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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2003

Commission File Number 000-30229

SONUS NETWORKS, INC.
(Exact name of Registrant as specified in its charter)

DELAWARE
(State or other jurisdiction of
incorporation or organization)		   04-3387074
(I.R.S. employer identification no.)

5 Carlisle Road, Westford, Massachusetts 01886
(Address of principal executive offices, including zip code)

(978) 692-8999
(Registrant's telephone number, including area code)

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

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

        As of October 31, 2003, there were 244,451,558 shares of $0.001 par value per share, common stock outstanding.


SONUS NETWORKS, INC.

FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2003


TABLE OF CONTENTS

 
    
   Page
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 Statement of Stockholders' Equity for the Nine Months Ended September 30, 2003 (unaudited)
 
5

 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2002 (unaudited)
 
6

 
 
Notes to Condensed Consolidated Financial Statements (unaudited)
 
7
 
Item 2:
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
19

 
 
Cautionary Statements
 
26
 
Item 3:
 
Quantitative and Qualitative Disclosures About Market Risk
 
34
 
Item 4:
 
Controls and Procedures
 
35


PART II—OTHER INFORMATION

 

 
 

Item 1:

 

Legal Proceedings

 

36
 
Item 6:
 
Exhibits and Reports on Form 8-K
 
37

 
 
Signature
 
38

2

PART I—FINANCIAL INFORMATION

Item 1: Financial Statements


SONUS NETWORKS, INC.

Condensed Consolidated Balance Sheets

(In thousands, except share and per share data)

 
   September 30,
2003
   December 31,
2002
  
 
   (unaudited)

    
  
Assets              
Current assets:              
  Cash and cash equivalents   $ 246,981   $ 50,307  
  Marketable securities     45,875     60,860  
  Accounts receivable, net     5,604     2,956  
  Inventories     12,333     10,776  
  Other current assets     6,313     3,806  
   
 
 
    Total current assets     317,106     128,705  
Property and equipment, net     6,514     11,174  
Purchased intangible assets, net     361     1,174  
Other assets, net     339     480  
   
 
 
    $ 324,320   $ 141,533  
   
 
 
Liabilities and Stockholders' Equity              
Current liabilities:              
  Accounts payable   $ 3,637   $ 4,142  
  Accrued expenses     32,923     33,379  
  Accrued restructuring expenses     845     3,143  
  Deferred revenue     34,036     29,235  
  Current portion of long-term obligations     1,329     1,606  
   
 
 
    Total current liabilities     72,770     71,505  
Long-term obligations, less current portion     1,822     3,293  
Convertible subordinated note     10,000     10,000  
Commitments and contingencies (Note 10)              
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, 246,318,848 and 206,860,358 shares issued and 244,021,938 and 204,593,548 shares outstanding at September 30, 2003 and December 31, 2002     246     207  
  Capital in excess of par value     1,045,077     858,126  
  Accumulated deficit     (804,250 )   (797,868 )
  Deferred compensation     (1,078 )   (3,469 )
  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     239,728     56,735  
   
 
 
    $ 324,320   $ 141,533  
   
 
 

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

3


SONUS NETWORKS, INC.

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(unaudited)

 
   Three months ended
September 30,
   Nine months ended
September 30,
  
 
   2003
   2002
   2003
   2002
  
Revenues:                          
  Product   $ 22,352   $ 3,256   $ 48,408   $ 34,864  
  Service     6,292     4,189     17,611     15,034  
   
 
 
 
 
    Total revenues     28,644     7,445     66,019     49,898  

Cost of revenues (1):
 
 
 
 
 
 
 
 
 
 
 
 
 
  Product     7,237     2,246     16,129     16,152  
  Service     3,810     2,501     9,876     8,418  
  Write-off (benefit) of inventory and purchase commitments     —     —     (735 )   9,434  
   
 
 
 
 
    Total cost of revenues     11,047     4,747     25,270     34,004  
   
 
 
 
 
Gross profit     17,597     2,698     40,749     15,894  

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
  Research and development (1)     7,984     9,685     23,931     36,525  
  Sales and marketing (1)     6,536     5,520     17,453     22,207  
  General and administrative (1)     999     2,445     3,267     5,601  
  Stock-based compensation     866     3,962     2,499     15,655  
  Amortization of purchased intangible assets     271     367     813     1,156  
  Write-off of goodwill     —     1,673     —     1,673  
  Restructuring charges (benefit), net     —     987     —     (10,141 )
   
 
 
 
 
    Total operating expenses     16,656     24,639     47,963     72,676  
   
 
 
 
 
Income (loss) from operations     941     (21,941 )   (7,214 )   (56,782 )
Interest expense     (128 )   (163 )   (406 )   (438 )
Interest income     396     466     1,238     1,570  
   
 
 
