          | (0.16 | ) | $ | (0.10 | ) | $ | (0.32 | ) |
|                                                        |       |                                        |       |                                       |       |   |   |   |   |
| **Shares  used in computing net loss per share**(Note 3(p)) |       | 224,356                                     |       | 193,155                                    |       | 213,322 |   | 189,962 |   |

 

----

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

 
| Cost of  revenues           |   | $   | 13     |   | $      | 99    |   | $     | 35     |   | $ | 463    |   |
|-----------------------------|--------|-----|--------|--------|--------|-------|--------|-------|--------|--------|---|--------|--------|
| Research and  development   |   | 314 |   | 1,207  |   | 943   |   | 7,532 |   |
| Sales and  marketing        |   | 603 |   | 752    |   | 1,282 |   | 4,413 |   |
| General and  administrative |   | 117 |   | 170    |   | 356   |   | 1,537 |   |
|                        |   | $   | 1,047  |   | $      | 2,228 |   | $     | 2,616  |   | $ | 13,945 |   |

 

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

 

4

----

 

**SONUSNETWORKS, INC.**

**Condensed Consolidated Statements of Cash Flows**

**(Inthousands, except per share data)**

**(Unauditedand As Restated)**

 
| ** **                                                                                 | ** ** | **Nine months ended   September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2003**                                   | ** ** | **2002** | ** ** |
|                                                                                       |       |                                       |       |   |   |
| **Cash  flows from operating activities:**                                                 |       |                                       |       |   |   |
| Net loss                                                                                   |       | $                                          | (22,037    | ) | $ | (60,446 | ) |
| Adjustments  to reconcile net loss to net cash provided by (used in) operating activities: |       |                                       |       |   |   |
| Depreciation  and amortization                                                             |       | 7,659                                      |       | 12,006 |   |
| Write-off of  inventory                                                                    |       | —                                     |       | 6,865 |   |
| Stock-based  compensation                                                                  |       | 2,616                                      |       | 13,945 |   |
| Amortization  of purchased intangible assets                                               |       | 1,806                                      |       | 3,553 |   |
| Write-off of  goodwill                                                                     |       | —                                     |       | 10,950 |   |
| Non-cash  restructuring benefit                                                            |       | —                                     |       | — |   |
| Changes in  current assets and liabilities:                                                |       |                                       |       |   |   |
| Accounts  receivable                                                                       |       | (3,714                                     | )          | 5,037 |   |
| Inventory                                                                                  |       | (5,973                                     | )          | 20,644 |   |
| Other  current assets                                                                      |       | (3,971                                     | )          | 4,261 |   |
| Accounts  payable                                                                          |       | (716                                       | )          | (9,672 | ) |
| Accrued  expenses                                                                          |       | (989                                       | )          | (9,993 | ) |
| Deferred  revenue                                                                          |       | 25,411                                     |       | (32,707 | ) |
| Net cash  provided by (used in) operating activities                                       |       | 93                                         |       | (35,557 | ) |
| **Cash  flows from investing activities:**                                                 |       |                                       |       |   |   |
| Purchases of  property and equipment                                                       |       | (3,046                                     | )          | (2,844 | ) |
| Maturities  of marketable securities                                                       |       | 19,682                                     |       | 35,631 |   |
| Purchases of  marketable securities                                                        |       | (4,697                                     | )          | (22,032 | ) |
| Other assets                                                                               |       | 137                                        |       | (8 | ) |
| Net cash  provided by investing activities                                                 |       | 12,076                                     |       | 10,747 |   |
| **Cash  flows from financing activities:**                                                 |       |                                       |       |   |   |
| Net proceeds  from sale of common stock to public                                          |       | 182,755                                    |       | — |   |
| Sale of  common stock in connection with employee stock purchase plan                      |       | 966                                        |       | 2,843 |   |
| Proceeds  from exercise of stock options                                                   |       | 3,162                                      |       | 108 |   |
| Additions to  long-term liabilities                                                        |       | —                                     |       | 3,300 |   |
| Payments of  long-term liabilities                                                         |       | (1,264                                     | )          | (620 | ) |
| Repurchase  of common stock                                                                |       | (6                                         | )          | (128 | ) |
| Net cash  provided by financing activities                                                 |       | 185,613                                    |       | 5,503 |   |
| **Net  increase (decrease) in cash and cash equivalents**                                  |       | 197,781                                    |       | (19,307 | ) |
| **Cash and  cash equivalents, beginning of period**                                        |       | 57,278                                     |       | 49,069 |   |
| **Cash and  cash equivalents, end of period**                                              |       | $                                          | 255,059    |   | $ | 29,762 |   |
|                                                                                       |       |                                       |       |   |   |
| **Supplemental  disclosure of cash flow information:**                                     |       |                                       |       |   |   |
| Cash paid  during the period for interest                                                  |       | $                                          | 288        |   | $ | 318 |   |

 

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

 

5

----

 

**SONUSNETWORKS, INC.**

**Notes to Condensed Consolidated Financial Statements**

**(Unaudited)**

 

**(1) Description of Business**

 

Sonus Networks, Inc. (Sonus) was incorporatedon August 7, 1997 and is a leading provider of packet voice infrastructuresolutions for wireline and wireless service providers. Sonus offers a newgeneration of carrier-class switching equipment and software that enabletelecommunications service providers to deliver voice services over packet-basednetworks.

 

**(2) Restatement of Consolidated Financial Statements**

 

Asreported in Sonus’ 2003 Annual Report on Form 10-K/A filed with the SEC onJuly 28, 2004, Sonus has restated its consolidated financial statementsfor the years ended December 31, 2002 and 2001 and the nine months ended September 30,2003. Sonus also reported in its 2003 Annual Report on Form 10-K/A that itanticipated 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 onForm 10-Q for the quarter ended September 30, 2003, filed with theSEC on November 10, 2003, for the purpose of restating its condensedconsolidated financial statements and related disclosures for the three andnine months ended September 30, 2003 and 2002. Amounts disclosedwith respect to the December 31, 2002 balance sheet have previously beenrestated in our Form 10-K/A filed with the SEC on July 28, 2004 and are notreported as restated herein.

 

6

----

 

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

 

**CondensedConsolidated Statements of Operations**

**(Inthousands, except per share data)**

**(Unaudited)**

 
| ** **                                                 | ** ** | **Three Months Ended September 30,  2003** | ** ** | **Nine Months Ended September 30,  2003** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                 | ** ** | **As Reported**                                 | ** ** | **Adjustments**                                | ** ** | **As Restated** | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| **Revenues:**                                              |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Product                                                    |       | $                                               | 22,352     |                                           | $          | (7,824 | ) | $ | 14,528 |   | $ | 48,408 |   | $ | (22,108 | ) | $ | 26,300 |   |
| Service                                                    |       | 6,292                                           |       | 1,431                                          |       | 7,723 |   | 17,611 |   | 2,915 |   | 20,526 |   |
|                                                       |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Total  revenues                                            |       | 28,644                                          |       | (6,393                                         | )          | 22,251 |   | 66,019 |   | (19,193 | ) | 46,826 |   |
| **Cost of  revenues:**                                     |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Product                                                    |       | 7,237                                           |       | (1,855                                         | )          | 5,382 |   | 16,129 |   | (5,313 | ) | 10,816 |   |
| Service                                                    |       | 3,810                                           |       | 64                                             |       | 3,874 |   | 9,876 |   | (78 | ) | 9,798 |   |
| Write-off  (benefit) of inventory and purchase commitments |       | —                                          |       | —                                         |       | — |   | (735 | ) | 735 |   | — |   |
|                                                       |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Total cost  of revenues                                    |       | 11,047                                          |       | (1,791                                         | )          | 9,256 |   | 25,270 |   | (4,656 | ) | 20,614 |   |
|                                                       |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| **Gross  profit**                                          |       | 17,597                                          |       | (4,602                                         | )          | 12,995 |   | 40,749 |   | (14,537 | ) | 26,212 |   |
| **Operating  expenses:**                                   |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Research and  development                                  |       | 7,984                                           |       | 52                                             |       | 8,036 |   | 23,931 |   | 314 |   | 24,245 |   |
| Sales and  marketing                                       |       | 6,536                                           |       | 1,196                                          |       | 7,732 |   | 17,453 |   | (1,274 | ) | 16,179 |   |
| General and  administrative                                |       | 999                                             |       | (157                                           | )          | 842 |   | 3,267 |   | 870 |   | 4,137 |   |
| Stock-based  compensation                                  |       | 866                                             |       | 181                                            |       | 1,047 |   | 2,499 |   | 117 |   | 2,616 |   |
| Amortization  of purchased intangible assets               |       | 271                                             |       | 331                                            |       | 602 |   | 813 |   | 993 |   | 1,806 |   |
|                                                       |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Total  operating expenses                                  |       | 16,656                                          |       | 1,603                                          |       | 18,259 |   | 47,963 |   | 1,020 |   | 48,983 |   |
|                                                       |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| **Income  (loss) from operations**                         |       | 941                                             |       | (6,205                                         | )          | (5,264 | ) | (7,214 | ) | (15,557 | ) | (22,771 | ) |
| Interest  expense                                          |       | (128                                            | )          | —                                         |       | (128 | ) | (406 | ) | — |   | (406 | ) |
| Interest  income                                           |       | 396                                             |       | —                                         |       | 396 |   | 1,238 |   | — |   | 1,238 |   |
| **Income  (loss) before income taxes**                     |       | 1,209                                           |       | (6,205                                         | )          | (4,996 | ) | (6,382 | ) | (15,557 | ) | (21,939 | ) |
| Provision  for income taxes                                |       | —                                          |       | 33                                             |       | 33 |   | — |   | 98 |   | 98 |   |
| **Net  income (loss)**                                     |       | $                                               | 1,209      |                                           | $          | (6,238 | ) | $ | (5,029 | ) | $ | (6,382 | ) | $ | (15,655 | ) | $ | (22,037 | ) |
| ** **                                                 |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| **Net  income (loss) per share:**                          |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Basic                                                      |       | $                                               | 0.01       |                                           | $          | (0.03 | ) | $ | (0.02 | ) | $ | (0.03 | ) | $ | (0.07 | ) | $ | (0.10 | ) |
|                                                       |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Diluted                                                    |       | $                                               | 0.01       |                                           | $          | (0.03 | ) | $ | (0.02 | ) | $ | (0.03 | ) | $ | (0.07 | ) | $ | (0.10 | ) |
|                                                       |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| **Shares  used in computing net income (loss) per share:** |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Basic                                                      |       | 224,356                                         |       | —                                         |       | 224,356 |   | 213,322 |   | — |   | 213,322 |   |
|                                                       |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Diluted                                                    |       | 239,446                                         |       | (15,090                                        | )          | 224,356 |   | 213,322 |   | — |   | 213,322 |   |

