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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 2000
COMMISSION FILE NUMBER 000-30229
SONUS NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 04-3387074
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
5 CARLISLE ROAD, WESTFORD, MASSACHUSETTS 01886
(Address of principal executive offices, including Zip Code)
(978) 692-8999
(Registrant's telephone number, including area code)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy statement or information
proxy statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
ALTHOUGH THE REGISTRANT HAS FILED ALL REPORTS REQUIRED TO BE FILED BY
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PERIOD
THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS, THE REGISTRANT DID NOT
BECOME SUBJECT TO SUCH FILING REQUIREMENTS UNTIL THE REGISTRATION OF CERTAIN
SHARES OF ITS COMMON STOCK PURSUANT TO A REGISTRATION STATEMENT ON FORM S-1
WHICH WAS DECLARED EFFECTIVE BY THE SECURITIES AND EXCHANGE COMMISSION ON MAY
25, 2000.
As of February 15, 2001, there were 202,286,745 shares of Common Stock,
$0.001 par value per share, outstanding. As of that date, the aggregate market
value of the voting stock held by non-affiliates of the Registrant was
approximately $5,845,035,466.
DOCUMENTS INCORPORATED BY REFERENCE
The information required in Items 10-13 are incorporated by reference to
specified portions of the Registrant's definitive Proxy Statement to be issued
in conjunction with the Registrant's 2001 Annual Meeting of Stockholders, which
is expected to be filed not later than 120 days after the Registrant's fiscal
year ended December 31, 2000.
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ITEM 1. BUSINESS.
OVERVIEW
We are a leading provider of voice infrastructure products for the new
public network. Our products are a new generation of carrier-class switching
equipment and software that enable voice services to be delivered over
packet-based networks. Our target customers include new and established
communications service providers, including long distance carriers, local
exchange carriers, Internet service providers, cable operators, international
telephone companies and carriers that provide services to other carriers. These
service providers are rapidly building packet-based networks to support the
dramatic growth in data traffic resulting from Internet use. Packet-based
networks, which transport traffic in small bundles, or "packets," offer a
significantly more flexible, cost-effective and efficient means for providing
communications services than existing circuit-based networks, designed years ago
for telephone calls. By enabling voice traffic to be carried over these
packet-based networks, our products will accelerate the convergence of voice and
data into the new public network.
Our suite of voice infrastructure products includes the GSX9000 Open
Services Switch, PSX6000 SoftSwitch, SGX2000 SS7 Signaling Gateway, System 9200
Internet offload solution and, as a result of our acquisition of telecom
technologies, inc., the INtelligentIP softswitch. Our products, designed for
deployment at the core of a service provider's network, significantly reduce the
cost to build and operate voice services compared to traditional alternatives.
Moreover, our products offer a powerful and open platform for service providers
to increase their revenues through the creation and delivery of new and
innovative voice and data services. Our switching equipment and software can be
rapidly and easily deployed, and readily expanded to accommodate growth in
traffic volumes. Our products also interoperate with service providers' existing
telephone infrastructure, allowing them to preserve the investment in their
current networks. Designed for the largest telephone networks in the world, our
products offer the reliability and voice quality that have been hallmarks of the
public telephone network for decades.
We expect two global forces--deregulation and the expansion of the
Internet--to revolutionize the 100-year old public telephone network worldwide.
Deregulation has fueled intense competition among service providers and is
driving them to reduce their costs and establish new revenue sources. The
dramatic rise in Internet use and accompanying growth in data traffic has led
service providers to make major investments in high-capacity, packet-based
networks. Building and maintaining these packet-based networks in parallel with
traditional circuit-switched telephone networks is complex and expensive,
driving the demand for a new public network that integrates both voice and data.
Our eleven announced customers include six of the world's leading service
providers: Global Crossing, Intermedia Communications, Qwest Communications,
Time Warner Telecom, Williams Communications and XO Communications. We sell our
products principally through a direct sales force and, in some markets, through
distributors and resellers. We also collaborate with our customers to identify
and develop new advanced services and applications that they can offer to their
customers.
Our objective is to capitalize on our early technology and market lead and
build the premier franchise in voice infrastructure solutions for the new public
network. The following are key elements of our strategy:
- Leverage our technology leadership to achieve key service provider design
wins;
- Expand and broaden our customer base by targeting specific market
segments;
- Expand our global sales, marketing, support and distribution capabilities;
- Grow our base of software applications and development partners;
- Leverage our technology platform from the core of the network out to the
access edge;
- Actively contribute to the standards definition and adoption process; and
- Expand through investments in and acquisitions of complementary products,
technologies and businesses.
1
ACQUISITION OF TELECOM TECHNOLOGIES, INC.
On January 18, 2001, we acquired telecom technologies, inc., or TTI. Upon
the closing of this acquisition, we issued an aggregate of 10,800,000 shares of
common stock in exchange for all outstanding capital stock of TTI. Of the
10,800,000 shares issued to the TTI shareholders, 1,200,000 shares were placed
into escrow as security for indemnity obligations under the merger agreement,
and will be released to TTI shareholders upon expiration of those indemnity
obligations, expected to be on the first anniversary of the closing date. In
addition, TTI shareholders will have the right to receive up to an aggregate of
4,200,000 additional shares of common stock which have been placed in escrow in
the event that TTI achieves certain specified business expansion and product
development milestones from time to time prior to December 31, 2002. In
connection with our acquisition of TTI, we adopted our 2000 Retention Plan and
agreed to issue up to 3,000,000 shares of common stock under this plan to
certain employees at TTI who became employees of Sonus, which are subject to
vesting and completion of milestones.
INDUSTRY BACKGROUND
The public telephone network is an integral part of our everyday lives. For
most of its 100-year history, the telephone industry has been heavily regulated,
which has slowed the evolution of its underlying circuit-switching technologies
and limited innovation in service offerings and the pricing of telephone
services. We expect two global forces--deregulation and the expansion of the
Internet--to revolutionize the public telephone network worldwide.
Deregulation of the telephone industry accelerated with the passage of the
Telecommunications Act of 1996. The barriers that once restricted service
providers to a specific geography or service offering, such as local or long
distance, are disappearing. The opportunity created by opening up the
$750 billion telephone services market has been attracting thousands of new
service providers.
Intense competition between new players and incumbents is driving down
prices. With limited ability to reduce the cost structure of the public
telephone network, profit margins for traditional telephone services are
eroding. In response, service providers are seeking both new, creative and
differentiated service offerings and the means to reduce their costs.
Simultaneously, the rapid adoption of the Internet is driving dramatic
growth of data traffic. Today a significant portion of this data traffic is
carried over the traditional circuit-switched telephone network. However, this
circuit-switched network, designed for voice traffic and built long before the
advent of the Internet, is not suited to efficiently transport data traffic. In
a circuit-switched network, a dedicated path, or circuit, is established for
each call, reserving a fixed amount of capacity or bandwidth in each direction.
The dedicated circuit is maintained for the duration of the call across all of
the circuit switches spanning the path from origination to the destination of
the call, even when no traffic is being sent. As a result, a circuit-switched
architecture is highly inefficient for Internet applications, which tend to
create large bursts of data traffic followed by long periods of silence.
In contrast, a packet network divides traffic into distinct units called
packets and routes each packet independently. By combining traffic from users
with differing capacity demands at different times, packet networks more
efficiently fill available network bandwidth with packets of data from many
users, thereby reducing the bandwidth wasted due to silence from any single
user. The volume of data traffic continues to increase as use of the Internet
and the number of connected users grow, driving service providers to build
large-scale, more efficient packet networks.
With voice traffic carried over the vast installed base of traditional
circuit-switched networks and data traffic carried over rapidly expanding packet
networks, service providers are faced with the expense and complexity of
building and maintaining parallel networks.
The following diagrams depict these parallel voice and data networks.
2
[Two diagrams appear: the first diagram is symmetric and depicts a
circuit-switched network. A large, rectangular box labeled "Circuit Switched.
Network" is in the center. The box contains a series of small shapes aligned
linearly and connected by a straight bold line. From left to right, the shapes
are a small circle labeled "End Office," two small hexagons labeled "Tandem" and
a small circle labeled "End Office." Outside of the rectangular box on each side
is an icon representing a telephone connected to the outer circle labeled "End
Office" by a bold line. Also on each side and connected to the outer "End
Office" circle by dotted lines are icons representing a fax machine and second
telephone. Above the rectangular box and connected by dotted lines to each of
the small shapes inside of the large rectangle is a shaded oval labeled "SS7."
Lower diagram is symmetric and depicts a generic packet-switched network.
Shaded cloud labeled "Packet Network" is aligned directly below the rectangular
box of the upper diagram. On the left and right side of the cloud, aligned
linearly, are icons representing a computer, connected to the cloud by dotted
lines. Connected to the bottom of the cloud by dotted lines are three additional
computers.]
THE NEED FOR, AND BENEFITS OF, COMBINING VOICE AND DATA NETWORKS
We believe significant opportunities exist in uniting these separate,
parallel networks into a new integrated public network capable of transporting
both voice and data traffic. Enormous potential savings can be realized by
eliminating redundant or overlapping equipment purchases and reducing network
operating costs. Also, combining traditional voice services with Internet or
Web-based services in a single network is expected to enable new and powerful
high-margin, revenue-generating service offerings such as single-number dialing,
unified messaging, Internet click-to-talk, sophisticated call centers and other
services.
The packet network is the platform for the new public network. The volume of
data traffic has already eclipsed voice traffic and is growing much faster than
voice. Packet architectures are more efficient at moving data, more flexible and
reduce equipment and operating costs. The key to realizing the full potential of
a converged, packet-based network is to enable the world's voice traffic to run
over those networks.
Early attempts to develop new technologies to carry voice traffic over
packet networks have included voice over Internet protocol, or VoIP, systems
using a personal computer platform and devices that added VoIP capability to
existing data devices such as remote access servers. While demonstrating the
viability of transmitting voice over packet technology, these approaches have
fallen far short of the quality, reliability and scalability required by the
public telephone network.
These early VoIP systems have also lacked the ability to interoperate with
the signaling infrastructure of the circuit-switched network. Without this
signaling capability, VoIP applications cannot provide the consistent "look,
sound and feel" of traditional telephone calls and are not
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well-suited to more complex applications such as voicemail, unified messaging
and other value-added services.
The public telephone network is large, highly complex and generates
significant revenues, a substantial majority of which are derived from voice
services. Given service providers' substantial investment in, and dependence
upon, traditional circuit-switched technology, their transition to the new
public network will be gradual. During this transition, an immediate opportunity
exists to reduce the burden on overloaded and expensive circuit-switched
resources. Internet offload will allow modem-connected Internet calls to be
identified and diverted from the circuit-switched network to the packet network,
thus optimizing use of valuable network bandwidth.
REQUIREMENTS FOR VOICE INFRASTRUCTURE PRODUCTS FOR THE NEW PUBLIC NETWORK
Users demand high levels of quality and reliability from the public
telephone network and service providers require a cost-efficient network that
enables new revenue-generating services. As a result, voice infrastructure
products for the new public network must satisfy the following requirements:
CARRIER-CLASS PERFORMANCE. Because they operate complex, mission-critical
networks, service providers have clear infrastructure requirements. These
include extremely high reliability, quality and interoperability. For example,
service providers typically require equipment that complies with their 99.999%
availability standard.
SCALABILITY AND DENSITY. Infrastructure solutions for the new public
network face challenging scalability requirements. Service providers' central
offices typically support tens or even hundreds of thousands of simultaneous
calls. In order to be economically attractive, the new infrastructure must
compare favorably with existing networks in terms of cost per port, space
occupied, power consumption and cooling requirements.