 
 
Net income (loss)   $ 1,209   $ (21,638 ) $ (6,382 ) $ (55,650 )
   
 
 
 
 

Net income (loss) per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
  Basic   $ 0.01   $ (0.11 ) $ (0.03 ) $ (0.30 )
   
 
 
 
 
  Diluted   $ 0.01   $ (0.11 ) $ (0.03 ) $ (0.30 )
   
 
 
 
 

Shares used in computing net income (loss) per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
  Basic     224,356     191,823     213,322     188,620  
   
 
 
 
 
  Diluted     239,446     191,823     213,322     188,620  
   
 
 
 
 
(1)
Excludes non-cash, stock-based compensation expense as follows:

  Cost of revenues   $ 11   $ 176   $ 34   $ 574
  Research and development     260     2,147     914     8,498
  Sales and marketing     499     1,338     1,205     5,010
  General and administrative     96     301     346     1,573
   
 
 
 
    $ 866   $ 3,962   $ 2,499   $ 15,655
   
 
 
 

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

4

SONUS NETWORKS, INC.

Condensed Consolidated Statement of Stockholders' Equity

(In thousands, except share data)

(unaudited)

 
   Common Stock
    
    
    
   Treasury Stock
    
  
 
   Capital in
Excess of
Par Value
   Accumulated
Deficit
   Deferred
Compensation
   Total
Stockholders'
Equity
  
 
   Shares
   Par Value
   Shares
   Cost
  
Balance, December 31, 2002   206,860,358   $ 207   $ 858,126   $ (797,868 ) $ (3,469 ) 2,266,810   $ (261 ) $ 56,735  
  Issuance of common stock to public, net of issuance costs of $9,995 (Note 11(a))   37,000,000     37     182,718     —     —   —     —     182,755  
  Issuance of common stock in connection with employee stock purchase plan   1,085,750     1     965     —     —   —     —     966  
  Exercise of stock options   1,372,740     1     3,160     —     —   —     —     3,161  
  Repurchase of common stock   —     —     —     —     —   30,100     (6 )   (6 )
  Amortization of deferred compensation   —     —     —     —     2,302   —     —     2,302  
  Compensation expense related to stock options issued to non-employees   —     —     197     —     —   —     —     197  
  Deferred compensation for terminated employees   —     —     (89 )   —     89   —     —     —  
  Net loss   —     —     —     (6,382 )   —   —     —     (6,382 )
   
 
 
 
 
 
 
 
 
Balance, September 30, 2003   246,318,848   $ 246   $ 1,045,077   $ (804,250 ) $ (1,078 ) 2,296,910   $ (267 ) $ 239,728  
   
 
 
 
 
 
 
 
 

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

5


SONUS NETWORKS, INC.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

 
   Nine months ended September 30,
  
 
   2003
   2002
  
Cash flows from operating activities:              
  Net loss   $ (6,382 ) $ (55,650 )
  Adjustments to reconcile net loss to net cash used in operating activities:              
    Depreciation and amortization     7,581     12,047  
    Write-off of inventory     —     7,026  
    Stock-based compensation     2,499     15,655  
    Amortization of purchased intangible assets     813     1,156  
    Write-off of goodwill     —     1,673  
    Non-cash restructuring benefit     (735 )   (16,557 )
    Changes in current assets and liabilities:              
      Accounts receivable     (2,648 )   6,483  
      Inventories     (1,557 )   2,412  
      Other current assets     (2,507 )   496  
      Accounts payable     (505 )   (5,402 )
      Accrued expenses     (2,707 )   (2,937 )
      Deferred revenue     4,801     (2,408 )
   
 
 
        Net cash used in operating activities     (1,347 )   (36,006 )
   
 
 
Cash flows from investing activities:              
  Purchases of property and equipment     (2,898 )   (2,435 )
  Maturities of marketable securities     19,682     35,631  
  Purchases of marketable securities     (4,697 )   (22,032 )
  Other assets     118     (23 )
   
 
 
        Net cash provided by investing activities     12,205     11,141  
   
 
 
Cash flows from financing activities:              
  Net proceeds from sale of common stock to public     182,755     —  
  Proceeds from sale of common stock in connection with employee stock purchase plan     966     2,843  
  Proceeds from exercise of stock options     3,161     108  
  Additions to long-term obligations     —     3,300  
  Payments of long-term obligations     (1,060 )   (619 )
  Repurchase of common stock     (6 )   (128 )
   
 
 
        Net cash provided by financing activities     185,816     5,504  
   
 
 
Net increase (decrease) in cash and cash equivalents     196,674     (19,361 )
Cash and cash equivalents, beginning of period     50,307     49,123  
   
 
 
Cash and cash equivalents, end of period   $ 246,981   $ 29,762  
   
 
 