 

7

----

 
| ** **                                       | ** ** | **Three Months Ended September 30,  2002** | ** ** | **Nine Months Ended September 30,  2002** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                       | ** ** | **As Reported**                                 | ** ** | **Adjustments**                                | ** ** | **As Restated** | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| **Revenues:**                                    |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Product                                          |       | $                                               | 3,256      |                                           | $          | 242 |   | $ | 3,498 |   | $ | 34,864 |   | $ | 27,863 |   | $ | 62,727 |   |
| Service                                          |       | 4,189                                           |       | 1,471                                          |       | 5,660 |   | 15,034 |   | 3,680 |   | 18,714 |   |
|                                             |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Total  revenues                                  |       | 7,445                                           |       | 1,713                                          |       | 9,158 |   | 49,898 |   | 31,543 |   | 81,441 |   |
| **Cost of  revenues:**                           |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Product                                          |       | 2,246                                           |       | 2,788                                          |       | 5,034 |   | 16,152 |   | 12,458 |   | 28,610 |   |
| Service                                          |       | 2,501                                           |       | 384                                            |       | 2,885 |   | 8,418 |   | 474 |   | 8,892 |   |
| Write-off of  inventory and purchase commitments |       | —                                          |       | —                                         |       | — |   | 9,434 |   | (2,569 | ) | 6,865 |   |
|                                             |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Total cost  of revenues                          |       | 4,747                                           |       | 3,172                                          |       | 7,919 |   | 34,004 |   | 10,363 |   | 44,367 |   |
|                                             |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| **Gross  profit**                                |       | 2,698                                           |       | (1,459                                         | )          | 1,239 |   | 15,894 |   | 21,180 |   | 37,074 |   |
| **Operating  expenses:**                         |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Research and  development                        |       | 9,685                                           |       | (467                                           | )          | 9,218 |   | 36,525 |   | (1,211 | ) | 35,314 |   |
| Sales and  marketing                             |       | 5,520                                           |       | (1,054                                         | )          | 4,466 |   | 22,207 |   | (865 | ) | 21,342 |   |
| General and  administrative                      |       | 2,446                                           |       | 486                                            |       | 2,932 |   | 5,603 |   | 1,108 |   | 6,711 |   |
| Stock-based  compensation                        |       | 3,962                                           |       | (1,734                                         | )          | 2,228 |   | 15,654 |   | (1,709 | ) | 13,945 |   |
| Amortization  of purchased intangible assets     |       | 366                                             |       | 807                                            |       | 1,173 |   | 1,155 |   | 2,398 |   | 3,553 |   |
| Write-off of  goodwill and purchased intangibles |       | 1,673                                           |       | 9,277                                          |       | 10,950 |   | 1,673 |   | 9,277 |   | 10,950 |   |
| Restructuring  charges (benefit), net            |       | 987                                             |       | 20                                             |       | 1,007 |   | (10,141 | ) | 16,913 |   | 6,772 |   |
|                                             |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Total  operating expenses                        |       | 24,639                                          |       | 7,335                                          |       | 31,974 |   | 72,676 |   | 25,911 |   | 98,587 |   |
|                                             |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| **Loss  from operations**                        |       | (21,941                                         | )          | (8,794                                         | )          | (30,735 | ) | (56,782 | ) | (4,731 | ) | (61,513 | ) |
| Interest  expense                                |       | (163                                            | )          | 1                                              |       | (162 | ) | (438 | ) | 1 |   | (437 | ) |
| Interest  income                                 |       | 466                                             |       | (1                                             | )          | 465 |   | 1,570 |   | (1 | ) | 1,569 |   |
| **Loss  before income taxes**                    |       | (21,638                                         | )          | (8,794                                         | )          | (30,432 | ) | (55,650 | ) | (4,731 | ) | (60,381 | ) |
| Provision  for income taxes                      |       | —                                          |       | 22                                             |       | 22 | ** ** | — |   | 65 |   | 65 |   |
| **Net loss**                                     |       | $                                               | (21,638    | )                                              | $          | (8,816 | ) | $ | (30,454 | ) | $ | (55,650 | ) | $ | (4,796 | ) | $ | (60,446 | ) |
|                                             |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| **Basic  and diluted net loss per share**        |       | $                                               | (0.11      | )                                              | $          | (0.05 | ) | $ | (0.16 | ) | $ | (0.30 | ) | $ | (0.02 | ) | $ | (0.32 | ) |
|                                             |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| **Shares  used in computing net loss per share** |       | 191,823                                         |       | 1,332                                          |       | 193,155 |   | 188,620 |   | 1,342 |   | 189,962 |   |

 

8

----

 

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

 

**CondensedConsolidated Balance Sheet**

**September 30,2003**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
|-----------------------------------------------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| **Assets**                                                |       |            |       |            |       |            |       |
| **Current  assets:**                                      |       |            |       |            |       |            |       |
| Cash and  cash equivalents                                |       | $               | 246,981    |            | $          | 8,078           |       | $ | 255,059 |   |
| Marketable  securities                                    |       | 45,875          |       | —          |       | 45,875          |       |
| Accounts  receivable, net                                 |       | 5,604           |       | 2,732           |       | 8,336           |       |
| Inventory,  net                                           |       | 12,333          |       | 4,089           |       | 16,422          |       |
| Other  current assets                                     |       | 6,313           |       | 1,174           |       | 7,487           |       |
| Total  current assets                                     |       | 317,106         |       | 16,073          |       | 333,179         |       |
| **Property  and equipment,** net                          |       | 6,514           |       | 419             |       | 6,933           |       |
| **Purchased  intangible assets,** net                     |       | 361             |       | 2,643           |       | 3,004           |       |
| **Other  assets**                                         |       | 339             |       | (40             | )          | 299             |       |
|                                                      |       | $               | 324,320    |            | $          | 19,095          |       | $ | 343,415 |   |
| **Liabilities  and Stockholders’ Equity**            |       |            |       |            |       |            |       |
| **Current  liabilities:**                                 |       |            |       |            |       |            |       |
| Accounts  payable                                         |       | $               | 3,637      |            | $          | (728            | )          | $ | 2,909 |   |
| Accrued  expenses                                         |       | 32,923          |       | (15,453         | )          | 17,470          |       |
| Accrued  restructuring expenses                           |       | 845             |       | —          |       | 845             |       |
| Current  portion of deferred revenue                      |       | 34,036          |       | 38,783          |       | 72,819          |       |
| Current  portion of long-term liabilities                 |       | 1,329           |       | —          |       | 1,329           |       |
|                                                      |       |            |       |            |       |            |       |
| Total  current liabilities                                |       | 72,770          |       | 22,602          |       | 95,372          |       |
|                                                      |       |            |       |            |       |            |       |
| **Long-term deferred revenue,** less current portion |       | —          |       | 12,344          |       | 12,344          |       |
| **Long-term  liabilities,** less current portion          |       | 1,822           |       | —          |       | 1,822           |       |
| **Convertible  subordinated note**                        |       | 10,000          |       | —          |       | 10,000          |       |
| **Commitments  and contingencies**                        |       |            |       |            |       |            |       |
| **Stockholders’  equity:**                           |       |            |       |            |       |            |       |
| Preferred  stock                                          |       | —          |       | —          |       | —          |       |
| Common stock                                              |       | 246             |       | —          |       | 246             |       |
| Capital in  excess of par value                           |       | 1,045,077       |       | (4,559          | )          | 1,040,518       |       |
| Accumulated  deficit                                      |       | (804,250        | )          | (11,213         | )          | (815,463        | )          |
| Deferred  compensation                                    |       | (1,078          | )          | (79             | )          | (1,157          | )          |
| Treasury  stock, at cost                                  |       | (267            | )          | —          |       | (267            | )          |
| Total  stockholders’ equity                          |       | 239,728         |       | (15,851         | )          | 223,877         |       |
|                                                      |       | $               | 324,320    |            | $          | 19,095          |       | $ | 343,415 |   |

 

These restated financial statements include a numberof adjustments, which primarily relate to revenue, deferred revenue, inventoryreserves, purchase accounting, impairments, accrued expenses and stock-basedcompensation. Adjustments to revenue result primarily in revenue being deferredand recognized in subsequent periods. Adjustments to inventory and accruedexpenses are primarily to increase or decrease reserve levels previouslyreported. Adjustments to purchase accounting, impairment, and stock-basedcompensation relate primarily to the timing of expense recognition.  The following discussion provides additionalinformation regarding these adjustments.