COMPATIBILITY WITH STANDARDS AND EXISTING INFRASTRUCTURE. New
infrastructure equipment and software must support the full range of telephone
network standards, including signaling protocols such as SS7 and various
physical interfaces such as ISDN, primary rate interface, or PRI, and T1. It
must also support data networking protocols such as Internet protocol, or IP,
and asynchronous transfer mode, or ATM, as well as newer protocols such as
H.323, IPDC and SIP. When operating, the new equipment and software cannot
hinder, and ideally should enhance, the capabilities of the existing
infrastructure, for example, by alleviating Internet access bottlenecks.
INTELLIGENT SOFTWARE IN AN OPEN AND FLEXIBLE PLATFORM. The architecture for
the new public network will decouple the capabilities of traditional
circuit-switching equipment into robust hardware elements and highly intelligent
software platforms that provide control, signaling and service creation
capabilities. This approach will transform the closed, proprietary
circuit-switched public telephone network into a flexible, open environment
accessible to a wide range of software developers. Service providers and
third-party vendors will be able to develop and implement new applications
independent of switch vendors. Moreover, the proliferation of independent
software providers promises to drive the creation of innovative voice and data
services that could expand service provider revenues.
SIMPLE AND RAPID INSTALLATION, DEPLOYMENT AND SUPPORT. Infrastructure
solutions must be easy to install, deploy, configure and manage. These
attributes will enable rapid growth and effective management of dynamic and
complex service provider networks.
4
THE SONUS SOLUTION
We develop, market and sell what we believe to be the first comprehensive
suite of voice infrastructure products purpose-built for the deployment and
management of voice and data services over the new public network. The Sonus
solution consists of five carrier-class products:
- the GSX9000 Open Services Switch;
- the PSX6000 SoftSwitch;
- the INtelligentIP softswitch;
- the SGX2000 SS7 Signaling Gateway; and
- the System 9200 Internet offload solution.
These products are designed to offer high reliability, toll-quality voice,
improved economics, interoperability, rapid deployment and an open architecture
enabling the design and implementation of new services and applications. Our
solution has been specifically designed to meet the requirements of the new
public network. As shown in the following diagram, our products unite the voice
and data networks, unleashing the potential of the new public network.
[Symmetric diagram with shaded cloud labeled "Packet Network" at the center.
Aligned on the horizontal axis extending from each of the left and right sides
of the "Packet Network" cloud is a box with caption reading "GSX9000 Open
Services Switch" and a small cloud labeled "Public Telephone Network." Connected
to the small cloud by bold lines are icons representing telephones and fax
machines. Below the center "Packet Network" cloud and connected by bold lines
are a stacked figure labeled "3rd Party Application Servers" and an icon
representing a computer. Above the center "Packet Network" cloud on the left
side is a small box labeled "SGX2000 SS7 Signaling Gateway" connected by a bold
line. Above that box to the left, connected by a dotted line, is an oval labeled
"SS7." Above the center "Packet Network" cloud on the right side are two small
boxes labeled "PSX6000 SoftSwitch" and "INtelligentIP Softswitch."]
CARRIER-CLASS PERFORMANCE. Our products are designed to offer the highest
levels of quality, reliability and interoperability, including:
- full redundancy, enabling 99.999% availability;
- voice quality as good as, or superior to, today's circuit-switched
network;
- system hardware designed for network equipment building standards, or
NEBS, Level 3 compliance;
- a complete set of service features, addressing those found in the existing
voice network and extending them to offer greater flexibility; and
- sophisticated network management and configuration capabilities.
COMPATIBILITY WITH STANDARDS AND EXISTING INFRASTRUCTURE. Our products are
designed to be compatible with all applicable voice and data networking
standards and interfaces, including:
- SS7 and other telephone network signaling protocols, including advanced
services as well as simple call management and routing;
- IP, ATM, Ethernet and optical data networking standards;
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- encoding, compression and call management standards including H.323, IPDC,
SIP and others;
- voice coding standards such as G.711 and echo cancellation standard G.168;
and
- all common interfaces, including T1, T3, E1 and PRI, and optical
interfaces.
The Sonus solution is designed to interface with legacy circuit-switching
equipment, supporting the transparent flow of calls and other information
between the circuit and packet networks. As a result, our products allow service
providers to migrate to the new public network, while preserving their
significant legacy infrastructure investments.
COST EFFECTIVENESS AND HIGH SCALABILITY. The Sonus solution can be used to
cost-effectively build packet-based switch configurations supporting a range
from a few hundred calls to hundreds of thousands of simultaneous calls. In
addition, the capital cost of our equipment is typically half that of
traditional circuit-switched equipment. At the same time, our GSX9000 Open
Services Switch offers unparalleled density, requires less than one-tenth of the
space needed by circuit-switching implementations and requires significantly
less power and cooling. This enables a significant reduction in expensive
central office facilities' cost and allows service providers to deploy our
equipment in locations where traditional circuit switches are not even an option
given the limited space and environmental services.
The GSX9000 Open Services Switch can create central office space savings as
shown below.
[Three dimensional diagram with a set of four rectangular bars parallel to one
another and lined up evenly with caption reading "Traditional Circuit Switch
(50,000 calls)." Depicted in front of the rectangular bars is a single, small,
upright rectangular box labeled "Sonus GSX9000 Open Services Switch (50,000
calls)." Extending from each of the left and right sides of the small
rectangular box back to the sides of the first of the four larger bars is a thin
line.]
OPEN SOFTWARE ARCHITECTURE AND FLEXIBLE PLATFORM. Our Open Services
Architecture, or OSA, is based on a software-centric design and a flexible
platform, allowing rapid development of new products and services. For example,
software intelligence in our System 9200 can detect Internet modem calls as they
enter the network and divert them to remote access servers to be routed directly
to a packet network. New services may be developed by us, by service providers
or by any number of third parties including software developers and systems
integrators. The OSA also facilitates the creation of services that were
previously not possible on the circuit-switched network. In addition, we have
partnered with a number of third-party application software developers to
stimulate the growth of new applications available for our platform.
EASE OF INSTALLATION AND DEPLOYMENT. Our equipment and software can be
installed and placed in service by our customers much more quickly than
circuit-switching equipment. By offering comprehensive testing, configuration
and management software, we expedite the deployment process as well as the
ongoing management and operation of our products. We believe that typical
installations of our solution require just weeks of time from product arrival to
final testing, thereby reducing the cost of deployment and speeding the time to
market for new services.
6
THE SONUS STRATEGY
Our objective is to capitalize on our early technology and market lead and
build the premier franchise in voice infrastructure solutions for the new public
network. The following are key elements of our strategy:
LEVERAGE TECHNOLOGY LEADERSHIP TO ACHIEVE KEY SERVICE PROVIDER DESIGN
WINS. As the first company to provide voice infrastructure products for the new
public network, we plan to achieve key design wins with market-leading service
providers as they develop the architecture for their new voice networks. We
expect service providers to select vendors that provide leading technology and
the ability to maintain that technology leadership. Our equipment is an integral
part of the network architecture and achieving design wins will enable us to
rapidly grow our business as these networks are deployed. We have been awarded
contracts by six major service providers including Global Crossing, Intermedia
Communications, Qwest Communications, Time Warner Telecom, Williams
Communications and XO Communications. Furthermore, by working closely with our
customers as they deploy these networks, we will gain valuable knowledge
regarding their requirements, positioning us to develop product enhancements and
extensions that address evolving service provider needs.
EXPAND AND BROADEN OUR CUSTOMER BASE BY TARGETING SPECIFIC MARKET
SEGMENTS. We plan to leverage our early success to penetrate new customer
segments. We believe new and incumbent service providers will build the new
public network at different rates. Initially, the next-generation service
providers, who are relatively unencumbered by legacy equipment, will be the most
likely first purchasers of our equipment and software, as they compete
aggressively with the incumbent service providers. Other newer entrants, such as
competitive local exchange carriers, or CLECs, and Internet service providers,
or ISPs, are also likely to be early adopters of our products. As competitive
service providers achieve greater market presence and leverage the lower costs
and advanced services inherent in packet-switching technology, we believe
incumbents including interexchange carriers, Regional Bell Operating Companies
and international PTTs will face further competitive pressure, increasing the
likelihood that, and the pace at which, they will adopt these new technologies.
EXPAND OUR GLOBAL SALES, MARKETING, SUPPORT AND DISTRIBUTION
CAPABILITIES. Becoming the primary supplier of voice infrastructure for the new
public network will require a strong worldwide presence. We are rapidly
expanding our sales, marketing, support and distribution capabilities to address
this need. We have recently opened regional sales offices in the United States,
Singapore, Germany and France and a European headquarters in the United Kingdom.
In addition, we plan to augment our global direct sales effort with
international distribution partners. As a carrier-class solution provider, we
are making a significant investment in professional services and customer
support.
GROW OUR BASE OF SOFTWARE APPLICATIONS AND DEVELOPMENT PARTNERS. We have
established and promote programs that bring together a broad range of
development partners to provide our customers with a variety of advanced
services, application options and interoperability research. These alliances
include more than one hundred member companies that are enabling new IP-based
enhanced services, call processing, billing, provisioning, network management
and operations systems or providing equipment or software for the new public
network. Our Open Services Partner Alliance, or OSPA, is focused on application
options, advanced services, and interoperability through work with leading
vendors in a testing laboratory. Our OSPA partners include companies such as
3Com, Agilent Technologies, Cisco Systems, Ericsson, Lucent Technologies,
Priority Call Management, Redback, Tellabs and Ulticom. We plan to expand our
complementary partner programs to maximize the services available to our
customers and speed their time to market.
LEVERAGE OUR TECHNOLOGY PLATFORM FROM THE CORE OF THE NETWORK OUT TO THE
ACCESS EDGE. Our robust and sophisticated technology platform has been designed
to operate at the heart of the largest networks in the world. From this
fundamental position in the trunking infrastructure, we are extending our reach
by moving outward to the access segments of the network. For example, we are
shipping our System 9200 Internet offload solution, a turnkey product that gives
service providers a cost effective means to
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manage Internet data traffic. Furthermore, with the addition of the
INtelligentIP softswitch to our product offerings, we are expanding into the
high-growth business and residential access markets. This approach will allow
our customers to design and execute a coordinated migration and expansion
strategy as they build entirely new networks or transition from their legacy
circuit-switched infrastructure.
ACTIVELY CONTRIBUTE TO THE STANDARDS DEFINITION AND ADOPTION PROCESS. To
advance our technology and market leadership, we will continue to actively lead
and contribute to standards bodies such as the International Softswitch
Consortium, the Internet Engineering Task Force and the International
Telecommunications Union. The definition of standards for the new public network
is in an early stage and we intend to drive these standards to meet the
requirements for an open, accessible, scalable and powerful new public network
infrastructure.
PURSUE STRATEGIC ACQUISITIONS AND ALLIANCES. As with our recent acquisition
of TTI, we intend to expand our products and services through selected
acquisitions and alliances. These may include acquisitions of complementary
products, technologies and businesses that further enhance our technology
leadership or product breadth. We also believe that allying with companies
providing complementary products or services for the new public network will
enable us to bring greater value to our customers and extend our lead over
potential competitors.
SONUS PRODUCTS
GSX9000 OPEN SERVICES SWITCH
The Sonus GSX9000 Open Services Switch enables voice traffic to be
transported over packet networks. Its carrier-class hardware, which is NEBS
Level 3 compliant and designed to provide 99.999% availability with no single
point of failure, offers optional full redundancy and full hot-swap capability.
It is powered from -48VDC sources standard in central offices and attaches to
the central office timing network. The basic building block of a GSX9000 is a
shelf. Each shelf is 28" high, mounts in a standard 19" or 23" rack and provides
16 slots for server and adapter modules. The first 2 slots are reserved for
management modules, while the other 14 slots may be used for any mix of other
module types. It supports the following interfaces:
[Diagram depicting a large box. Detail on the
face includes the Sonus logo in the upper left
corner and a set of vertical slots.]