Supplemental disclosure of cash flow information:
 
 
 
 
 
 
 
Cash paid during the period for interest   $ 288   $ 319  
   
 
 

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

6


SONUS NETWORKS, INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)

(1) Description of Business

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

(2) Summary of Significant Accounting Policies

        The accompanying unaudited condensed consolidated financial statements have been prepared by Sonus and reflect all adjustments, consisting only of normal recurring adjustments that in the opinion of management are necessary for a fair statement of the results for the interim periods. The unaudited condensed consolidated financial statements have been prepared in accordance with the regulations of the Securities and Exchange Commission (SEC), and omit or condense certain information and footnote disclosures pursuant to existing SEC rules and regulations. Results for the interim periods are not necessarily indicative of results to be expected for any other interim period or for the entire fiscal year. These statements should be read in conjunction with the consolidated financial statements and related footnotes included in Sonus' Annual Report on Form 10-K for the year ended December 31, 2002 filed with the SEC.

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

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

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

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

        For the nine months ended September 30, 2003 and 2002, three and two customers each contributed more than 10% of Sonus' revenues and collectively represented an aggregate of 59% and 43% of total revenues. As of September 30, 2003 and 2002, two and three customers each accounted for more than 10% of Sonus' accounts receivable balance. International revenues, primarily attributable to Asia and Europe, were 23% and 21% of total revenues for the nine months ended September 30, 2003 and 2002.

7


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

        Sonus recognizes revenues from product sales to end users, resellers and distributors upon shipment, provided there are no uncertainties regarding acceptance, persuasive evidence of an arrangement exists, the sales price is fixed or determinable and collection of the related receivable is probable. If uncertainties exist, Sonus recognizes revenues when those uncertainties are resolved. In multiple element arrangements, in accordance with Statement of Position 97-2 and 98-9, Sonus uses the residual method when vendor-specific objective evidence does not exist for one of the delivered elements in the arrangement. Service revenues are recognized as the services are provided. Revenues from maintenance and support arrangements are recognized ratably over the term of the contract. Amounts collected prior to satisfying the revenue recognition criteria are reflected as deferred revenues. Warranty costs are estimated and recorded by Sonus at the time of product revenue recognition.

        In October 1995, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 provides that companies may account for stock-based compensation under either the fair value-based method of accounting under SFAS No. 123 or the intrinsic value-based method provided by Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees. Sonus uses the intrinsic value-based method of APB No. 25 to account for all of its employee stock-based compensation plans and uses the fair value method of SFAS No. 123 to account for all non-employee stock-based compensation. SFAS No. 123, as amended by SFAS No. 148 (Note 2(i)), requires companies following APB No. 25 to make pro forma disclosure in the notes to the financial statements using the measurement provisions of SFAS No. 123.

8

        Sonus has computed the pro forma disclosures required under SFAS No. 123 for stock options granted to employees and shares purchased under the 2000 Employee Stock Purchase Plan (ESPP) using the Black-Scholes option pricing model. The pro forma information is as follows:

 
   Three months ended
September 30,
   Nine months ended
September 30,
  
 
   2003
   2002
   2003
   2002
  
 
   (in thousands, except per share data)

  
Net income (loss)—                          
  As reported   $ 1,209   $ (21,638 ) $ (6,382 ) $ (55,650 )
  Add stock-based compensation included in reported net income (loss)     866     3,962     2,499     15,655  
  Less total employee stock-based compensation under fair value method     (7,902 )   (12,241 )   (15,018 )   (41,762 )
   
 
 
 
 
  Pro forma   $ (5,827 ) $ (29,917 ) $ (18,901 ) $ (81,757 )
   
 
 
 
 

Net income (loss) per share—
 
 
 
 
 
 
 
 
 
 
 
 
 
  Basic as reported   $ 0.01   $ (0.11 ) $ (0.03 ) $ (0.30 )
  Basic pro forma     (0.03 )   (0.16 )   (0.09 )   (0.43 )
 
Diluted as reported
 
 
0.01
 
 
(0.11
)
 
(0.03
)
 
(0.30
)
  Diluted pro forma     (0.03 )   (0.16 )   (0.09 )   (0.43 )

        The comprehensive income (loss) for the three and nine months ended September 30, 2003 and 2002 does not differ from the reported net income (loss).

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ materially from those estimates.

        Basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of shares of unrestricted common stock outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of shares of unrestricted common stock and dilutive potential common shares outstanding based on the average market price of Sonus' common stock (under the treasury stock method). Dilutive potential common shares consist of restricted common stock, common stock issuable upon the exercise of stock options, conversion of a convertible subordinated note and common shares

9

issued in connection with Sonus' acquisition in January 2001 of telecom technologies, inc. (TTI) that were subject to the achievement of milestones and employee retention.

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