 

9

----

 

***Revenue Adjustments***

 

*Deferral of product revenue*

 

Sonus has deferred revenues of $36.7 millionpreviously reported in 2001 and the first quarter of 2002 from a particularcustomer transaction. The amount of $27.5 million was subsequentlyrecognized in the second quarter of 2002, while the remainder was allocated tomaintenance revenue and recognized over the period the services are provided.This transaction involved a complex multiple element arrangement that requiredsignificant analysis with respect to the facts surrounding the transaction andtechnical accounting analysis to determine when revenue should be recognized.Sonus previously recognized revenue in 2001 under this contractual arrangementupon delivery and acceptance of certain product and software releases. As aresult of a comprehensive review and analysis of this arrangement, and based onthe application of complex revenue recognition guidance, Sonus has nowdetermined that there was insufficient support to establish vendor specificobjective evidence of fair value (VSOE) with respect to certain undeliveredsoftware releases 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 itsarrangement with this customer to include, among other items, certainadditional future software releases. Sonus previously recognized revenue fromthis arrangement in the fourth quarter of 2002 and in each of the first threequarters of 2003 upon delivery of the products and software releases. Uponreview and analysis of the arrangement, Sonus has determined that, based on atechnical analysis of software revenue recognition rules,that VSOE was not established for certain undelivered software releases.As a result, Sonus has deferred revenues of $16.2 million associated withproducts and software releases shipped to this customer during the fourthquarter of 2002 and the first three quarters of 2003, including the deferral of$3.1 million and $15.5 million of products and software releases shipped duringthe three and nine months ended September 30, 2003. Sonus recognized$10.9 million of those revenues in the fourth quarter of 2003 when thefinal software release specified in the amendment was delivered to thecustomer, and the remaining amount was deferred and allocated to maintenanceservices and estimated discounts on future purchases.

 

*Maintenance revenue*

 

A number of Sonus’ customer transactions involvemultiple elements, including the delivery of product and maintenance servicesas part of a bundled offering. Statement of Position (SOP) 97-2, *Software Revenue Recognition*, requiresmaintenance revenue to be recognized over the period services are provided.Based on Sonus’ review and analysis, Sonus identified certain circumstances inwhich Sonus offered maintenance services at no additional charge or atdiscounted rates to certain customers but did not separate the fair value forthe maintenance from product revenue. This resulted in revenue associated withthe value of the undelivered maintenance services not being recognized over theservice period. In the restated financial statements, Sonus has recognizedmaintenance revenue ratably over the period in which the maintenance serviceswere provided based on the deferral of the applicable VSOE of maintenanceservices. In such cases, Sonus has reclassified maintenance services fromproduct revenue to service revenue for the applicable periods presented. Basedon Sonus’ review and analysis, Sonus also identified certain circumstances inwhich insufficient value was allocated to maintenance. In such cases, Sonus hasreclassified additional amounts from product revenue to service revenue for theapplicable periods presented. In connection with the recognition of thedeferred product revenue described above in the second quarter of 2002 and thefourth quarter of 2003, a significant portion of the product revenue wasallocated to the value of undelivered maintenance services and deferred overthe five-year period in which the maintenance services are provided.

 

*Delivery*

 

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

 

10

----

 

product.

 

*Customer acceptance*

 

Sonus identified certain circumstances where revenuewas recognized in a period other than the one in which acceptance was achievedor other contingencies were resolved. As restated, revenue from sucharrangements is recorded in the period in which customer acceptance occurred orother contingencies were resolved.

 

*Summary*

 

The following table is a reconciliation of revenueas previously reported to amounts as restated for the periods indicated, inthousands:

 
| ** **                             | ** ** | **Three months  ended   September 30,  2003** | ** ** | **Three months  ended   September 30,  2002** | ** ** | **Nine months  ended  September 30,  2003** | ** ** | **Nine months  ended   September 30,  2002** | ** ** |
|----------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                         | ** ** | ** **                                         | ** ** | ** **                                       | ** ** | ** **                                        | ** ** |
| Revenues, as  previously reported      |       | $                                                  | 28,644     |                                               | $          | 7,445                                            |       | $                                                 | 66,019     |   | $ | 49,898 |   |
| Revenue  Restatement Adjustments:      |       |                                               |       |                                               |       |                                             |       |                                              |       |
| Deferral of  product revenue           |       | (3,072                                             | )          | 2,255                                              |       | (15,452                                          | )          | 35,389                                            |       |
| Maintenance  revenue                   |       | (2,627                                             | )          | (1,575                                             | )          | (2,816                                           | )          | (11,934                                           | )          |
| Delivery                               |       | (12                                                | )          | (12                                                | )          | (332                                             | )          | 3,908                                             |       |
| Customer  acceptance                   |       | (682                                               | )          | (35                                                | )          | (754                                             | )          | 1,622                                             |       |
| Other                                  |       | —                                             |       | 1,080                                              |       | 161                                              |       | 2,558                                             |       |
| Total  Revenue Restatement Adjustments |       | (6,393                                             | )          | 1,713                                              |       | (19,193                                          | )          | 31,543                                            |       |
| Revenues, as  restated                 |       | $                                                  | 22,251     |                                               | $          | 9,158                                            |       | $                                                 | 46,826     |   | $ | 81,441 |   |

 

###### ***Expense Adjustments***

######  

*Accrued expenses*

 

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

 

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

 
| ** **                                                 | ** ** | **Sept. 30, 2003** | ** ** | **December 31, 2002** | ** ** |
|------------------------------------------------------------|------------|--------------------|------------|----------------------------|------------|
| Accrued  expense adjustments—increase/(decrease) for: |       |               |       |                       |       |
| Employee  compensation and related costs                   |       | $                  | (991       | )                          | $          | 208 |   |
| Professional  fees                                         |       | (1,080             | )          | (1,239                     | )          |
| Royalties                                                  |       | 1,163              |       | 1,492                      |       |
| Warranty  reserve                                          |       | (3,109             | )          | (3,385                     | )          |
| Post-shipment  obligations to customers                    |       | (2,527             | )          | (2,527                     | )          |
| Customer  deposits                                         |       | (6,576             | )          | (7,240                     | )          |
| Other                                                      |       | (2,333             | )          | (4,199                     | )          |
| Total accrued expense adjustments                          |       | $                  | (15,453    | )                          | $          | (16,890 | ) |

 

11

----

 

*Restructuring expense and benefits*

 

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

 

***Valuation of Intangibles***

 

During 2001, Sonus acquired two companies, 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 an independent third-partyappraiser. In connection with the TTI acquisitionre-appraisal, Sonus has re-examained the total consideration paid, netliabilities assumed, and certain assumptions and calculations supporting theoriginal appraisal of the identified intangible assets acquired from TTI. Theseassumptions included the customer turnover rate, the gross and operating marginpercentages and inconsistencies in the profit assumptions used to value in-processresearch and development compared to other identified intangible assets. Theresults of these changes to the purchase price and related allocation for theTTI acquisition are as follows, in thousands:

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

 

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

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

 

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

 

***Impairment***

 

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

 

12

----

 

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

 

**SFAS No.121 Impairment of Assets Acquired from TTI**

**(in thousands)**

 
| ** **              | ** ** | **Remaining   Value as of  December 31, 2001** | ** ** | **Remaining  Value as of   December 31, 2001** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **              | ** ** | **(as reported)**                                   | ** ** | **(as restated)**                                   | ** ** |
| Customer  relationships |       | $                                                   | 2,308      |                                                | $          | 16,350 |   |
| Developed  technology   |       | —                                              |       | —                                              |       |
| Workforce               |       | 797                                                 |       | 2,381                                               |       |
| Fixed assets            |       | —                                              |       | —                                              |       |
| Total                   |       | $                                                   | 3,105      |                                                | $          | 18,731 |   |

 

In 2002, Sonus adopted SFAS No. 141, whichresulted in a reclassification of all remaining workforce-related intangibleassets into goodwill. As a result of the continuing and significant decline inthe market for telecommunications equipment and pursuant to SFAS No. 144, *Accounting for the Impairment or Disposal of Long-livedAssets*, Sonus performed an impairment analysis of certain technologyacquired from Linguateq. In addition, Sonus performed an impairment analysis onits remaining goodwill for both the TTI and Linguateq acquisitions pursuant toSFAS No. 142, *Goodwill and OtherIntangible Assets*. The results of these analyses are summarized inthe following table, in thousands:

 
| ** **                                                | ** ** | **Three and Nine Months Ended September 30,  2002** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                | ** ** | **Impairment  charge,   As Reported**                    | ** ** | **Adjustments** | ** ** | **Impairment  charge,   As Restated** | ** ** |
| TTI customer  relationships                               |       | $                                                        | —     |   | $ | 7,669 |   | $ | 7,669 |   |
| TTI goodwill                                              |       | 796                                                      |       | 1,585 |   | 2,381 |   |
| Linguateq  developed technology and customer relationship |       | 175                                                      |       | — |   | 175 |   |
| Linguateq  goodwill                                       |       | 877                                                      |       | (152 | ) | 725 |   |
| Total                                                     |       | $                                                        | 1,848      |   | $ | 9,102 |   | $ | 10,950 |   |

 

***Stock-based Compensation***

 

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

 

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

 

13

----

 

*Accounting for Certain Transactions involving StockCompensation, an interpretation of APB Opinion No. 25*, requires that compensation expense beadjusted to recapture the compensation expense previously recorded related tounvested stock-based awards, in the period of forfeiture. Sonus previously hadnot recorded recapture of any such excess compensation expense upon theforfeiture of a stock-based award upon employee termination. As a result, Sonushas decreased stock-based compensation by $55,000 and $2,051,000 for the threemonths ended September 30, 2003 and 2002 and $229,000 and $4,119,000 forthe nine months ended September 30, 2003 and 2002, in these restatedfinancial statements, which includes the recapture of excess compensationexpense related to the items discussed in the following two paragraphs.

 

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

 

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

 

Sonus has determined that it improperly calculateddeferred stock-based compensation and the related amortization associated withthe restricted stock issued under the TTI Retention Plan. As a result, Sonusdecreased stock-based compensation by $3,000 and $4,000 for the three and ninemonths ended September 30, 2003 and increased stock-based compensation by  $176,000 and$2,133,000 for the three and nine months ended September 30, 2002 toreflect the amortization of deferred stock-based compensation that should havebeen recorded.