- - T1;
- - T3;
- - E1;
- - OC3;
- - 100BaseT; and
- - OC12c/STM-4.
The GSX9000 is designed to deliver voice quality equal, or superior, to that
of the public network. It is designed to support the G.711 approach used in
circuit switches and will deliver a number of other voice compression
algorithms. It also is designed to provide world-class echo cancellation,
conforming to the latest G.168 standard, on every circuit port. It automatically
disables echo cancellation when it detects a modem signal. The GSX9000 is also
designed to minimize delay, further enhancing perceived voice quality. The
GSX9000 scales to the very large configurations required by major carriers. A
single
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GSX9000 shelf can support up to 8,064 simultaneous calls. A single GSX9000,
consisting of multiple shelves, can support 100,000 or more simultaneous calls.
The GSX9000 is designed to operate with our PSX6000 SoftSwitch, our
INtelligentIP softswitch and with softswitches and network products offered by
other vendors.
SOFTSWITCHES
Softswitches provide the network intelligence in next-generation networks,
including call control, signaling, core network routing and a management
foundation. We provide carriers with a comprehensive softswitch solution. Our
PSX6000 SoftSwitch, designed for deployment in the core of carrier networks,
delivers the levels of scalability, performance and reliability required by
major service providers. Our INtelligentIP softswitch emphasizes
interoperability and services at the access edge of the network. Our softswitch
solutions offer a powerful platform providing broad interoperability with other
components of the network, including access devices, media gateways and other
softswitches.
Depending on the network application and equipment configuration, service
providers may choose to deploy the PSX6000 SoftSwitch, the INtelligentIP
softswitch, or both in their networks. This combination of softswitch offerings
gives service providers broad control over intelligence in the new public
network.
We believe that in addition to traditional voice services, our softswitches
will enable service providers to offer differentiated, value-added features and
services to their customers, including:
- follow-me anywhere communication, which is the ability to route a
subscriber's email, phone and Web services to any location;
- unified messaging that integrates telephone services, email and Web
applications, and allows subscribers to have a unified mailbox for email,
voicemail and message filtering;
- conference calling across the Internet;
- multimedia conferencing;
- Internet-enabled call centers; and
- Internet content delivered with voice.
PSX6000 SOFTSWITCH. The Sonus PSX6000 SoftSwitch controls the operation of
the GSX9000. It contains the service provider's specifications of the features
to be used for each subscriber or group of subscribers, the available services
and when to provide them and the policies for routing calls across the packet
core. The PSX6000 does not handle voice calls directly; instead, it controls a
GSX9000 to implement the necessary services. The PSX6000 supports a broad range
of carrier switching requirements and provides a platform upon which new
services can be easily and quickly created and implemented. It allows carriers
to deploy a circuit-switched, packet or converged circuit/packet infrastructure
with the capacity, reliability and intelligence that they require. Functions
such as provisioning, service selection and routing can be centralized in a
small number of PSX6000 SoftSwitches.
The PSX6000 can reside in a wide range of standard hardware platforms to fit
any size network. It may be replicated as required for high availability or to
support very high call processing requirements. The service provider can
designate a primary softswitch to control each GSX9000 gateway. In case of a
failure of the primary PSX6000, the GSX9000 will transparently transfer control
to another PSX6000 without affecting calls.
We believe the PSX6000 has the flexibility to support the requirements of
the full range of service providers. Typical applications include Internet
offload, PRI switching, domestic and international direct dial, business direct
access, virtual private networks and toll/tandem switching. The PSX6000 also
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facilitates new applications and services, integrating enhanced applications on
IP-based platforms similar to Internet Web servers.
INTELLIGENTIP SOFTSWITCH. The INtelligentIP softswitch was designed with an
open architecture, enabling integration of new applications from us and various
third-party providers within both existing and next generation voice and data
networks. The INtelligentIP softswitch resides on standard hardware platforms
and can control a number of different types of media gateways. Consequently, the
INtelligentIP softswitch supports a broad range of carrier services, including
the services required to support both circuit-based and packet-based networks
and provides a platform upon which new value-added services can be created and
implemented.
The architecture of our INtelligentIP softswitch allows for interoperability
with existing circuit-based telephony networks. This interoperability enables
service providers to rapidly deploy new, next generation networks and services
while maximizing their existing network investment.
Through our Open Services Partner Alliance (OSPA) vendors achieve
interoperability with our products quickly and efficiently, allowing those
vendors, as well as service and network providers, to reduce the time to deploy
new services. This partner program also allows network and service providers to
select from a list of vendors that are Sonus Powered. We believe that this
flexibility allows those service and network providers a choice of solutions and
value-added services, and enables them to achieve differentiation through an
integrated suite of "best-of-breed" solutions, rather than having to rely on a
single vendor's products, timeframes and decisions.
SGX2000 SS7 SIGNALING GATEWAY
The Sonus SGX2000 SS7 Signaling Gateway offers carriers a comprehensive and
cost-effective SS7 signaling solution that provides interconnection between the
traditional public telephone network and elements of our Open Services
Architecture. With the SGX2000, existing public telephone network voice switches
can interact with the Sonus GSX9000 using the same signaling methods they would
use with other circuit switches. This compatibility means that carriers can
preserve their existing investment in infrastructure and can offer their
customers the full range of normal public telephone network services, such as
800 services and 1+ dialing in the new public network.
The SGX2000 also supports full access to SS7 service control points. Using
the SGX2000, our products gain access to signal control processor-based
applications such as 800 number translation and local number portability. This
support allows service providers to preserve their application investment and
ensure compatibility between applications common to both circuit and packet
voice services. The SGX2000 supports up to 64 A-links to the SS7 network and
transports the SS7 messages to other network devices using IP protocols. The
SGX2000 can be deployed in a redundant configuration, providing the performance
and high availability required of a carrier-class SS7 solution.
SYSTEM 9200
The Sonus System 9200 Internet offload solution is a turnkey product that
allows local service providers, including CLECs and ISPs, to more effectively
handle the rapidly increasing amount of modem-originated Internet traffic
traversing voice networks. The System 9200 is designed to divert Internet
traffic from expensive circuit switches as calls enter the network, enabling
service providers to improve network performance and significantly reduce
network operating costs.
The System 9200 utilizes the technology delivered in the GSX9000, PSX6000,
INtelligentIP softswitch and SGX2000 to provide a smooth migration to packetized
voice and data transport.
10
CUSTOMER SUPPORT AND PROFESSIONAL SERVICES
We believe our comprehensive technical customer support and professional
services capabilities are an important element of our solution for customers.
These services cover the full network lifecycle: planning; design; installation;
and operations. We help our customers create or revise their business plans and
design their networks and also provide the following:
- turnkey network installation services;
- system integration and testing;
- 24-hour technical support; and
- educational services to customer personnel on the installation, operation
and maintenance of our equipment.
We have established a technical assistance center at our headquarters in
Westford, Massachusetts. The technical assistance center provides customers with
periodic updates to our software and product documentation. We offer our
customers a variety of service plans.
A key differentiator of our support activities is our professional services
group, many members of which hold advanced technical degrees in electrical
engineering or related disciplines. We offer a broad range of professional
services, including sophisticated network deployment, assistance with logistics
and project management support. We also maintain a customer support laboratory
in which customers can test the utility of our products for their specific
applications and in which they can gain an understanding of the applications
enabled by the converged network. Our approach to professional services is
designed to ensure that our products are integrated into our customers' networks
to meet their specific needs and that these customers realize the maximum value
from their networking technology investments. As of January 31, 2001, our
customer support and professional services organization consisted of 107
employees.
CUSTOMERS
Our target customer base includes long distance carriers, local exchange
carriers, ISPs, cable operators, international telephone companies and carriers
that provide services to other carriers. We have shipped products to customers
including: Global Crossing, Intermedia Communications, Qwest Communications,
Time Warner Telecom, Williams Communications and XO Communications. For the year
ended December 31, 2000, Global Crossing, Intermedia and Time Warner Telecom
each contributed more than 10% of our revenues and collectively represented an
aggregate of 70% of our total revenues. Currently, some of our customers are
using our products in laboratory testing and internal trials, while others have
deployed our products in their commercial networks.
SALES AND MARKETING
We sell our products principally through a direct sales force and, in some
markets, through distributors and resellers, including Nissho Electronics
Corporation and Samsung Corporation. In addition, we intend to establish
relationships with selected original equipment manufacturers and other marketing
partners in order to serve particular markets or geographies and provide our
customers with opportunities to purchase our products in combination with
related services and products. As of January 31, 2001, our sales and marketing
organization consisted of 105 employees, of which 18 were located in Westford
and Littleton, Massachusetts and 87 were located in sales and support offices
around the world.
11
RESEARCH AND DEVELOPMENT
We believe that strong product development capabilities are essential to our
strategy of enhancing our core technology, developing additional applications,
incorporating that technology into new products and maintaining the
comprehensiveness of our product and service offerings. Our research and
development process is driven by the availability of new technology, market data
and customer feedback. We have invested significant time and resources in
creating a structured process for undertaking all product development projects.
We have assembled a team of highly skilled engineers with significant
telecommunications and networking industry experience. Our engineers have
experience in, and have been drawn from, leading computer data networking,
telecommunications and multimedia companies. As of January 31, 2001, we had 344
employees responsible for research and development, of which 310 were software
and quality assurance engineers and 34 were hardware engineers. Our engineering
effort is focused on new applications and network access features, new network
interfaces, improved scalability, interoperability, quality, reliability and
next generation technologies. We currently maintain United States research and
development offices in New Jersey, Massachusetts and Texas and have an office in
the United Kingdom. In addition, we have a joint development effort in Japan
with Nissho Electronics Corp. and NTT Communicationware Corp., a wholly owned
subsidiary of NTT, the world's largest carrier.
We have made, and intend to continue to make, a substantial investment in
research and development. Research and development expenses, excluding those of
TTI, were $299,000 for the period from inception on August 7, 1997 to
December 31, 1997, $5.8 million for the year ended December 31, 1998,
$10.8 million for the year ended December 31, 1999 and $26.4 million for the
year ended December 31, 2000.
COMPETITION
The market for voice infrastructure products for the new public network is
intensely competitive, subject to rapid technological change and significantly
affected by new product introductions and other market activities of industry
participants. We expect competition to persist and intensify in the future. Our
primary sources of competition include vendors of networking and
telecommunications equipment, such as Cisco Systems, Lucent Technologies, Nortel
Networks and Tellabs. These competitors have significantly greater financial
resources than we do and are able to devote greater resources to the
development, promotion, sale and support of their products. In addition, these
competitors have more extensive customer bases and broader customer
relationships than we do, including relationships with our potential customers.
Numerous smaller and mostly private companies, including Convergent Networks,
Unisphere Networks and others, are also focusing on similar market
opportunities.
In order to compete effectively, we must deliver innovative products that:
- provide extremely high network reliability and voice quality;
- scale easily and efficiently;
- interoperate with existing network designs and other vendors' equipment;
- provide effective network management;
- are accompanied by comprehensive customer support and professional
services; and
- provide a cost-effective and space-efficient solution for service
providers.
In addition, we believe that the ability to provide vendor-sponsored
financing, which some of our competitors currently offer, is an important
competitive factor in our market.
12
INTELLECTUAL PROPERTY
Our success and ability to compete are dependent on our ability to develop
and maintain our technology and operate without infringing on the proprietary
rights of others. We rely on a combination of patent, trademark, trade secret
and copyright law and contractual restrictions to protect the proprietary
aspects of our technology. These legal protections afford only limited
protection for our technology. We presently hold one patent, and have twelve
patent applications pending, in the United States. In addition, we have two
patent applications pending abroad. We can't be certain that patents will be
granted based on these pending applications. We seek to protect our intellectual
property by:
- protecting our source code for our software, documentation and other
written materials under trade secret and copyright laws;
- licensing our software pursuant to signed license agreements, which impose
restrictions on others' ability to use our software; and
- seeking to limit disclosure of our intellectual property by requiring
employees and consultants with access to our proprietary information to
execute confidentiality agreements.