 

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

 

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

 
| ** **                                                                             | ** ** | **Three months  ended   September 30,  2003** | ** ** | **Three months  ended  September 30,  2002** | ** ** | **Nine months  ended  September 30,  2003** | ** ** | **Nine months  ended  September 30,  2002** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| Stock-based  Compensation  Adjustments—increase/(decrease) for:                   |       |                                               |       |                                              |       |                                             |       |                                             |       |
| Recapture of  compensation expense in connection with employee terminations            |       | $                                                  | (55        | )                                                 | $          | (2,051                                           | )          | $                                                | (229       | ) | $ | (4,119 | ) |
| Amortization  related to the intrinsic value of options granted to new employees       |       | 18                                                 |       | 79                                                |       | 74                                               |       | 328                                              |       |
| Adjusted  amortization under accelerated method prescribed by FIN 28              |       | 17                                                 |       | (12                                               | )          | 72                                               |       | (183                                             | )          |
| Amortization  related to restricted stock issued in connection with TTI Retention Plan |       | (3                                                 | )          | 176                                               |       | (4                                               | )          | 2,133                                            |       |
| Charge for  modification in connection with employee terminations                      |       | 204                                                |       | 74                                                |       | 204                                              |       | 132                                              |       |
| Total Stock-based  Compensation Restatement Adjustments                                |       | $                                                  | 181        |                                              | $          | (1,734                                           | )          | $                                                | 117        |   | $ | (1,709 | ) |

 

14

----

 

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

 

###### ***Inventory Reserves***

######  

As of September 30, 2003 and September 30,2002 Sonus’ originally reported excess, obsolete and evaluation reservebalances were $17,904,000 and $17,914,000. Sonus has determined that itsexcess, obsolete and evaluation reserve balances were not consistentlycalculated and, as a result of Sonus’ review of its reserves and considerationof contemporaneous facts and circumstances, Sonus decreased its reserves andreduced cost of product revenues by $937,000 and $266,000 as of and for thenine months ended September 30, 2003 and 2002.

 

***Other Balance Sheet Adjustments***

 

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

 

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

 

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

 

***Other Statement of OperationsAdjustments***

 

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

 

15

----

 

**(3) Summary of Significant Accounting Policies**

 

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

 

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

 

The accompanying unaudited condensed consolidatedfinancial statements have been prepared by Sonus and reflect all adjustments,consisting only of normal recurring adjustments that in the opinion ofmanagement are necessary for a fair statement of the results for the interimperiods. The unaudited condensed consolidated financial statements have beenprepared in accordance with the regulations of the Securities and ExchangeCommission (SEC), and omit or condense certain information and footnotedisclosures pursuant to existing SEC rules and regulations. Results for theinterim period are not necessarily indicative of results to be expected for anyother interim period or the entire fiscal year. These statements should be readin conjunction with the consolidated financial statements and related notesincluded in Sonus’ Annual Report on Form 10-K/A for the year ended December 31,2003 filed with the SEC.

 

The accompanying condensed consolidated financialstatements include the accounts of Sonus and its wholly owned subsidiaries. Allmaterial intercompany transactions and balances have been eliminated.

 

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

 

The preparation of financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting periods. Significant estimates relied upon in preparingthese financial 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 accruedinterest, which approximates market value, and have maturities of three monthsor less at the date of purchase.

 

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

 

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

 

The financial instruments that potentially subjectSonus to concentrations of credit risk are cash, cash equivalents, marketable securities and accounts receivables. Sonus has nooff-balance sheet concentrations such as foreign exchange contracts, optionscontracts or other foreign hedging arrangements. Sonus’ cash and cashequivalent holdings are diversified among four financial institutions.

 

16

----

 

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

 
| ** **                      | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| **Customer:**                   | ** ** | **2003**                                  | ** ** | **2002**                                 | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                      | ** ** | **(As Restated)**                         | ** ** | **(As Restated)**                        | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** |
| Verizon  Global Networks        |       | 28                                        | %          | *                                        | %          | 21 | % | * | % |
| Global  Crossing                |       | 14                                        |       | *                                        |       | 18 |   | * |   |
| Qwest  Communications           |       | *                                         |       | 36                                       |       | * |   | 47 |   |
| T-Nova  Deutsche Telekom        |       | *                                         |       | 17                                       |       | * |   | * |   |
| Nissho  Electronics Corporation |       | *                                         |       | *                                        |       | 10 |   | * |   |

 

----

*                                         Represents less than 10% of revenues.

 

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

 

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

 

Certain components and software licenses from thirdparties used in Sonus’ products are procured from single sources of supply. Thefailure of a supplier, including a subcontractor, to deliver on schedule coulddelay or interrupt Sonus’ delivery of products and thereby materially adverselyaffect Sonus’ revenues and operating results.

 

***(e) AccountsReceivable***

 

Accounts receivable consist of the following, inthousands:

 
| ** **                       | ** ** | **September 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(As Restated)**            | ** ** | ** **                  | ** ** |
| Earned  accounts receivable      |       | $                            | 6,355      |                        | $          | 4,873 |   |
| Unearned  accounts receivable    |       | 2,123                        |       | 90                          |       |
| Accounts  receivable, gross      |       | 8,478                        |       | 4,963                       |       |
| Allowance  for doubtful accounts |       | (142                         | )          | (341                        | )          |
| Accounts  receivable, net        |       | $                            | 8,336      |                        | $          | 4,622 |   |

 

Unearned accounts receivable represent productsshipped to customers where Sonus has a contractual right to bill the customerand collectibility is probable prior to satisfying Sonus’ revenue recognitioncriteria. The allowance for doubtful accounts is based on Sonus’ detailedassessment of the collectibility of specific customer accounts.

 

***(f) Inventory***

 

Inventory consists of the following, in thousands:

 

17

----

 
| ** **                                             | ** ** | **September 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **(As Restated)**            | ** ** | ** **                  | ** ** |
| On-hand  final assemblies and finished goods inventory |       | $                            | 15,779     |                        | $          | 12,292 |   |
| Unearned  inventory                                    |       | 13,735                       |       | 10,441                      |       |
| Evaluation  inventory                                  |       | 3,982                        |       | 6,022                       |       |
| Inventory,  gross                                      |       | 33,496                       |       | 28,755                      |       |
| Excess,  obsolete and evaluation reserve               |       | (17,074                      | )          | (18,306                     | )          |
| Inventory,  net                                        |       | $                            | 16,422     |                        | $          | 10,449 |   |

 

Unearned inventory represents deferred cost ofrevenues for product shipments prior to satisfaction of Sonus’ revenuerecognition criteria.

 

Sonus values inventory at the lower of cost or netrealizable value and provides inventory reserves based on excess and obsoleteinventories determined primarily by future demand forecasts and records changesto such reserves through charges to cost of revenues. Sonus also records a fullinventory reserve for evaluation equipment at the time of shipment to itscustomers as a charge to sales and marketing expense as Sonus’ experience withthis type of inventory indicates it is probable that the inventory will not berealizable. If these evaluation shipments should convert to revenue, Sonusrecords a benefit to sales and marketing expense and records the full cost ofrevenues in the period of revenue recognition.

 

***(g) Property andEquipment***

 

Property and equipment are stated at cost, net ofaccumulated depreciation. Expenditures for maintenance and repairs are chargedto expense as incurred. Depreciation is computed using the straight-line methodover the estimated useful life of the related assets, which ranges from threeto five years. Leasehold improvements are amortized over the lesser of the lifeof the lease or five years. When an item is sold or retired, the cost andrelated accumulated 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 $3,004,000 as of September 30,2003 and $4,810,000 as of December 31, 2002 are carried at cost lessaccumulated amortization. Amortization is computed over the estimated usefullives of the respective assets. Sonus expects that the remaining amount ofpurchased intangible assets will be fully amortized by December 2004.

 

***(i) DeferredRevenue***

 

Deferred revenue consists of the following, inthousands:

 
| ** **                         | ** ** | **September 30,  2003** | ** ** | **December 31,  2002** | ** ** |
|------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **(As Restated)**            | ** ** | ** **                  | ** ** |
| Maintenance  and support contracts |       | $                            | 29,612     |                        | $          | 24,832 |   |
| Customer  deposits                 |       | 53,428                       |       | 34,830                      |       |
| Unearned  revenue                  |       | 2,123                        |       | 90                          |       |
| Total  deferred revenue            |       | 85,163                       |       | 59,752                      |       |
| Less current  portion              |       | (72,819                      | )          | (51,728                     | )          |
|                               |       | $                            | 12,344     |                        | $          | 8,024 |   |

 

Maintenance and support contracts are recognizedratably over the life of the service contract. Customer deposits representpayments received in advance of revenue recognition. Unearned revenuerepresents billings for which payment has not been received and revenuerecognition criteria have not been met.

 

18

----

 

***(j) RevenueRecognition***

 

Sonus recognizes 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 isprobable under ordinary payment terms. When Sonus has future obligations,including a requirement to deliver additional elements which are essential tothe functionality of the delivered elements or for which vendor specificobjective evidence of fair value (VSOE) does not exist or customer acceptanceis required, Sonus defers 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 Sonus’ sales are generated from complexcontractual arrangements which require significant revenue recognitionjudgments, particularly in the case of multiple element arrangements. When asale involves multiple elements, such as products, maintenance or professionalservices, Sonus allocates the entire sales price to each respective elementbased on VSOE or using the residual method when VSOE cannot be established fora single delivered element in the arrangement. Sonus then recognizes revenue oneach element in accordance with its policies for revenue recognition related toeach element. Sonus determines VSOE based upon the price charged when the sameelement is sold separately. If Sonus cannot establish VSOE for each undeliveredelement, it defers revenue recognition on the entire arrangement until theearlier of the establishment of VSOE or delivery of the undelivered element.

 

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

 

Maintenance and support services are recognizedratably over the life of the maintenance and support service period, whichtypically is one year when the services are sold separately and up to fiveyears when the fees for the services are bundled with the product fees as partof a multiple element arrangement. Maintenance and support services includetelephone support and unspecified rights to product upgrades and enhancements.Maintenance and support VSOE represents a consistent percentage of the salesprices charged to customers. The application of judgment could affect thecontinued determination of maintenance and support VSOE and Sonus’ ability torecognize revenue using the residual method.

 

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

 

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

 

Sonus records deferred revenue for product shippedto customers and related services where amounts are billed pursuant to acontractual right and collection is probable, or collected, in the ordinarycourse of business if the revenue recognition criteria have not been satisfied.Deferred revenues include customer deposits and amounts associated withmaintenance contracts Deferred revenues not expected to be recognized withinone year of the balance sheet date are classified as long-term deferredrevenues.

 

Sonus defers recognition of incremental directcosts, such as cost of goods, royalties, commissions and third-partyinstallation costs, until satisfaction of the criteria for recognition of therelated revenue.

 

***(k) SoftwareDevelopment Costs***

 

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

 

19

----

 

Standards (SFAS) No. 86, *Accounting for the Costs of Computer Software to BeSold, Leased or Otherwise Marketed*. Accordingly, the costs for the developmentof new software and substantial enhancements to existing software are expensedas incurred until technological feasibility has been established, at which timeany additional costs would be capitalized. Sonus has determined thattechnological feasibility is established at the time a working model of thesoftware 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-Based Compensation***

 

SFAS No. 123, *Accounting for Stock-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 plans and uses the fair valuemethod of SFAS No. 123 to account for all non-employee stock-basedcompensation. Sonus follows FASB Interpretation (FIN) No. 28, *Accounting for Stock Appreciation Rights and OtherVariable Stock Option or Award Plans* and amortizes the intrinsicvalue for all awards as measured under APB No. 25 on an accelerated basis.SFAS No. 123, as amended by SFAS No. 148, *Accounting for Stock-Based Compensation—Transition and Disclosure—anamendment of FASB Statement No. 123*, requires companiesfollowing APB No. 25 to make pro forma disclosure in the notes to thefinancial statements using the measurement provisions of SFAS No. 123.

 

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

 
| ** **                                                                                                             | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2003**                                   | ** ** | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                             | ** ** | **(As Restated)**                          | ** ** | **(As Restated)**                         | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** |
| **Net  loss—**                                                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| As reported                                                                                                            |       | $                                          | (5,029     | )                                         | $          | (30,454 | ) | $ | (22,037 | ) | $ | (60,446 | ) |
| Plus:  Employee stock-based compensation expense included in net loss under  intrinsic value method related to options |       | 540                                        |       | 2,130                                     |       | 1,894 |   | 12,894 |   |
| Less:  Employee stock-based compensation under fair value method                                                       |       | (11,932                                    | )          | (11,628                                   | )          | (31,330 | ) | (35,745 | ) |
| Pro forma                                                                                                              |       | $                                          | (16,421    | )                                         | $          | (39,952 | ) | $ | (51,473 | ) | $ | (83,297 | ) |
|                                                                                                                   |       |                                       |       |                                      |       |   |   |   |   |
| **Basic  and diluted net loss per share—**                                                                        |       |                                       |       |                                      |       |   |   |   |   |
| As reported                                                                                                            |       | $                                          | (0.02      | )                                         | $          | (0.16 | ) | $ | (0.10 | ) | $ | (0.32 | ) |
| Pro forma                                                                                                              |       | $                                          | (0.07      | )                                         | $          | (0.21 | ) | $ | (0.24 | ) | $ | (0.44 | ) |

 

***(m) ComprehensiveLoss***

 

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

 

20

----

 

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

 

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

 

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

 

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

 

SFAS No. 131, *Disclosuresabout Segments 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.

 

***(p) Net Loss Per Share***

 

Basic net loss per share is computed by dividing thenet loss for the period by the weighted average number of shares ofunrestricted common stock outstanding during the period. Diluted net loss pershare is computed by dividing the net loss for the period by the weightedaverage number of shares of unrestricted common stock and dilutive potentialcommon shares outstanding based on the average market price of Sonus’ commonstock (under the treasury stock method). Dilutive potential common sharesconsist of restricted common stock and common stock issuable upon the exerciseof stock options and conversion of a convertible subordinated note.  There were no dilutive shares of potentialcommon stock for the three and nine months ended September 30, 2003 and2002 as Sonus incurred a net loss in each period.

 

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

 
| ** **                                                  | ** ** | **Three months ended   September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                  | ** ** | **2003**                                    | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                  | ** ** | **(As Restated)**                           | ** ** | **(As Restated)**                          | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** |
|                                                        |       |                                        |       |                                       |       |   |   |   |   |
| Weighted  average common shares outstanding                 |       | 227,343                                     |       | 203,853                                    |       | 217,893 |   | 203,450 |   |
| Less  weighted average restricted common shares outstanding |       | (2,987                                      | )          | (10,698                                    | )          | (4,571 | ) | (13,488 | ) |
| Shares used  in basic and diluted per share calculation     |       | 224,356                                     |       | 193,155                                    |       | 213,322 |   | 189,962 |   |

 

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

 

***(q) RecentAccounting Pronouncements***

 

In June 2002, the FASB issued SFASNo. 146, *Accounting for CostsAssociated with Exit or Disposal Activities*. SFAS No. 146addresses the recognition, measurement and reporting of costs associated withexit and disposal activities, including restructuring activities that wereaccounted for in accordance with Emerging Issues Task Force IssueNo. 94-3, *Liability Recognition forCertain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring*). The scope ofSFAS No. 146 includes costs related to terminating a contract that is nota capital lease, costs to consolidate facilities or relocate employees, andcertain termination benefits provided to employees who are involuntarilyterminated. SFAS No. 146 is effective for exit or disposal activitiesinitiated after December 31, 2002. The implementation of this statement didnot have a material impact on its financial position or results of operations.

 

In November 2002, the FASB issuedInterpretation No. (FIN) 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others.* FIN 45 elaborates on thedisclosures to be made by a guarantor in its interim and annual financialstatements about its obligations under certain guarantees that it has issued.It also clarifies that a guarantor is required to recognize, at the inceptionof a guarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee. The initial recognition and initial measurementprovisions of the interpretation are applicable on a prospective basis toguarantees issued or modified after December 31, 2002 and the disclosurerequirements in this interpretation are effective for financial statements ofinterim or annual periods ending after December 15, 2002. The FINNo. 45 disclosure requirements are included in Note 5 to 

 

21

----

 

Sonus’ unaudited condensed consolidated financialstatements. Theadoption of FIN 45 did not have a material impact on Sonus’ financial positionor results of operations.

 

In December 2002, the FASB issued SFASNo. 148, *Accounting for Stock-BasedCompensation—Transition and Disclosure,* an amendment of SFASNo. 123. SFAS No. 148 provides alternative methods of transition fora voluntary change to the fair value-based method of accounting for employeestock-based compensation. These alternative methods will only impact Sonus ifit voluntarily changes to the fair value-based method of accounting foremployee stock-based compensation. SFAS No. 148 also requires companieswho account for employee stock-based compensation under the intrinsic value-basedmethod to disclose additional footnote information in annual financialstatements effective for fiscal years ending after December 15, 2002 andin financial statements for interim periods beginning after December 15,2002. The requisite disclosure appears in Note 3(l) to Sonus’ unauditedcondensed consolidated financial statements.

 

In January 2003, the FASB issued InterpretationNo. 46, *Consolidation of VariableInterest Entities* (FIN No. 46) to clarify the conditions underwhich assets, liabilities and activities of another entity should beconsolidated into the financial statements of a company. FIN No. 46requires the consolidation of a variable interest entity by a company thatbears the majority of the risk of loss from the variable interest entity’sactivities, is entitled to receive a majority of the variable interest entity’sresidual returns or both. Sonus does not have any variable interest entities.

 

In May 2003, the FASB issued SFAS No. 150,*Accounting For Certain Financial Instrumentswith Characteristics of Both Liabilities and Equity*, whichestablishes standards for how an issuer of financial instruments classifies andmeasures certain financial instruments with characteristics of both liabilitiesand equity. SFAS No. 150 requires that an issuer classify a financialinstrument that is within its scope as a liability (or an asset in somecircumstances) because that financial instrument embodies an obligation of theissuer. SFAS No. 150 is effective for financial instruments entered intoor modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003. Theadoption of SFAS No. 150 did not have any impact on Sonus’ overallfinancial position or results of operations.

 

In August 2003, the EITF reached a consensus onIssue No. 03-05, *Applicability of AICPAStatement of Position 97-2 to Non-Software Deliverables in an ArrangementContaining More-Than-Incidental Software.* EITF Issue No. 03-05addresses the applicability of SOP 97-2 to non-software deliverables in anarrangement containing more-than-incidental software. In an arrangement thatincludes software that is more-than-incidental to the products or services as awhole, software and software-related elements are included within the scope ofSOP 97-2. Software-related elements include software products andservices, as well as any non-software deliverables for which a softwaredeliverable is essential to its functionality. The adoption of this statementdid not have a material impact on Sonus’ consolidated financial results.

 

***(r) WarrantyReserve***

 

Sonus’ products are covered by a standard warrantyof 90 days for software and one year for hardware. In addition, certaincustomer contracts include warranty-type provisions for epidemic or similarproduct failures, generally for the contractual period or the life of theproduct in accordance with published telecommunications standards. Sonusaccrues for such contingent obligations when the occurrence of such obligationis probable and the amount of such obligation is reasonably estimable. Sonushas not incurred significant costs related to such obligations. Sonus’customers typically purchase maintenance and support contracts, which encompassits warranty obligations. Sonus’ estimates of anticipated rates of warrantyclaims and costs are primarily based on historical information and futureforecasts.