Due to rapid technological change, we believe that factors such as the
technological and creative skills of our personnel, new product developments and
enhancements to existing products are more important than the various legal
protections of our technology to establishing and maintaining technology
leadership.
We have incorporated third-party licensed technology into our current
products. From time to time, we may be required to license additional technology
from third parties to develop new products or product enhancements. Third-party
licenses may not be available or continue to be available to us on commercially
reasonable terms. The inability to maintain or re-license any third-party
licenses required in our current products, or to obtain any new third-party
licenses to develop new products and product enhancements could require us to
obtain substitute technology of lower quality or performance standards or at
greater cost, and delay or prevent us from making these products or
enhancements, any of which could seriously harm the competitiveness of our
products.
MANUFACTURING
Currently, we outsource the manufacturing of our products. Our contract
manufacturers provide comprehensive manufacturing services, including assembly
of our products and procurement of materials on our behalf. We perform final
test and assembly at our facility to ensure that we meet our internal and
external quality standards. We believe that outsourcing our manufacturing will
enable us to conserve working capital, better adjust manufacturing volumes to
meet changes in demand and more quickly deliver products. At present, we
purchase products from our outside contract manufacturers on a purchase order
basis. We may not be able to enter into long-term contracts with outside
manufacturers on terms acceptable to us, if at all. As of January 31, 2001, we
had 52 employees responsible for manufacturing, final testing and assembly.
EMPLOYEES
As of January 31, 2001, we had a total of 656 employees, including 344 in
research and development, 105 in sales and marketing, 107 in customer support
and professional services, 52 in manufacturing and 48 in finance and
administration. Our employees are not represented by any collective bargaining
unit. We believe our relations with our employees are good.
13
ITEM 2. PROPERTIES.
Our headquarters are located in a leased facility in Westford,
Massachusetts, consisting of 90,000 square feet under leases that expire in
2004. We have additional facilities in Littleton, Massachusetts, consisting of
42,000 square feet under subleases that expire in 2004, and in Richardson,
Texas, consisting of 49,000 square feet under a lease that expires in
March 2003. We expect to relocate our Texas office to a new facility in
Richardson in 2001, consisting of 110,000 square feet, under a seven-year lease
with our existing lessor. We also lease short-term office space in Colorado,
Oklahoma, New Jersey, the United Kingdom and Singapore. We believe our existing
facilities are adequate for our current needs and that suitable additional space
will be available as needed.
ITEM 3. LEGAL PROCEEDINGS.
We are not currently a party to any material litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
Our common stock has been quoted on the Nasdaq National Market under the
symbol "SONS" since May 25, 2000. Prior to that time, there was no public market
for the common stock. The following table sets forth, for the time periods
indicated, the high and low sales prices of the common stock as reported on the
Nasdaq National Market. We have never declared or paid cash dividends and have
no present intention to pay cash dividends in the foreseeable future. At
February 15, 2001, there were approximately 650 holders of record of our common
stock.
HIGH LOW
-------- --------
FISCAL 2000:
Second quarter (since May 25, 2000)......................... $56.65 $10.67
Third quarter............................................... $93.67 $38.50
Fourth quarter.............................................. $49.00 $18.50
On October 6, 2000, Sonus effected a three-for-one stock split in the form
of a stock dividend to each stockholder of record. All stock information has
been retroactively adjusted to reflect the stock split.
In May 2000, Sonus completed its initial public offering of 17,250,000
shares of common stock, which includes the exercise of the underwriters'
over-allotment option of 2,250,000 shares, at $7.67 per share. The IPO generated
net proceeds of $121,705,000, after deducting the underwriting discount and
commissions and offering expenses of $10,545,000.
14
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data of Sonus should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our consolidated financial statements and notes
to those statements included elsewhere in this report.
PERIOD FROM
INCEPTION
(AUGUST 7,
1997) TO YEAR ENDED DECEMBER 31,
DECEMBER 31, ------------------------------
1997 1998 1999 2000
------------ -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues........................................... $ -- $ -- $ -- $ 51,770
Manufacturing and product costs (1)................ -- -- 1,861 27,848
------ ------- -------- --------
Gross profit (loss)................................ -- -- (1,861) 23,922
Operating expenses:
Research and development (1)..................... 299 5,824 10,780 26,430
Sales and marketing (1).......................... -- 426 5,606 21,569
General and administrative (1)................... 187 919 1,723 5,477
Stock-based compensation......................... -- 59 4,404 26,729
------ ------- -------- --------
Total operating expenses........................... 486 7,228 22,513 80,205
------ ------- -------- --------
Loss from operations............................... (486) (7,228) (24,374) (56,283)
Interest income (expense), net..................... 25 314 487 6,245
------ ------- -------- --------
Net loss........................................... (461) (6,914) (23,887) (50,038)
Beneficial conversion feature of Series C preferred
stock............................................ -- -- (2,500) --
------ ------- -------- --------
Net loss applicable to common stockholders......... $ (461) $(6,914) $(26,387) $(50,038)
====== ======= ======== ========
Net loss per share (2):
Basic and diluted................................ $ -- $(1.42) $(1.84) $(0.52)
Pro forma basic and diluted...................... (0.25) (0.37)
Shares used in computing net loss per share (2):
Basic and diluted................................ -- 4,858 14,324 95,877
Pro forma basic and diluted...................... 96,188 135,057
DECEMBER 31,
-------------------------------------------
1997 1998 1999 2000
---------- -------- -------- --------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable securities... $6,606 $16,501 $ 23,566 $142,065
Working capital.................................... 6,308 15,321 19,604 135,597
Total assets....................................... 6,987 18,416 30,782 194,835
Long-term obligations, less current portion........ 6 1,220 3,402 --
Redeemable convertible preferred stock............. 7,100 22,951 46,109 --
Total stockholders' equity (deficit)............... (447) (7,097) (25,199) 150,706
- ------------------------
(FOOTNOTES ON FOLLOWING PAGE)
15
(1) Excludes non-cash, stock-based compensation expense as follows:
YEAR ENDED DECEMBER 31,
------------------------------
1998 1999 2000
-------- -------- --------
(IN THOUSANDS)
Manufacturing and product costs............................. $ -- $ 92 $ 404
Research and development.................................... 29 1,537 11,428
Sales and marketing......................................... 12 2,104 12,051
General and administrative.................................. 18 671 2,846
---- ------ -------
$ 59 $4,404 $26,729
==== ====== =======
(2) See note (1)(o) to our consolidated financial statements for an explanation
of the method of calculation. Pro forma per share calculation reflects the
conversion of all outstanding shares of Series A, Series B, Series C and
Series D redeemable convertible preferred stock into shares of common stock
which occurred upon the closing of our initial public offering in May 2000,
as if the conversion occurred at the date of original issuance.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED
FINANCIAL STATEMENTS AND NOTES TO THOSE STATEMENTS AND OTHER FINANCIAL
INFORMATION APPEARING ELSEWHERE IN THIS REPORT. THE FOLLOWING DISCUSSION
CONTAINS FORWARD-LOOKING INFORMATION THAT INVOLVES RISKS AND UNCERTAINTIES. OUR
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE
FORWARD-LOOKING STATEMENTS AS A RESULT OF A NUMBER OF FACTORS, INCLUDING THE
RISKS DISCUSSED IN "RISK FACTORS" AND ELSEWHERE IN THIS REPORT.
OVERVIEW
Sonus is a leading provider of voice infrastructure products for the new
public network. We offer a new generation of carrier-class switching equipment
and software that enable voice services to be delivered over packet-based
networks.
Since our inception, we have incurred significant losses and, as of
December 31, 2000, had an accumulated deficit of $84.0 million. We have not
achieved profitability on a quarterly or an annual basis and anticipate that we
will continue to incur net losses. We have a lengthy sales cycle for our
products and, accordingly, we expect to incur sales and other expenses before we
realize the related revenues. We expect to incur significant sales and
marketing, research and development, general and administrative and non-cash
expenses and, as a result, we will need to generate significant revenues to
achieve and maintain profitability.
We sell our products principally through a direct sales force and, in some
markets, through distributors and resellers. In the future, we anticipate
expanding our sales efforts to include additional overseas distribution
partners. Customers' decisions to purchase our products to deploy in commercial
networks involve a significant commitment of resources and a lengthy evaluation,
testing and product qualification process. We believe these long sales cycles,
as well as our expectation that customers will tend to sporadically place large
orders with short lead times, will cause our revenues and results of operations
to vary significantly and unexpectedly from quarter to quarter. We expect to
recognize revenues from a limited number of customers for the foreseeable
future.
In November 1999, we began shipping our products and recognized initial
revenues in the first quarter of 2000. For the year ended December 31, 2000, we
recognized $51.8 million in revenue. As of December 31, 2000 we had a total of
$14.5 million in deferred revenue. See note 1(g) to our consolidated financial
statements.
ACQUISITION OF TELECOM TECHNOLOGIES, INC.
On January 18, 2001, we acquired TTI. Upon the closing of this acquisition,
we issued an aggregate of 10,800,000 shares of common stock in exchange for all
outstanding capital stock of TTI. Of the 10,800,000 shares issued to the TTI
shareholders, 1,200,000 shares were placed into escrow as security for indemnity
obligations under the merger agreement, and will be released to TTI shareholders
upon expiration of those indemnity obligations, expected to be on the first
anniversary of the closing date. In addition, TTI shareholders will have the
right to receive an aggregate of 4,200,000 additional shares of common stock
which have been placed in escrow in the event that TTI achieves certain
specified business expansion and product development milestones from time to
time prior to December 31, 2002. In connection with our acquisition of TTI, we
adopted our 2000 Retention Plan and agreed to issue up to 3,000,000 shares of
common stock under this plan to certain employees of TTI who became employees of
Sonus, which are subject to vesting and completion of milestones.
We intend to account for the acquisition as a purchase for financial
reporting purposes. The purchase price will be allocated to TTI's assets and
liabilities based on the fair values of the assets acquired and the liabilities
assumed. Any excess of the purchase price over the fair value of the net
17
tangible assets and identifiable intangible assets acquired will be classified
as goodwill. In addition, a portion of the purchase price will be allocated to
in-process research and development. Goodwill and other intangibles are expected
to be amortized by charges to operations over their estimated useful lives of
three to four years and in-process research and development will be charged to
operations at the time of closing. Sonus expects to record stock-based
compensation relating to the issuance of awards under our 2000 Retention Plan.
The amount of charges for stock-based compensation, in-process research and
development and amortization of goodwill and other intangibles will be
significant and will therefore have a material negative impact on the combined
company's future operating results. See notes 2 and 10(h) to our consolidated
financial statements.
Over our next several quarters the sources from which TTI has historically
derived revenue are expected to decline significantly as we shift TTI's focus to
the development and deployment of the INtelligentIP softswitch product. In
addition, as a result of TTI's sale of its network testing software product
line, we expect revenues related to these products to decline or cease in 2001.
As of December 31, 2000, TTI had not recognized any revenue on its INtelligentIP
softswitch, but had shipped the softswitch to customers who are currently using
it in laboratory testing and internal trials.
RESULTS OF OPERATIONS
The following discussion of our results of operations relates solely to
Sonus and does not include any financial information of TTI, unless otherwise
specified.
REVENUES. We recognize revenue from product sales to end users, resellers
and distributors upon shipment, provided there are no uncertainties regarding
acceptance, persuasive evidence of an arrangement exists, the sales price is
fixed or determinable and collection of the related receivable is probable. If
uncertainties exist, we recognize revenue when those uncertainties are resolved.
In multiple element arrangements, in accordance with the Statement of Position
97-2 and 98-9, we use the residual method to recognize revenue when vendor
specific objective evidence does not exist for one of the delivered elements in
the arrangement. Service revenue is recognized as the services are provided.