 

In addition, certain of Sonus’ customer contractsinclude provisions under which Sonus may be obligated to pay penaltiesgenerally for the contractual period or for the life of the product if itsproducts fail or do not perform in accordance with specifications. Sonusaccrues for such contingent obligations when the occurrence of such obligationis probable and the amount of such obligation is reasonably estimable. Sonushas not incurred significant costs related to such provisions. Sonusperiodically assesses the adequacy of its recorded warranty liabilities andadjusts the amounts as necessary. Increases in product failures rates, materialusage or service delivery costs may result in increases to Sonus’ warrantyreserve and its gross profit could be adversely affected.

 

22

----

 

**(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 service providers,Sonus implemented restructuring plans designed to reduce expenses and align itscost structure with its revised business outlook. The restructuring plansincluded worldwide workforce reductions, consolidation of excess facilities andthe write-off of excess inventory and purchase commitments.

 

**2002 Restructuring Accrual**

 

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

 
| ** **                        | ** ** | **December 31,  2002  Accrual  Balance** | ** ** | **Cash  Payments** | ** ** | **September  30, 2003  Accrual  Balance** | ** ** | **Current  Portion** | ** ** | **Long-term  Portion** | ** ** |
|-----------------------------------|------------|-----------------------------------------------|------------|--------------------|------------|-------------------------------------------|------------|----------------------|------------|------------------------|------------|
| ** **                        | ** ** | ** **                                    | ** ** | ** **         | ** ** | **(As Restated)**                         | ** ** | ** **           | ** ** | ** **             | ** ** |
|                              |       |                                          |       |               |       |                                      |       |                 |       |                   |       |
| Workforce reduction               |       | $                                             | 534        |               | $          | (534                                      | )          | $                    | —     |                   | $          | — |   | $ | — |   |
| Consolidation of facilities       |       | 2,214                                         |       | (885               | )          | 1,329                                     |       | 485                  |       | 844                    |       |
| Sub-total                         |       | 2,748                                         |       | (1,419             | )          | 1,329                                     |       | 485                  |       | 844                    |       |
| Write-off of purchase commitments |       | 340                                           |       | (260               | )          | 80                                        |       | 80                   |       | —                 |       |
| Total                             |       | $                                             | 3,088      |               | $          | (1,679                                    | )          | $                    | 1,409      |                   | $          | 565 |   | $ | 844 |   |

 

The remaining cash expenditures relating to the consolidation of excessfacilities are expected to be paid through 2008. The purchase commitmentobligations are expected 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 $1,507,000and $4,355,000 were recorded in the three and nine months ended September 30,2002. In addition, Sonus recorded non-cash stock-based compensation expense of$1,467,000 in the nine months ended September 30, 2002 related to thewrite-off of deferred compensation associated with shares and options held byterminated employees.

 

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

 

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

 

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

 

During the nine months ended September 30, 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.

 

23

----

 

**2001 Restructuring Accrual**

 

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

 
| ** **                                     | ** ** | **December 31,  2002  Accrual  Balance** | ** ** | **Cash  Payments** | ** ** | **September 30,  2003  Accrual  Balance** | ** ** | **Current  Portion** | ** ** | **Long-Term  Portion** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------|------------|--------------------|------------|------------------------------------------------|------------|----------------------|------------|------------------------|------------|
|                                           |       |                                          |       |               |       | **(As Restated)**                              |       |                 |       |                   |       |
|                                           |       |                                          |       |               |       | ** **                                     |       |                 |       |                   |       |
| Consolidation of facilities and other  charges |       | $                                             | 571        |               | $          | (291                                           | )          | $                    | 280        |                   | $          | 280 |   | $ | — |   |
|                                                |            |                                               |            |                    |            |                                                |            |                      |            |                        |            |  |  |  |  |  |

 

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

 

**(5) Warranty Reserve**

 

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

 
| Balance at December 31, 2002  |   | $      | 1,300  |   |
|------------------------------------|--------|--------|--------|--------|
| Charges to costs and expenses      |   | 1,600  |   |
| Deductions                         |   | — |   |
| Balance at September 30, 2003 |   | $      | 2,900  |   |

 

**(6) Long-term Liabilities**

 

Long-term liabilities consist of capital leases, borrowings from a 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 monthlyinstallments expiring at various dates through March 2005 and accrueinterest at annual rates ranging from 4.8% to 10.3%. The future minimum annualpayments under capital leases and amounts due for long-term liabilities, as of September 30,2003, are as follows, in thousands:

 
| **Capital  Leases:**                                     | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|------------|------------|
| 2003 obligations (three months)                          |       | $          | 83         |   |
| 2004 obligations                                         |       | 189        |       |
| 2005 obligations                                         |       | 30         |       |
| Total minimum lease payments                             |       | 302        |       |
| Less amount representing interest                        |       | (13        | )          |
| Present value of minimum payments                        |       | 289        |       |
| **Borrowings  under equipment line of credit with bank** |       | 2,017      |       |
| **Long-term  portion of restructuring expenses**         |       | 845        |       |
| Total long-term liabilities                              |       | 3,151      |       |
| Less current portion                                     |       | (1,329     | )          |
| Long-term liabilities, net of current  portion           |       | $          | 1,822      |   |

 

The future principal payments on total long-term liabilities, excludingthe capital leases, as of September 30, 2003 are: $275,000 in 2003 (threemonths); $1,147,000 in 2004; $828,000 in 2005; $195,000 in 2006; $204,000 in2007; and $213,000 in 2008.

 

24

----

 

**(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 (4.00% at September, 2003), available through March 23,2004. Amounts borrowed under the equipment line were repayable over a 36-monthperiod. For both lines of credit, Sonus had to comply with certain restrictivecovenants including maintaining certain minimum investment balances with thebank, a minimum tangible stockholders’ equity of $131,000,000 as of September 30,2003 and a quick ratio of 1.5 to 1.0, as defined in the credit agreement. Underthe agreement, all of Sonus’ assets, except intellectual property, had beenpledged as collateral. As of September 30, 2003, Sonus had $2,017,000outstanding under the equipment line of credit (Note 6) and was incompliance with all bank covenants. Interest expense related to the line of credit was $2,000 and $59,000for the three and nine months ended September 30, 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 September 30, 2003 and 2002 and $357,000 for boththe nine months ended September 30, 2003 and 2002.

 

**(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.

 

In October 2003, Sonus entered into a sublease agreement(Sublease) for a new corporate headquarters facility with rent commencing in April 2004and extending through January 2007. The future minimum payments underoperating lease arrangements as of September 30, 2003, including the newSublease, are as follows: $1,949,000 in 2003 (three months); $1,693,000 in2004; $1,068,000 in 2005; $876,000 in 2006; $261,000 in 2007; and $213,000 in2008. The 2003 payment includes a rent prepayment in the amount of $1,250,000due upon signing of the Sublease.

 

***(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’ initialpublic offering (IPO) and seeking unspecified monetary damages. The purchaserseeks to represent a class of persons who purchased Sonus’ common stock betweenthe IPO on May 24, 2000 and December 6, 2000. An amended complaintwas filed in April 2002. The amended complaint alleges that Sonus’registration statement contained false or misleading information or omitted tostate material facts concerning the alleged receipt of undisclosed compensationby the 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 of theSecurities Act. Other plaintiffs have filed substantially similar class actioncases against approximately 300 other publicly traded companies and their IPOunderwriters which, along with the actions against Sonus, have been transferredto a single federal judge for purposes of coordinated case management. On July 15,2002, Sonus, together with the other issuers named as defendants in thesecoordinated proceedings, filed a collective motion to dismiss the consolidatedamended complaints on various legal grounds common to all or most of the issuerdefendants. The plaintiffs voluntarily dismissed the claims against theindividual defendants, including those Sonus officers named in the

 

25

----

 

complaint. On February 19, 2003, the court granted a portion ofthe motion 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 proceeded against Sonus on the Section 11claims. In June 2003, a special committee of Sonus’ Board of Directorsauthorized Sonus to enter into a proposed settlement with the plaintiffs onterms substantially consistent with the terms of a Memorandum of Understandingnegotiated among representatives of the plaintiffs, the issuer defendants andthe insurers for the issuer defendants. The settlement contemplated by theMemorandum of Understanding is subject to a number of conditions includingapproval by the court. It remains uncertain whether and when the conditionswill be met and the settlement will become final. Sonus does not expect thatthe settlement contemplated by the Memorandum of Understanding would have amaterial impact on Sonus’ business or financial results.

 

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 ClassAction Complaints were essentially identical and alleged that Sonus made falseand misleading statements about its products and business. On March 3,2003, the plaintiffs filed a Consolidated Amended Complaint. On April 22,2003, Sonus filed a motion to dismiss the Consolidated Amended Complaint onvarious grounds. The plaintiffs’ filed an opposition to the motion on June 6,2003. Sonus filed its reply on July 8, 2003. The parties have requestedoral argument on the motion, but a date has not yet been set. Sonus believesthe claims in the Consolidated Amended Complaint are without merit and that ithas substantial legal and factual defenses, which it intends to pursuevigorously.

 

**(10) Stockholders’ Equity**

 

***(a) PublicOfferings***

 

In September 2003, Sonus completed a public offering of 17,000,000shares of its common stock at $7.75 per share, resulting in net proceeds of$126,088,000 after deducting offering costs of $5,662,000.

 

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.

 

***(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 September 30, 2003, 110,611,642 shares were authorizedand 35,310,118 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. On May 27, 2003, employees receivedan option to purchase one share of common stock for each share of common stockunder the exchanged options.  The newoptions were granted at an exercise price of $4.08 per share, which representedthe fair market value of 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 September 30, 2003, 15,444,657 shares wereauthorized and 3,306,330 shares were available under the ESPP for futureissuance.