Revenue from support arrangements is recognized ratably over the term of the
support contracts. Amounts collected prior to satisfying the revenue recognition
criteria are reflected as deferred revenue. We estimate and record warranty
costs at the time of product revenue recognition.
MANUFACTURING AND PRODUCT COSTS. Our manufacturing and product costs
consist primarily of amounts paid to third-party manufacturers, manufacturing
start-up expenses and manufacturing and professional services personnel and
related costs. Commencing in 1999, we outsourced a majority of our manufacturing
processes to third-parties. Manufacturing engineering, documentation control,
final testing and assembly are performed at our facility.
GROSS PROFIT MARGINS. We believe that our gross profit margins will be
affected primarily by the following factors:
- demand for our products and services;
- new product introductions and enhancements both by us and by our
competitors;
- product service and support costs associated with initial deployment of
our products in customers' networks;
- changes in our pricing policies and those of our competitors;
- the mix of product configurations sold;
- the mix of sales channels through which our products and services are
sold; and
- the volume of manufacturing and costs of manufacturing and components.
18
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist primarily of salaries and related personnel costs, recruiting expenses
and prototype costs related to the design, development, testing and enhancement
of our products. We have expensed our research and development costs as
incurred. Some aspects of our research and development effort require
significant short-term expenditures, the timing of which can cause significant
quarterly variability in our expenses. We believe that research and development
is critical to our strategic product development objectives and we intend to
enhance our technology to meet the changing requirements of our customers. As a
result, we expect our research and development expenses to increase in absolute
dollars in the future.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of salaries and related personnel expenses, commissions, recruiting
expenses, promotions, customer evaluations and other marketing expenses. We
expect that sales and marketing expenses will increase substantially in absolute
dollars in the future as we increase our direct sales efforts, expand our
operations internationally, hire additional sales and marketing personnel,
initiate additional marketing programs and establish sales offices in new
locations.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of salaries and related expenses for executive, finance and
administrative personnel, recruiting expenses and professional fees. We expect
that general and administrative expenses will increase in absolute dollars as we
add personnel and incur additional costs related to the growth of our business
and our operation as a public company.
STOCK-BASED COMPENSATION EXPENSES. In connection with our grant of stock
options and issuance of restricted common stock during the years ended
December 31, 1999 and 2000, we recorded deferred stock-based compensation of
$20.9 million and $39.4 million, respectively. Stock-based compensation expenses
include the amortization of stock compensation charges resulting from the
granting of stock options and sale of restricted common stock to employees with
exercise or sales prices that may be deemed for accounting purposes to be below
the fair value of our common stock on the date of grant and compensation expense
associated with the grant of stock options and issuance of restricted stock to
non-employees. Deferred compensation amounts are being amortized over the
vesting periods of the applicable options or restricted stock, which are four to
five years. The compensation expense associated with non-employees is recorded
at the time services are provided.
In connection with the acquisition of TTI, we expect to record deferred
stock-based compensation of approximately $22.6 million related to the value for
accounting purposes of unvested TTI options assumed by us. We expect to
recognize this deferred compensation as an expense over the remaining vesting
period of the underlying stock options of up to four years. We expect to record
deferred stock-based compensation of approximately $112.1 million for the value
of the up to 3,000,000 shares to be awarded under our 2000 Retention Plan, based
upon the fair value of our common stock on the date of closing of our
acquisition of TTI. This deferred compensation is expected to be expensed
ratably over the approximate two-year vesting period of the retention shares and
adjusted for changes in the fair value of our common stock on the date the
related milestone conditions are satisfied.
Based on the grant of Sonus' stock options and sale of restricted common
stock through December 31, 2000, the unvested TTI options assumed by Sonus and
the awards under the 2000 Retention Plan, we expect to record approximately
$76.0 million, $72.3 million, $14.5 million and $3.6 million in employee
stock-based compensation expense in the years ending December 31, 2001, 2002,
2003 and 2004, respectively. See note 10(h) to our consolidated financial
statements.
BENEFICIAL CONVERSION OF PREFERRED STOCK. In 1999, we recorded a charge to
accumulated deficit of $2.5 million representing the beneficial conversion
feature of our Series C redeemable convertible preferred stock that was sold in
November and December 1999. This charge is accounted for as a
19
dividend to preferred stockholders and, as a result, will increase the net loss
available to common stockholders and the related net loss per share.
YEARS ENDED DECEMBER 31, 1999 AND 2000
REVENUES. Revenues were $51.8 million for the year ended December 31, 2000
as a result of the introduction of our voice infrastructure products. No
revenues were reported for the year ended December 31, 1999. Three of our
customers, each of whom contributed more than 10% of our revenues during the
year ended December 31, 2000, collectively represented an aggregate of 70% of
our total revenues.
MANUFACTURING AND PRODUCT COSTS. Manufacturing expenses and product costs
were $27.8 million, or 54% of revenues, for the year ended December 31, 2000, an
increase of $25.9 million from $1.9 million in 1999. The increase is primarily
the result of an increase in product manufacturing and personnel costs
associated with revenues recorded in fiscal 2000. We expect manufacturing and
product costs to decrease as a percentage of revenues based on product mix
changes and improved efficiencies as our revenue increases.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$26.4 million in 2000, an increase of $15.6 million, or 145%, from
$10.8 million in 1999. The increase reflects costs primarily associated with a
significant increase in personnel and personnel-related expenses and, to a
lesser extent, prototype and software expenses for the development of our
products.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were
$21.6 million in 2000, an increase of $16.0 million, or 285%, from $5.6 million
in 1999. The increase reflects costs primarily associated with the hiring of
additional U.S. and international sales and marketing personnel and the opening
of international sales offices and, to a lesser extent, sales commissions,
travel-related expenses, marketing program costs, trade shows and product launch
activities.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $5.5 million in 2000, an increase of $3.8 million, or 218%, from
$1.7 million in 1999. The increase reflects the hiring of additional general and
administrative personnel and, to a lesser extent, costs associated with being a
public company.
STOCK-BASED COMPENSATION EXPENSES. Stock-based compensation expenses were
$26.7 million in 2000, an increase of $22.3 million from $4.4 million in 1999.
This increase is due to the amortization of deferred stock-based compensation
resulting from the granting of additional stock options and sale of restricted
common stock to employees and non-employees.
INTEREST INCOME (EXPENSE), NET. Interest income consists of interest earned
on our cash balances and marketable securities. Interest expense consists of
interest incurred on equipment debt. Interest income, net of interest expense
was $6.2 million in 2000, an increase of $5.7 million from $487,000 in 1999.
This increase reflects higher invested cash and marketable securities balances
as a result of our May 2000 initial public offering and private financings and
is partially offset by interest expense from increased borrowings, which were
repaid in June 2000.
NET OPERATING LOSS CARRYFORWARDS. As of December 31, 2000, we had
approximately $40.0 million of federal net operating loss carryforwards for tax
purposes available to offset future taxable income. These net operating loss
carryforwards expire at dates through 2020, to the extent that they are not
used. We have not recognized any benefit from the future use of loss
carryforwards for these periods, or for any other periods since inception. Use
of the net operating loss carryforwards may be limited in future years if there
is a significant change in our ownership. Management has recorded a full
valuation allowance for the related net deferred tax asset due to the
uncertainty of realizing the benefit of this asset.
20
YEARS ENDED DECEMBER 31, 1998 AND 1999
MANUFACTURING EXPENSES. Manufacturing expenses were $1.9 million in 1999,
compared to no expense in 1998. The increase was due to the commencement of
manufacturing operations.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$10.8 million in 1999, an increase of $5.0 million, or 85%, from $5.8 million in
1998. The increase reflects costs primarily associated with a significant
increase in personnel and personnel-related expenses and, to a lesser extent,
recruiting expenses and prototype expenses for the development of our products.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were
$5.6 million in 1999, an increase of $5.2 million from $426,000 in 1998. The
increase reflects costs primarily associated with the hiring of additional sales
and marketing personnel and, to a lesser extent, marketing program costs,
including Web development, trade shows and product launch activities.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $1.7 million in 1999, an increase of $804,000, or 87%, from $919,000 in
1998. The increase reflects costs primarily associated with the hiring of
additional general and administrative personnel and, to a lesser extent,
expenses necessary to support and scale our operations.
STOCK-BASED COMPENSATION EXPENSES. Stock-based compensation expenses were
$4.4 million in 1999, an increase of $4.3 million, from $59,000 in 1998. The
increase is due to the amortization of deferred stock-based compensation
resulting from the granting of stock options and sale of restricted common stock
to employees with exercise or sales prices below the deemed fair value of our
common stock on the date of grant or sale for accounting purposes.
INTEREST INCOME (EXPENSE), NET. Interest income, net of interest expense
was $487,000 and $314,000 for 1999 and 1998, respectively. This increase
reflects higher invested balances partially offset by an increase in interest
expense from increased borrowings.
LIQUIDITY AND CAPITAL RESOURCES
Prior to our initial public offering, we financed our operations primarily
through private sales of redeemable convertible preferred stock totaling
$70.7 million in net proceeds. Upon the closing of our initial public offering
on May 31, 2000, we received cash proceeds, net of the underwriting discount and
offering expenses, totaling $121.7 million, and all of our redeemable
convertible preferred stock converted into 96,957,222 shares of common stock. At
December 31, 2000 cash, cash equivalents and marketable securities totaled
$142.1 million.
Net cash used in operating activities was $14.4 million for the year ended
December 31, 2000, as compared to $16.0 million for the year ended December 31,
1999. The decrease reflects increased net losses, inventory purchases and
accounts receivable offset by increased non-cash charges for stock-based
compensation and depreciation, and increases in accounts payable, accrued
expenses and deferred revenue.
Net cash used in investing activities was $55.8 million for the year ended
December 31, 2000, as compared to $6.4 million for the year ended December 31,
1999. Net cash used in investing activities for the year ended December 31, 2000
primarily reflects net purchases of marketable securities of $40.3 million and
purchases of property and equipment, primarily computers and test equipment for
our development and manufacturing activities of $14.8 million. We expect capital
expenditures to continue to increase in the year 2001 to approximately
$30.0 million, due to our expansion, our acquisition of TTI and expenditures for
software licenses, computers and test equipment.
Net cash provided by financing activities was $148.4 million for the year
ended December 31, 2000, as compared to $27.6 million for the year ended
December 31, 1999. The increase was primarily a
21
result of the net cash proceeds from our initial public offering partially
offset by repayment of long-term obligations.
We believe our current cash and cash equivalents will be sufficient to meet
our anticipated cash needs for working capital and capital expenditures for at
least 12 months. In connection with our acquisition of TTI, we expect to make
cash expenditures of up to approximately $20.0 million during fiscal 2001 for
transaction-related expenses, consisting primarily of professional fees and the
full repayment of TTI's bank debt. If our existing resources and cash generated
from operations are insufficient to satisfy our liquidity requirements, we may
seek to sell additional equity or debt securities. The sale of additional equity
or convertible debt securities could result in additional dilution to our
stockholders, and we cannot be certain that additional financing will be
available in amounts or on terms acceptable to us, if at all. If we are unable
to obtain this additional financing, we may be required to reduce the scope of
our planned product development and sales and marketing efforts, which could
harm our business, financial condition and operating results.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS. This
bulletin established guidelines for revenue recognition. Our revenue recognition
policy complies with this pronouncement.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVES AND HEDGING
ACTIVITIES, as amended by SFAS No. 138, which establishes accounting and
reporting standards for derivative instruments, including derivative instruments
embedded in other contracts, and for hedging activities. We do not currently
engage in trading market risk sensitive instruments, purchase hedging
instruments or "other than trading" instruments that are likely to expose us to
market risk, whether interest rate, foreign currency exchange, commodity price
or equity price risk. We may do so in the future as our operations expand
domestically and abroad. We will evaluate the impact of foreign currency
exchange risk and other derivative instrument risk on our results of operations
when appropriate. We will adopt SFAS No. 133 as required by SFAS No. 137,
DEFERRAL OF THE EFFECTIVE DATE OF FASB STATEMENT NO. 133, in fiscal year 2001.
The adoption of SFAS No. 133 is not expected to have a material impact on our
financial condition or results of operations.
In March 2000, the FASB issued Interpretation No. 44, ACCOUNTING FOR CERTAIN
TRANSACTIONS INVOLVING STOCK COMPENSATION--AN INTERPRETATION OF ACCOUNTING
PRINCIPLES BOARD OPINION NO. 25, which clarifies the application of APB Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, in certain situations, as
defined. Interpretation No. 44 is effective July 1, 2000, but is retroactive for
specified events occurring after December 15, 1998. Interpretation No. 44 does
not have a material impact on our financial condition or results of operations.
22
RISK FACTORS
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD
CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE BUYING OUR COMMON STOCK. IF
ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, THE TRADING PRICE OF OUR COMMON
STOCK COULD DECLINE AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT.
WE EXPECT THAT A MAJORITY OF OUR REVENUES WILL BE GENERATED FROM A LIMITED
NUMBER OF CUSTOMERS AND OUR REVENUES WILL NOT GROW IF WE DO NOT SUCCESSFULLY
SELL PRODUCTS TO THESE CUSTOMERS.
To date, we have shipped our products to a limited number of customers and
only during the first quarter of fiscal 2000 did we begin to recognize revenues.
We expect that in the foreseeable future, substantially all of our revenues will
depend on sales of our products to a limited number of customers. For example,
for the year ended December 31, 2000, three customers each contributed more than
10% of our revenues and collectively represented an aggregate of 70% of our
total revenues. The customers to whom we have shipped products are currently
using our products in laboratory testing or internal trials or have deployed our
products in their commercial networks. Our customers may not, or may not
continue to, deploy our products in their commercial networks on a timely basis,
or at all, and any delay or failure by our customers to introduce commercial
services based on our products, or a downturn in their business, would seriously
harm our ability to sell products and generate revenues.
WE WILL NOT BE SUCCESSFUL IF WE DO NOT GROW OUR CUSTOMER BASE.
Our future success will depend on our ability to attract additional
customers beyond our current limited number. The growth of our customer base
could be adversely affected by:
- customer unwillingness to implement our new voice infrastructure products;
- any delays or difficulties that we may incur in completing the development
and introduction of our planned products or product enhancements;
- new product introductions by our competitors;
- any failure of our products to perform as expected; or
- any difficulty we may incur in meeting customers' delivery requirements.
If we do not expand our customer base to include additional customers that
deploy our products in operational commercial networks, our revenues will not
grow significantly, or at all.
THE MARKET FOR VOICE INFRASTRUCTURE PRODUCTS FOR THE NEW PUBLIC NETWORK IS NEW
AND EVOLVING AND OUR BUSINESS WILL SUFFER IF IT DOES NOT DEVELOP AS WE EXPECT.
The market for our products is rapidly evolving. Packet-based technology may
not be widely accepted as a platform for voice and a viable market for our
products may not develop or be sustainable. If this market does not develop, or
develops more slowly than we expect, we may not be able to sell our products in
significant volumes, or at all.
WE ARE ENTIRELY DEPENDENT UPON OUR VOICE INFRASTRUCTURE PRODUCTS AND OUR FUTURE
REVENUES DEPEND UPON THEIR COMMERCIAL SUCCESS.
Our future growth depends upon the commercial success of our voice
infrastructure products. We intend to develop and introduce new products and
enhancements to existing products in the future. We may not successfully
complete the development or introduction of these products. If our target
customers do not adopt, purchase and successfully deploy our current or planned
products, our revenues will not grow.
23
BECAUSE OUR PRODUCTS ARE SOPHISTICATED AND DESIGNED TO BE DEPLOYED IN COMPLEX
ENVIRONMENTS, THEY MAY HAVE ERRORS OR DEFECTS THAT WE FIND ONLY AFTER FULL
DEPLOYMENT, WHICH COULD SERIOUSLY HARM OUR BUSINESS.
Our products are sophisticated and are designed to be deployed in large and
complex networks. Because of the nature of our products, they can only be fully
tested when substantially deployed in very large networks with high volumes of
traffic. Some of our customers have only recently begun to commercially deploy
our products and they may discover errors or defects in the software or
hardware, or the products may not operate as expected.
If we are unable to fix errors or other performance problems that may be
identified after full deployment of our products, we could experience:
- loss of, or delay in, revenues;
- loss of customers and market share;
- a failure to attract new customers or achieve market acceptance for our
products;
- increased service, support and warranty costs and a diversion of
development resources; and
- costly and time-consuming legal actions by our customers.
IF WE DO NOT RESPOND RAPIDLY TO TECHNOLOGICAL CHANGES OR TO CHANGES IN INDUSTRY
STANDARDS, OUR PRODUCTS COULD BECOME OBSOLETE.
The market for voice infrastructure products for the new public network is
likely to be characterized by rapid technological change and frequent new
product introductions. We may be unable to respond quickly or effectively to
these developments. We may experience difficulties with software development,
hardware design, manufacturing or marketing that could delay or prevent our
development, introduction or marketing of new products and enhancements. The
introduction of new products by our competitors, the market acceptance of
products based on new or alternative technologies or the emergence of new
industry standards could render our existing or future products obsolete. If the
standards adopted are different from those that we have chosen to support,
market acceptance of our products may be significantly reduced or delayed. If
our products become technologically obsolete, we may be unable to sell our
products in the marketplace and generate revenues.
WE DEPEND UPON CONTRACT MANUFACTURERS AND ANY DISRUPTION IN THESE RELATIONSHIPS
MAY CAUSE US TO FAIL TO MEET THE DEMANDS OF OUR CUSTOMERS AND DAMAGE OUR
CUSTOMER RELATIONSHIPS.
We rely on a small number of contract manufacturers to manufacture our
products according to our specifications and to fill orders on a timely basis.
Our contract manufacturers provide comprehensive manufacturing services,
including assembly of our products and procurement of materials. Each of our
contract manufacturers also builds products for other companies and may not
always have sufficient quantities of inventory available to fill our orders or
may not allocate their internal resources to fill these orders on a timely
basis. We do not have long-term supply contracts with our manufacturers and they
are not required to manufacture products for any specified period. We do not
have internal manufacturing capabilities to meet our customers' demands.
Qualifying a new contract manufacturer and commencing commercial-scale
production is expensive and time consuming and could result in a significant
interruption in the supply of our products. If a change in contract
manufacturers results in delays in our fulfillment of customer orders or if a
contract manufacturer fails to make timely delivery of orders, we may lose
revenues and suffer damage to our customer relationships.
24
WE HAVE BEEN IN BUSINESS FOR A SHORT PERIOD OF TIME AND YOUR BASIS FOR
EVALUATING US IS LIMITED.
We were founded in August 1997, and only during the first quarter of fiscal
2000 did we begin to recognize any revenues. We have a limited meaningful
operating history upon which you may evaluate us and our prospects. Moreover, we
cannot be sure that we have accurately identified all of the risks to our
business. Also, our assessment of the prospects for our success may prove
inaccurate.
THE UNPREDICTABILITY OF OUR QUARTERLY RESULTS MAY ADVERSELY AFFECT THE TRADING
PRICE OF OUR COMMON STOCK.
Our revenues and operating results will vary significantly from quarter to
quarter due to a number of factors, many of which are outside of our control and
any of which may cause our stock price to fluctuate. Generally, purchases by
service providers of telecommunications equipment from manufacturers have been
unpredictable and clustered, rather than steady, as the providers build out
their networks. The primary factors that may affect our revenues and results
include the following:
- fluctuation in demand for our voice infrastructure products and the timing
and size of customer orders;
- the length and variability of the sales cycle for our products and the
corresponding timing of recognizing or deferring revenues;
- new product introductions and enhancements by our competitors and us;
- changes in our pricing policies, the pricing policies of our competitors
and the prices of the components of our products;
- our ability to develop, introduce and ship new products and product
enhancements that meet customer requirements in a timely manner;
- the mix of product configurations sold;
- our ability to obtain sufficient supplies of sole or limited source
components;
- our ability to attain and maintain production volumes and quality levels
for our products;
- costs related to acquisitions of complementary products, technologies or
businesses; and
- general economic conditions, as well as those specific to the
telecommunications, networking and related industries and other factors.
As with other telecommunications product suppliers, we may recognize a
substantial portion of our revenue in a given quarter from sales booked and
shipped in the last weeks of that quarter. As a result, a delay in customer
orders is likely to result in a delay in shipments and recognition of revenue
beyond the end of a given quarter, which would have a significant impact on our
operating results for that quarter.
Our operating expenses are largely based on anticipated organizational
growth and revenue trends. As a result, a delay in generating or recognizing
revenues for the reasons set forth above, or for any other reason, could cause
significant variations in our operating results. We believe that
quarter-to-quarter comparisons of our operating results are not a good
indication of our future performance. It is likely that in some future quarters,
our operating results may be below the expectations of public market analysts
and investors. In this event, the price of our common stock will probably
substantially decrease.
WE MAY NOT BECOME PROFITABLE.
We have incurred significant losses since inception and expect to continue
to incur losses in the future. As of December 31, 2000, we had an accumulated
deficit of $84.0 million and had only
25
recognized cumulative revenues since inception of $51.8 million through
December 31, 2000. We have not achieved profitability on a quarterly or annual
basis. As a result of our acquisition of TTI, we expect to incur significant
expenses for stock-based compensation, in-process research and development and
amortization of goodwill and other intangibles, which will make achieving
profitability more difficult in the near to mid-term.
Our revenues may not grow and we may never generate sufficient revenues to
achieve or sustain profitability. We expect to continue to incur significant and
increasing sales and marketing, product development, administrative and other
expenses. As a result, we will need to generate significant revenues to achieve
and maintain profitability.
WE WILL NOT RETAIN CUSTOMERS OR ATTRACT NEW CUSTOMERS IF WE DO NOT ANTICIPATE
AND MEET SPECIFIC CUSTOMER REQUIREMENTS OR IF OUR PRODUCTS DO NOT INTEROPERATE
WITH OUR CUSTOMERS' EXISTING NETWORKS.
To achieve market acceptance for our products, we must effectively
anticipate, and adapt in a timely manner to, customer requirements and offer
products and services that meet changing customer demands. Prospective customers
may require product features and capabilities that our current products do not
have. The introduction of new or enhanced products also requires that we
carefully manage the transition from older products in order to minimize
disruption in customer ordering patterns and ensure that adequate supplies of
new products can be delivered to meet anticipated customer demand. If we fail to
develop products and offer services that satisfy customer requirements, or to
effectively manage the transition from older products, our ability to create or
increase demand for our products would be seriously harmed and we may lose
current and prospective customers.
Many of our customers will require that our products be designed to
interface with their existing networks, each of which may have different
specifications. Issues caused by an unanticipated lack of interoperability may
result in significant warranty, support and repair costs, divert the attention
of our engineering personnel from our hardware and software development efforts
and cause significant customer relations problems. If our products do not
interoperate with those of our customers' networks, installations could be
delayed or orders for our products could be cancelled, which would seriously
harm our gross margins and result in loss of revenues or customers.
IF WE FAIL TO COMPETE SUCCESSFULLY, OUR ABILITY TO INCREASE OUR REVENUES OR
ACHIEVE PROFITABILITY WILL BE IMPAIRED.