 

26

----

 

***(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 $1,047,000 and $2,228,000for the three months ended September 30, 2003 and 2002 and $2,616,000 and$13,945,000 for the nine months ended September 30, 2003 and 2002.

 

27

----

 

## **Item 2: Management’s Discussionand Analysis of Financial Condition and Results of Operations**

##  

*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 three and nine months ended September 30,2003 were $22.3 million and $46.8 million, compared to$9.2 million and $81.4 million for the same periods in fiscal 2002.Significant declines in capital spending by telecommunications serviceproviders, and financial difficulties, including in some cases bankruptcies,experienced by certain emerging service providers, including some of ourcustomers, caused the reduction in our revenues in 2002 and in the first ninemonths of 2003. In response to the unfavorable economic conditions, commencingin the third quarter of fiscal 2001 and continuing through fiscal 2002, weimplemented restructuring plans designed to reduce expenses and align our coststructure with our revised business outlook. The restructuring plans includedworldwide workforce reductions, consolidation of excess facilities and thewrite-off of excess inventory and purchase 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 September 30,2003, had an accumulated deficit of $815.5 million. Although we achievedprofitability in the second quarter of fiscal 2002, as of September 30,2003 we had not achieved profitability on an annual basis and may incuradditional net losses in future quarters and years. The quarterly net income inthe second quarter of 2002 was primarily the result of recognizing previouslydeferred revenue of $27.5 million from arrangements with a single customer uponthe delivery of certain specified software releases in the second quarter of2002. We have a lengthy sales cycle for our products and, accordingly, weexpect to incur sales and other expenses before we realize the relatedrevenues.

 

**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

28

----

 

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.

 

29

----

 

***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 accountsor receive payments on a timely basis could have a material adverse effect onour business, 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 product repairs.Accordingly, if inventory previously written down to its net realizable valueis subsequently sold, we may realize improved gross profit margins on thosetransactions 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.

 

30

----

 

***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,statutory minimum tax rates or changes to federal, state or foreign tax laws,future expansion into areas with varying country, state, and local income taxrates, including statutory minimum tax rates, deductibility of certain costsand expenses by jurisdiction and as a result of acquisitions.

 

***Threeand Nine Months Ended September 30, 2003 and 2002***

 

***Revenues.***  Revenues for the three and nine months ended September 30,2003 and 2002 were as follows, in thousands:

 
| ** **     | ** ** | **Three Months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **     | ** ** | **2003**                                   | ** ** | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **     | ** ** | **(As Restated)**                          | ** ** | **(As Restated)**                         | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** |
| **Revenues:**  |       |                                       |       |                                      |       |   |   |   |   |
| Product        |       | $                                          | 14,528     |                                      | $          | 3,498 |   | $ | 26,300 |   | $ | 62,727 |   |
| Service        |       | 7,723                                      |       | 5,660                                     |       | 20,526 |   | 18,714 |   |
| Total revenues |       | $                                          | 22,251     |                                      | $          | 9,158 |   | $ | 46,826 |   | $ | 81,441 |   |

 

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 revenuesincreased 315% for the three months ended September 30, 2003 and decreased58% for the nine months ended September 30, 2003, compared to the sameperiods in fiscal 2002. The increase in product revenues for the three monthsended September 30, 2003 was primarily a result of improved marketconditions for the sale of voice infrastructure products to telecommunicationsservice providers. The decrease in product revenue for the nine months ended September 30,2003 was

 

31

----

 

primarily due to the recognition of $27.5 million from one customer inthe second quarter of 2002 upon completion of the delivery of a specifiedsoftware upgrade for product shipped in 2001. In addition, during the first twoquarters of 2003, there was lower demand caused by significant declines incapital spending by telecommunications service providers and financialdifficulties, including in some cases bankruptcies, experienced by certainemerging service providers, including some of our customers.

 

Service revenues primarily comprise hardware and software maintenance,network design and other professional services. Service revenues for the threeand nine months ended September 30, 2003 increased 36% and 10% from thesame periods in fiscal 2002. The increases in service revenues were primarilydue to an increase in maintenance revenue as a result of the growing installedcustomer base and the completion of significant professional services andinstallation projects.

 

For the three months ended September 30, 2003 and 2002, twocustomers each contributed 10% or more of our revenues, representing anaggregate of 42% and 53% of total revenues. For the nine months ended September 30,2003 and 2002, three customers and one customer each contributed 10% or more ofour revenues, representing an aggregate of 49% and 47% of total revenues. Thefollowing customers contributed 10% or more of our revenues in the three andnine months ended September 30, 2003 and 2002:

 
| ** **                     | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| **Customer:**                  | ** ** | **2003**                                  | ** ** | **2002**                                 | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                     | ** ** | **(As Restated)**                         | ** ** | **(As Restated)**                        | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** |
| Verizon Global Networks        |       | 28                                        | %          | *                                        | %          | 21 | % | * | % |
| Global Crossing                |       | 14                                        |       | *                                        |       | 18 |   | * |   |
| Qwest Communications           |       | *                                         |       | 36                                       |       | * |   | 47 |   |
| T-Nova Deutsche Telekom        |       | *                                         |       | 17                                       |       | * |   | * |   |
| Nissho Electronics Corporation |       | *                                         |       | *                                        |       | 10 |   | * |   |

 

----

*                                         Representsless than 10% of revenues.

 

International revenues, primarily to Asia and Europe, were 37% and 32%of revenues for the three months ended September 30, 2003 and 2002.  International revenues, primarily to Asia andEurope, were 33% and 18% of revenues for the nine months ended September 30,2003 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. In addition, product cost of revenues for the three andnine months ended September 30, 2002 includes an accrued amount for patentinfringement claims. Cost of revenues and gross profit as a percentage of revenuesfor the three and nine months ended September 30, 2003 and 2002 were asfollows, in thousands except percentages):

 
| ** **                                       | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                       | ** ** | **2003**                                  | ** ** | **2002**                                 | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                       | ** ** | **(As Restated)**                         | ** ** | **(As Restated)**                        | ** ** | **(As Restated)** | ** ** | **(As Restated)** | ** ** |
| **Cost of  revenues:**                           |       |                                      |       |                                     |       |   |   |   |   |
| Product                                          |       | $                                         | 5,382      |                                     | $          | 5,034 |   | $ | 10,816 |   | $ | 28,610 |   |
| Service                                          |       | 3,874                                     |       | 2,885                                    |       | 9,798 |   | 8,892 |   |
| Write-off of inventory and purchase  commitments |       | —                                    |       | —                                   |       | — |   | 6,865 |   |
| Total cost of revenues                           |       | $                                         | 9,256      |                                     | $          | 7,919 |   | $ | 20,614 |   | $ | 44,367 |   |
|                                             |       |                                      |       |                                     |       |   |   |   |   |
| **Gross profit**(%  of respective revenues):     |       |                                      |       |                                     |       |   |   |   |   |
| Product                                          |       | 63                                        | %          | (44                                      | )%         | 59 | % | 54 | % |
| Service                                          |       | 50                                        |       | 49                                       |       | 52 |   | 52 |   |
| Total gross profit                               |       | 58                                        |       | 14                                       |       | 56 |   | 46 | (1) |

 

32

----

 

----

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

 

The increase in product gross profit as a percentage of productrevenues for the three months ended September 30, 2003 compared to thesame period in fiscal 2002 was primarily due to $1.5 million of costs during thethree months ended September 30, 2002 for patent infringement claims andas well as the reduction of previously reported product revenue for the VSOE ofmaintenance services for a particular customer transaction. In addition, agreater proportion of revenues were related to higher margin software for thethree months ended September 30, 2003. The increase in product grossprofit as a percentage of product revenues for the nine months ended September 30,2003 compared to the same period in fiscal 2002, excluding the write-offs ofinventory and purchase commitments, was primarily due to changes in product andcustomer mix, partially offset by a higher proportion of fixed costs resultingfrom the significant decline in revenue. Service gross profit as a percentageof revenues was consistent for both the three and nine months ended September 30,2003 compared to the same periods in fiscal 2002. Our service cost of revenuesis relatively fixed in advance of any particular quarter.

 

During the nine months ended September 30, 2002, we included incost of revenues charges of $6.9 million, consisting of $4.5 million for thewrite-off of inventory determined to be excess and obsolete and $2.4 millionfor materials that were expected to be purchased from third-party contractmanufacturers and suppliers under purchase commitments, but which were inexcess of required quantities. Remaining cash expenditures of $0.1 million at September 30,2003 for purchase commitments are included on the balance sheet as accruedrestructuring 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 $8.0 million for the three months ended September 30,2003, a decrease of $1.2 million, or 13%, from $9.2 million for thesame period in fiscal 2002. Research and development expenses were$24.2 million for the nine months ended September 30, 2003, adecrease of $11.1 million, or 31%, from $35.3 million for the sameperiod in fiscal 2002. These decreases primarily reflect a reduction insalaries and related expenses attributable to restructuring actions, reductionsin consulting fees, prototype costs and depreciation expense. The decrease forthe three months ended September 30, 2003 as compared to the same periodin fiscal 2002 was partially offset by the reinstatement in April 2003 ofa temporary salary reduction originally implemented in April 2002.  Some aspects of our research and developmentefforts require significant short-term expenditures, the timing of which cancause significant variability 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 and marketing expenses were$7.7 million for the three months ended September 30, 2003, anincrease of $3.2 million, or 73%, from $4.5 million for the sameperiod in fiscal 2002. Sales and marketing expenses were $16.2 million forthe nine months ended September 30, 2003, a decrease of $5.1 million,or 24%, from $21.3 million for the same period in fiscal 2002. Theincrease for the three months ended September 30, 2003 as compared to thesame period in fiscal 2002 was primarily due to an increase in salary levelsresulting from the reinstatement in April 2003 of a temporary salaryreduction originally implemented in April 2002 and increased commissionsdue to higher sales, partially off set by reductions in customer evaluationexpense. The decrease for the nine months ended September 30, 2003compared to the same period in 2002 primarily reflects a reduction in salariesand related expenses attributable to restructuring actions and, to a lesserextent, a decrease in commissions due to decreased revenues and a reduction incosts for customer evaluations, travel entertainment and trade shows.