Competition in the telecommunications market is intense. This market has
historically been dominated by large companies, such as Lucent Technologies and
Nortel Networks, both of whom are our direct competitors. We also face
competition from other large telecommunications and networking companies,
including Cisco Systems and Tellabs, that have entered our market by acquiring
companies that design competing products. In addition, a number of smaller and
mostly private companies, including Convergent Networks, Unisphere Networks and
others, have announced plans for new products that address similar market
opportunities that we address. Because this market is rapidly evolving,
additional competitors with significant financial resources may enter these
markets and further intensify competition.
Many of our current and potential competitors have significantly greater
selling and marketing, technical, manufacturing, financial and other resources,
including the ability to offer vendor-sponsored financing programs. If we are
unable or unwilling to offer vendor-sponsored financing, prospective customers
may decide to purchase products from one of our competitors who offers this type
of financing. Furthermore, some of our competitors are currently selling
significant amounts of other products to our current and prospective customers.
Our competitors' broad product portfolios coupled with already existing
relationships may cause our customers to buy our competitors' products or harm
our ability to attract new customers.
26
To compete effectively, we must deliver innovative products that:
- provide extremely high reliability and voice quality;
- scale easily and efficiently;
- interoperate with existing network designs and other vendors' equipment;
- provide effective network management;
- are accompanied by comprehensive customer support and professional
services; and
- provide a cost-effective and space-efficient solution for service
providers.
If we are unable to compete successfully against our current and future
competitors, we could experience price reductions, order cancellations, loss of
revenues and reduced gross margins.
WE AND OUR CONTRACT MANUFACTURERS RELY ON SINGLE OR LIMITED SOURCES FOR SUPPLY
OF SOME COMPONENTS OF OUR PRODUCTS AND IF WE FAIL TO ADEQUATELY PREDICT OUR
MANUFACTURING REQUIREMENTS OR IF OUR SUPPLY OF ANY OF THESE COMPONENTS IS
DISRUPTED, WE WILL BE UNABLE TO SHIP OUR PRODUCTS.
We and our contract manufacturers currently purchase several key components
of our products, including commercial digital signal processors, from single or
limited sources. We purchase these components on a purchase order basis. If we
overestimate our component requirements, we could have excess inventory, which
would increase our costs. If we underestimate our requirements, we may not have
adequate supply, which could interrupt manufacturing of our products and result
in delays in shipments and revenues.
We currently do not have long-term supply contracts with our component
suppliers and they are not required to supply us with products for any specified
periods, in any specified quantities or at any set price, except as may be
specified in a particular purchase order. In the event of a disruption or delay
in supply, or inability to obtain products, we may not be able to develop an
alternate source in a timely manner or at favorable prices, or at all. A failure
to find acceptable alternative sources could hurt our ability to deliver
high-quality products to our customers and negatively affect our operating
margins. In addition, our reliance on our suppliers exposes us to potential
supplier production difficulties or quality variations. Our customers rely upon
our ability to meet committed delivery dates, and any disruption in the supply
of key components would seriously impact our ability to meet these dates and
could result in legal action by our customers, loss of customers or harm to our
ability to attract new customers.
IF WE ARE NOT ABLE TO OBTAIN NECESSARY LICENSES OF THIRD-PARTY TECHNOLOGY AT
ACCEPTABLE PRICES, OR AT ALL, OUR PRODUCTS COULD BECOME OBSOLETE.
We have incorporated third-party licensed technology into our current
products. From time to time, we may be required to license additional technology
from third parties to develop new products or product enhancements. Third-party
licenses may not be available or continue to be available to us on commercially
reasonable terms. The inability to maintain or re-license any third-party
licenses required in our current products or to obtain any new third-party
licenses to develop new products and product enhancements could require us to
obtain substitute technology of lower quality or performance standards or at
greater cost, and delay or prevent us from making these products or
enhancements, any of which could seriously harm the competitiveness of our
products.
27
OUR FAILURE TO MANAGE OUR EXPANSION EFFECTIVELY IN A RAPIDLY CHANGING MARKET
COULD INCREASE OUR COSTS, HARM OUR ABILITY TO SELL FUTURE PRODUCTS AND IMPAIR
OUR FUTURE GROWTH.
We intend to expand our operations rapidly and plan to hire a significant
number of employees during 2001. Our growth has placed, and our anticipated
growth will continue to place, a significant strain on our management systems
and resources. Our ability to successfully offer our products and implement our
business plan in a rapidly evolving market requires effective planning and
management processes. We expect that we will need to continue to improve our
financial, managerial and manufacturing controls and reporting systems, and will
need to continue to expand, train and manage our work force worldwide. If we
fail to implement adequate control systems in an efficient and timely manner,
our costs may be increased and our growth could be impaired and we may not be
able to accurately anticipate and fulfill market demand, the result of which
will be a loss of revenues and customers.
IF WE FAIL TO HIRE AND RETAIN NEEDED PERSONNEL, THE IMPLEMENTATION OF OUR
BUSINESS PLAN COULD SLOW OR OUR FUTURE GROWTH COULD HALT.
Competition for highly skilled engineering, sales, marketing and support
personnel is intense because there are a limited number of people available with
the necessary technical skills and understanding of our market. Any failure to
attract, assimilate or retain qualified personnel to fulfill our current or
future needs could impair our growth. The support of our products requires
highly trained customer support and professional services personnel. Once we
hire them, they may require extensive training in our voice infrastructure
products. If we are unable to hire, train and retain our customer support and
professional services personnel, we may not be able to increase sales of our
products.
Our future success depends upon the continued services of our executive
officers who have critical industry experience and relationships that we rely on
to implement our business plan. Most of our officers or key employees are not
bound by an employment agreement for any specific term. The loss of the services
of any of our officers or key employees could delay the development and
introduction of, and negatively impact our ability to sell, our products.
OUR ABILITY TO COMPETE AND OUR BUSINESS COULD BE JEOPARDIZED IF WE ARE UNABLE TO
PROTECT OUR INTELLECTUAL PROPERTY OR BECOME SUBJECT TO INTELLECTUAL PROPERTY
RIGHTS LITIGATION, WHICH COULD REQUIRE US TO INCUR SIGNIFICANT COSTS.
We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
Despite our efforts to protect our proprietary rights, unauthorized parties may
attempt to copy or otherwise obtain and use our products or technology.
Monitoring unauthorized use of our products is difficult and we cannot be
certain that the steps we have taken will prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. If competitors are able to
use our technology, our ability to compete effectively could be harmed.
In addition, we may also become involved in litigation as a result of
allegations that we infringe the intellectual property rights of others. Any
parties asserting that our products infringe upon their proprietary rights would
force us to defend ourselves and possibly our customers or contract
manufacturers against the alleged infringement. These claims and any resulting
lawsuit, if successful, could subject us to significant liability for damages
and invalidation of our proprietary rights. Any potential intellectual property
litigation also could force us to do one or more of the following:
- stop selling, incorporating or using our products that use the challenged
intellectual property;
28
- obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on reasonable terms, or at all; or
- redesign those products that use any allegedly infringing technology.
Any lawsuits regarding intellectual property rights, regardless of their
success, would be time-consuming, expensive to resolve and would divert our
management's time and attention.
ANY INVESTMENTS OR ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND SERIOUSLY
HARM OUR FINANCIAL CONDITION.
Although we have no current agreements to do so, we intend to consider
investing in, or acquiring, complementary products, technologies or businesses.
In the event of any additional future investments or acquisitions, we could, and
in connection with our recent acquisition of TTI, we did:
- issue stock that would dilute our current stockholders' percentage
ownership;
- incur debt or assume liabilities;
- incur significant amortization expenses related to goodwill and other
intangible assets; or
- incur large and immediate write-offs for in-process research and
development and stock-based compensation.
Our integration of any acquired products, technologies or businesses,
including those associated with our acquisition of TTI, will also involve
numerous risks, including:
- problems and unanticipated costs associated with combining the purchased
products, technologies or businesses;
- diversion of management's attention from our core business;
- adverse effects on existing business relationships with suppliers and
customers;
- risks associated with entering markets in which we have limited or no
prior experience; and
- potential loss of key employees, particularly those of the acquired
organizations.
We may be unable to successfully integrate any products, technologies,
businesses or personnel that we might acquire in the future, including those
associated with our acquisition of TTI, without significant costs or disruption
to our business.
WE MAY FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL EXPANSION THAT COULD IMPAIR
OUR ABILITY TO GROW OUR REVENUES ABROAD.
Our expansion into international markets will require significant management
attention and financial resources to successfully develop direct and indirect
international sales and support channels. In addition, we may not be able to
develop international market demand for our products, which could impair our
ability to grow our revenues.
We have limited experience marketing and distributing our products
internationally and, to do so, we expect that we will need to develop versions
of our products that comply with local standards. Furthermore, international
operations are subject to other inherent risks, including:
- greater difficulty collecting accounts receivable and longer collection
periods;
- difficulties and costs of staffing and managing international operations;
- the impact of differing technical standards outside the United States;
29
- the impact of recessions in economies outside the United States;
- unexpected changes in regulatory requirements and currency exchange rates;
- certification requirements;
- reduced protection for intellectual property rights in some countries; and
- potentially adverse tax consequences.
IF WE ARE SUBJECT TO UNFAIR HIRING CLAIMS, WE COULD INCUR SUBSTANTIAL COSTS IN
DEFENDING OURSELVES.
Companies in our industry whose employees accept positions with competitors
frequently claim that their competitors have engaged in unfair hiring practices.
We may be subject to claims of this kind in the future as we seek to hire
qualified personnel. Those claims may result in material litigation. We could
incur substantial costs defending ourselves or our employees against those
claims, regardless of their merits. In addition, defending ourselves from those
types of claims could divert our management's attention from our operations. If
we are found to have engaged in unfair hiring practices, or our employees are
found to have violated agreements with previous employers, we may suffer a
significant disruption in our operations.
WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE, WHICH MAY NOT BE AVAILABLE TO US,
AND IF IT IS AVAILABLE, MAY DILUTE OWNERS OF OUR COMMON STOCK.
We may need to raise additional funds through public or private debt or
equity financings in order to:
- fund ongoing operations;
- take advantage of opportunities, including more rapid expansion or
acquisition of complementary products, technologies or businesses;
- develop new products; or
- respond to competitive pressures.
Any additional capital raised through the sale of equity may dilute an
investor's percentage ownership of our common stock. Furthermore, additional
financings may not be available on terms favorable to us, or at all. A failure
to obtain additional funding could prevent us from making expenditures that may
be required to grow or maintain our operations.
OUR STOCK PRICE MAY BE VOLATILE.
The market for technology stocks has been and will likely continue to be
extremely volatile. The following factors could cause the market price of our
common stock to fluctuate significantly:
- loss of any of our major customers;
- the addition or departure of key personnel;
- variations in our quarterly operating results;
- announcements by us or our competitors of significant contracts, new
products or product enhancements, acquisitions, distribution partnerships,
joint ventures or capital commitments;
- changes in financial estimates by securities analysts;
- sales of common stock or other securities by us or by our stockholders in
the future;
- any acquisitions, distribution partnerships, joint ventures or capital
commitments;
30
- changes in market valuations of telecommunications and networking
companies; and
- fluctuations in stock market prices and volumes.
In addition, stock markets in general, and the Nasdaq Stock Market and
technology companies in particular, have experienced extreme price and volume
fluctuations that have often been unrelated or disproportionate to the operating
performance of these companies. The trading prices of many technology companies'
stocks are substantially above historical levels and may not be sustained. These
broad market and industry trends may materially and adversely affect the market
price of our common stock, regardless of our actual operating performance. In
the past, following periods of volatility in the market price of a company's
securities, securities class-action litigation has often been initiated against
these companies. Class-action litigation, if initiated, could result in
substantial costs and a diversion of management's attention and resources.
SALES OF A SUBSTANTIAL AMOUNT OF OUR COMMON STOCK IN THE FUTURE COULD CAUSE OUR
STOCK PRICE TO FALL.