 

***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 $842,000 forthe three months ended September 30, 2003, a decrease of$2.1 million, or 71%, from $2.9 million for the same period in fiscal2002. General and administrative expenses were $4.1 million for the ninemonths ended September 30, 2003, a decrease of $2.6 million, or 38%,from $6.7 million for the same period in fiscal 2002. These decreasesprimarily reflect reductions in salaries and related expenses attributed torestructuring actions and, to a lesser extent, a reduction in professional feesand depreciation expenses. The decrease for the

 

33

----

 

three months ended September 30, 2003 as compared to the sameperiod in fiscal 2002 was partially offset by the reinstatement in April 2003of a temporary salary reduction originally implemented in April 2002.

 

***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 $1.0 million for the three monthsended September 30, 2003, a decrease of $1.2 million, or 53%, from$2.2 million for the same period in fiscal 2002. Stock-based compensationexpenses were $2.6 million for the nine months ended September 30,2003, a decrease of $11.3 million, or 81%, from 13.9 million for thesame period in fiscal 2002. These decreases are primarily due to lowereddeferred compensation balances resulting from write-offs made in connectionwith employee terminations and accelerated recognition of deferred compensationexpense 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 and Write-offof Purchased 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.  Amortization of purchased intangible assetswas $602,000 for the three months ended September 30, 2003, a decrease of$571,000, or 49%, from $1.2 million for the same period in fiscal 2002.Amortization of purchased intangible assets was $1.8 million for the ninemonths ended September 30, 2003, a decrease of $1.8 million, or 49%, from$3.6 million for the same period in fiscal 2002. In the third quarter offiscal 2002, in accordance with SFAS No. 142, in response to unfavorablebusiness conditions, we re-evaluated the fair value of our goodwill and as aresult recorded a non-cash impairment charge of $10.9 million for the write-offof goodwill established in connection with the acquisitions of TTI andLinguateq. The decreases of amortization of purchased intangible assets weredue to the 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.  We reduced our worldwide workforce for whichwe recorded charges of $1.5 million and $4.3 million for the three and nine monthsended September 30, 2002. As of September 30, 2003, all cashexpenditures had been made related to this reduction. In the three and ninemonths ended September 30, 2002, we recorded a restructuring benefit of$500,000 and a net restructuring charge of $2.4 million for the additionalconsolidation of excess facilities, which were included on the balance sheet inaccrued restructuring expenses and long-term liabilities.

 

***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 ofinterest expense, was $268,000 for the three months ended September 30,2003, a decrease of $35,000 from $303,000 for the same period in fiscal 2002.Interest income, net of interest expense, was $832,000 for the nine monthsended September 30, 2003, a decrease of $300,000 from $1.1 million for thesame period in fiscal 2002. These decreases primarily reflect a reduction ininterest rates, partially offset by an increase in our cash balances.

 

***Income Taxes.***  Provision for income taxes recorded was$33,000 for the three months ended September 30, 2003, compared to $22,000for same period in fiscal 2002. For the nine months ended September 30,2003, provision for income taxes,recorded was $98,000, compared to $65,000 forsame period in fiscal 2002.  The incometax provision in all periods is attributable primarily to foreign income taxesand state minimum income taxes in the U.S.

 

34

----

 

**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 September 30, 2003, our principal sources of liquidity were ourcash, cash equivalents and marketable securities that totaled$300.9 million. In September 2003, we completed a public offering of17,000,000 shares of our common stock at a price of $7.75 per share resultingin net proceeds of $126.1 million after deducting offering costs of$5.7 million.  In April 2003,we completed a public offering of 20,000,000 shares of our common stock at aprice of $3.05 per share resulting in net proceeds of $56.7 million afterdeducting offering expenses of $4.3 million.

 

Our operating activities provided net cash of $93,000 for the ninemonths ended September 30, 2003, as compared to net cash used of$35.6 million for the same period in fiscal 2002. The increase 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 increases in receivables, inventory and other current assets and adecrease in non-cash items.

 

Net cash provided by investing activities was $12.1 million forthe nine months ended September 30, 2003 primarily reflects net maturitiesof marketable securities of $15.0 million, partially offset by purchasesof property and equipment of $3.0 million, as compared to$10.7 million for the same period in fiscal 2002 which primarily reflectsnet maturities of marketable securities of $13.6 million, partially offsetby purchases of property and equipment of $2.8 million.

 

Net cash provided by financing activities was $185.6 million for thenine months ended September 30, 2003, as compared to $5.5 million for thesame period in fiscal 2002. The net cash provided by financing activities forthe nine months ended September 30, 2003 primarily resulted from thepublic offerings of common stock completed in April and September 2003.The net cash provided by financing activities for the nine months ended September 30,2002 primarily resulted from the sale of common stock in connection with ouremployee stock purchase plan and additions to long-term liabilities, net ofpayments on our long-term liabilities.

 

As of September 30, 2003 we had a $10.0 million equipmentline of credit and a $20.0 million working capital line of credit with abank available through March 23, 2004. The lines of credit werecollateralized by all of our assets, except intellectual property, and boreinterest at the bank’s prime rate. We were required to comply with variousfinancial and restrictive covenants. As of September 30, 2003, we had $2.0million outstanding under the equipment line of credit and were in compliancewith all bank covenants.

 

The following summarizes our future contractual cash obligations as of September 30,2003, in thousands:

 
| ** **                   | ** ** | **Payment Due by Period** | ** ** |
|------------------------------|------------|---------------------------|------------|
| **Contractual  Obligations** | ** ** | **Total**                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **Thereafter** | ** ** |
| Long-term debt obligations   |       | $                         | 13,526     |   | $ | 1,641 |   | $ | 11,885 |   | $ | — |   | $ | — |   |
| Capital lease obligations    |       | 302                       |       | 240 |   | 62 |   | — |   | — |   |
| Operating lease obligations  |       | 6,060                     |       | 3,367 |   | 1,999 |   | 640 |   | 54 |   |
| Total                        |       | $                         | 19,888     |   | $ | 5,248 |   | $ | 13,946 |   | $ | 640 |   | $ | 54 |   |

 

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.

 

35

----

 

***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 FIN 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others.*FIN 45 elaborates on the disclosures to be made by a guarantor in its interimand annual financial statements about its obligations under certain guaranteesthat it has issued. It also clarifies that a guarantor is required torecognize, at the inception of a guarantee, a liability for the fair value ofthe obligation undertaken in issuing the guarantee. The initial recognition andinitial measurement provisions of the interpretation are applicable on aprospective basis to guarantees issued or modified after December 31, 2002and the disclosure requirements in this interpretation are effective forfinancial statements of interim or annual periods ending after December 15,2002. The FIN 45 disclosure requirements are included in Note 5 to ourcondensed consolidated unaudited financial statements. The adoption of FIN 45did not have a material impact on our financial position or results ofoperations.

 

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.

 

In May 2003, the FASB issued SFAS No. 150, *Accounting For Certain Financial Instruments withCharacteristics of Both Liabilities and Equity*, which establishes standardsfor how an issuer of financial instruments classifies and measures certainfinancial instruments with characteristics of both liabilities and equity. SFASNo. 150 requires that an issuer classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances) becausethat financial instrument embodies an obligation of the issuer. SFAS No. 150is effective for financial instruments entered into or modified after May 31,2003, and otherwise is effective at the beginning of the first interim periodbeginning after June 15, 2003. The adoption of SFAS No. 150 did nothave any impact on our overall financial position or results of operations.

 

In August 2003, the EITF reached a consensus on Issue No. 03-05,*Applicability of AICPA Statement of Position97-2 to Non-Software Deliverables in an Arrangement ContainingMore-Than-Incidental Software.* EITF Issue No. 03-05 addressesthe applicability of SOP 97-2 to non-software deliverables in anarrangement containing more-than-incidental software. In an arrangement thatincludes software that is more-than-incidental to the products or services as awhole, software and software-related elements are included within the scope ofSOP 97-2. Software-related elements include software products andservices, as well as any non-software deliverables for which a softwaredeliverable is essential to its functionality. The adoption of this statementdid not have a material impact on our consolidated financial results.

 

## **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 September 30,2003. 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 September 30, 2003.

 

36

----

 

An initial evaluation of our disclosure controls and procedures wasperformed shortly following the quarter ended September 30, 2003 by ourmanagement at that time.  Subsequently,in connection with the restatement of our consolidated financial statements forthe years ended 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 September 30, 2003, as described in theabove referenced periodic reports, no change in our internal control overfinancial reporting occurred during the fiscal quarter ended September 30,2003 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,described below, on which we currently rely will fail to be sufficientlyeffective, which could result in material misstatement of our financialposition or results of operations 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 somepersons, by collusion of two or more people, or by management override of thecontrols. The design of any system of controls also is based in part uponcertain assumptions 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 should be read in conjunction with thisItem 4 for a more complete understanding of the matters covered by the

 

37

----

 

certifications.

 

**PART II—OTHERINFORMATION**

 

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

##  

(a)                                  Exhibits:

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                   |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                              |
| 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. |

 

(b)                                 Reportson Form 8-K:

 

Sonus furnished a Current Report on Form 8-K dated July 10,2003 reporting under Item 9 (Regulation FD Disclosure) its actual financialresults for the quarter ended June 30, 2003.

 

Sonus filed a Current Report on Form 8-K dated September 23,2003 reporting under Item 5 (Other Events and Regulation FD Disclosure) apublic offering of 17,000,000 shares of its common stock pursuant to aneffective registration statement on FormS-3.

 

38

----

 

# **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)* |

 

39

----

 

**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                   |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                              |
| 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. |

 

40

----