Some stockholders who acquired shares prior to our initial public offering
hold a substantial number of shares of our common stock that have not yet been
sold in the public market. Sales of a substantial number of shares of our common
stock within a short period of time in the future could cause our stock price to
fall. In addition, the sale of these shares could impair our ability to raise
capital through the sale of debt or additional stock.
INSIDERS HAVE SUBSTANTIAL CONTROL OVER US AND COULD LIMIT YOUR ABILITY TO
INFLUENCE THE OUTCOME OF KEY TRANSACTIONS, INCLUDING A CHANGE OF CONTROL.
Our executive officers, directors and entities affiliated with them
beneficially own, in the aggregate, approximately 24.9% of our outstanding
common stock. These stockholders, if acting together, would be able to influence
significantly all matters requiring approval by our stockholders, including the
election of directors and the approval of mergers or other business combination
transactions. See "Security Ownership of Certain Beneficial Owners and
Management."
PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY HAVE ANTI-TAKEOVER
EFFECTS THAT COULD PREVENT A CHANGE OF CONTROL.
Provisions of our amended and restated certificate of incorporation, amended
and restated by-laws and Delaware law could make it more difficult for a third
party to acquire us, even if doing so would be beneficial to our stockholders.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements that involve substantial
risks and uncertainties. In some cases you can identify these statements by
forward-looking words such as "anticipate," "believe," "could," "estimate,"
"expect," "intend," "may," "should," "will," and "would" or similar words. You
should read statements that contain these words carefully because they discuss
future expectations, contain projections of future results of operations or of
financial position or state other "forward-looking" information. The important
factors listed above in the section captioned "Risk Factors," as well as any
cautionary language in this report, provide examples of risks, uncertainties and
events that may cause the actual results of either company to differ materially
from the expectations described in these forward-looking statements. You should
be aware that the occurrence of the events described in these risk factors and
elsewhere in this report could have a material adverse effect on the business,
results of operations and financial position of Sonus.
Any forward-looking statements in this report are not guarantees of future
performances, and actual results, developments and business decisions may differ
from those envisaged by such forward-
31
looking statements, possibly materially. Sonus disclaims any duty to update any
forward-looking statements, all of which are expressly qualified by the
statements in this section.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
We do not currently use derivative financial instruments. We generally place
our marketable security investments in high-quality credit instruments,
primarily U.S. Government obligations and corporate obligations with contractual
maturities of less than one year. We do not expect any material loss from our
marketable security investments and therefore believe that our potential
interest rate exposure is not material. To date, sales from our international
operations have been made in United States dollars. Accordingly, we have no
material exposure to foreign currency rate fluctuations, though we will continue
to evaluate the impact of foreign currency exchange risk on our results of
operations as we expand internationally.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements of Sonus Networks, Inc. are filed as a
part of this Annual Report on Form 10-K beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT.
The information required by this Item 10 is incorporated by reference to our
definitive Proxy Statement with respect to our 2001 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item 11 is incorporated by reference to our
definitive Proxy Statement with respect to our 2001 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item 12 is incorporated by reference to our
definitive Proxy Statement with respect to our 2001 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item 13 is incorporated by reference to our
definitive Proxy Statement with respect to our 2001 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year.
32
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) DOCUMENTS FILED AS PART OF FORM 10-K:
(1) FINANCIAL STATEMENTS.
The following consolidated financial statements and notes thereto included
in Item 8 are filed as part of this report:
- Report of Independent Accountants
- Consolidated Balance Sheets
- Consolidated Statements of Operations
- Consolidated Statements of Redeemable Convertible Preferred Stock and
Stockholders' Equity (Deficit)
- Consolidated Statements of Cash Flows
- Notes to Consolidated Financial Statements
(2) FINANCIAL STATEMENT SCHEDULES.
None. All schedules are omitted because they are inapplicable, not required
under the instructions or because the information is reflected in the
consolidated financial statements or notes thereto.
(3) LIST OF EXHIBITS.
The following is a list of exhibits filed as a part of this registration
statement:
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
3.1** Fourth Amended and Restated Certificate of Incorporation of
the Registrant.
3.2** Amended and Restated By-Laws of the Registrant.
4.1** Form of Stock Certificate representing shares of the
Registrant's Common Stock.
9.1*** Voting Agreement, dated as of November 2, 2000, among the
Registrant, the Stockholder parties thereto and telecom
technologies, inc.
10.1* Registration Rights Agreement, dated as of November 2, 2000,
by and among the Registrant and the Stockholder parties
thereto.
10.2* 2000 Retention Plan of the Registrant.
10.3* telecom technologies, inc. 1998 Amended Equity Incentive
Plan.
10.4** Amended and Restated 1997 Stock Incentive Plan of the
Registrant.
10.5** 2000 Employee Stock Purchase Plan of the Registrant.
10.6** Lease, dated January 21, 1999, as amended, between the
Registrant and Glenborough Fund V, Limited Partnership with
respect to property located at 5 Carlisle Road, Westford,
Massachusetts.
10.7* Sub-lease, dated October 20, 2000, between the Registrant
and Unisphere Networks, Inc. with respect to property
located at 5 Carlisle Road, Westford, Massachusetts.
10.8* Sub-Lease, dated October 20, 2000, between the Registrant
and Unisphere Networks, Inc. with respect to property
located at 235 Littleton Road, Westford, Massachusetts.
10.9* Lease, dated September 30, 2000, between the Registrant and
BCIA New England Holdings LLC with respect to property
located at 25 Porter Road, Littleton, Massachusetts.
33
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
10.10** Series C Preferred Stock Purchase Agreement, dated as of
September 10, 1999, by and among the Registrant and the
"Purchaser" parties thereto.
10.11** Series D Preferred Stock Purchase Agreement, dated as of
March 9, 2000, by and among the Registrant and the
"Purchaser" parties thereto.
10.12** Third Amended and Restated Investor Rights Agreement, dated
as of March 9, 2000, by and among the Registrant and the
"Purchaser" parties thereto.
10.13** Third Amended and Restated Right of First Refusal and
Co-Sale Agreement, dated as of March 9, 2000, among the
Registrant and the persons and entities listed on the
signature pages thereto.
10.14** Modification Agreement, dated as of November 29, 1999, by
and between the Registrant and Silicon Valley Bank.
10.15** Agreement of Sublease, dated April 14, 2000, between the
Registrant and Unisphere Solutions, Inc. with respect to
property located at 25 Porter Road, Littleton,
Massachusetts.
10.16** Promissory Note, dated November 4, 1998, of Hassan M. Ahmed
to the Registrant and associated Pledge Agreement.
10.17** Promissory Note, dated September 1, 1999, of Stephen J. Nill
to the Registrant and associated Pledge Agreement.
10.18*** Agreement and Plan of Merger and Reorganization, dated as of
November 2, 2000, by and among the Registrant, Storm Merger
Sub, Inc. and telecom technologies, inc.
10.19 Employment Agreement, dated November 2, 2000, among telecom
technologies, inc., Anousheh Ansari and the Registrant.
10.20 Office Lease Agreement, dated as of November 14, 2000,
between telecom technologies, inc. and TR Lookout
Partners, Ltd. with respect to property located at
1301 East Lookout Drive, Suite 3000, Richardson, Texas.
10.21 First Amendment to Office Lease Agreement, dated as of
January 8, 2001, between telecom technologies, inc. and
TR Lookout Partners, Ltd. with respect to property located
at 1300 East Lookout Drive, Suite 3000, Richardson, Texas.
21.1 Subsidiaries of the Registrant.
- ------------------------
* Incorporated by reference to the Registrant's Registration Statement on
Form S-4 (file No. 333-52682).
** Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (file No. 333-32206).
*** Incorporated by reference to the Registrant's Current Report on Form 8-K,
filed November 17, 2000.
(B) REPORTS ON FORM 8-K DURING THE FOURTH QUARTER OF FISCAL 2000:
On October 13, 2000, the Registrant filed a Current Report on Form 8-K in
connection with its 3-for-1 stock split.
On November 17, 2000, the Registrant filed a Current Report on Form 8-K in
connection with its merger agreement to acquire telecom technologies, inc.
34
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
Town of Westford, Commonwealth of Massachusetts, on this 28th day of March,
2001.
SONUS NETWORKS, INC.
By: /s/ HASSAN M. AHMED
-----------------------------------------
Hassan M. Ahmed
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- ----
President, Chief Executive
/s/ HASSAN M. AHMED Officer and Director
------------------------------------------- (Principal Executive March 28, 2001
Hassan M. Ahmed Officer)
Chief Financial Officer,
Vice President of Finance
/s/ STEPHEN J. NILL and Administration and
------------------------------------------- Treasurer (Principal March 28, 2001
Stephen J. Nill Financial and Accounting
Officer)
/s/ RUBIN GRUBER
------------------------------------------- Chairman of the Board of March 28, 2001
Rubin Gruber Directors and a Director
/s/ EDWARD T. ANDERSON
------------------------------------------- Director March 28, 2001
Edward T. Anderson
/s/ PAUL J. FERRI
------------------------------------------- Director March 28, 2001
Paul J. Ferri
/s/ PAUL J. SEVERINO
------------------------------------------- Director March 28, 2001
Paul J. Severino
35
SONUS NETWORKS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statements of Redeemable Convertible Preferred
Stock and Stockholders' Equity (Deficit).................. F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Sonus Networks, Inc.:
We have audited the accompanying consolidated balance sheets of Sonus
Networks, Inc. (a Delaware corporation) as of December 31, 1999 and 2000 and the
related consolidated statements of operations, redeemable convertible preferred
stock and stockholders' equity (deficit) and cash flows for the years ended
December 31, 1998, 1999 and 2000. These consolidated financial statements are
the responsibility of the Sonus Networks, Inc. management. Our responsibility is
to express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Sonus Networks, Inc. as of
December 31, 1999 and 2000, and the results of its operations and its cash flows
for the years ended December 31, 1998, 1999 and 2000 in conformity with
accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
Boston, Massachusetts
January 15, 2001
(except with respect to the matters discussed
in Note 2 as to which the date is January 18, 2001)
F-2
SONUS NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31,
-------------------
1999 2000
-------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 8,885 $ 87,108
Marketable securities..................................... 14,681 54,957
Accounts receivable, net of allowance of $1,000........... -- 14,100
Inventories............................................... 2,210 20,668
Other current assets...................................... 298 2,893
-------- --------
Total current assets.................................. 26,074 179,726
PROPERTY AND EQUIPMENT, net of accumulated depreciation and
amortization.............................................. 4,269 14,273
OTHER ASSETS, net of accumulated amortization............... 439 836
-------- --------
$ 30,782 $194,835
======== ========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(DEFICIT)
CURRENT LIABILITIES:
Accounts payable.......................................... $ 1,412 $ 13,439
Accrued expenses.......................................... 2,691 16,239
Deferred revenue.......................................... 1,031 14,451
Current portion of long-term obligations.................. 1,336 --
-------- --------
Total current liabilities............................. 6,470 44,129
LONG-TERM OBLIGATIONS, less current portion................. 3,402 --
COMMITMENTS (Note 8)........................................ -- --
REDEEMABLE CONVERTIBLE PREFERRED STOCK, $0.01 par value;
17,000,000 shares authorized, 12,323,968 shares issued and
outstanding at December 31, 1999; no shares authorized,
issued and outstanding at
December 31, 2000......................................... 46,109 --
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, $0.01 par value 5,000,000 shares
authorized, none issued and outstanding................. -- --
Common stock, $0.001 par value; 300,000,000 shares
authorized, 65,510,921 and 184,244,474 shares issued and
65,510,921 and 183,471,974 shares outstanding at
December 31, 1999 and 2000, respectively................ 66 184
Capital in excess of par value............................ 25,567 266,488
Accumulated deficit....................................... (33,882) (83,966)
Stock subscriptions receivable............................ (346) (238)
Deferred compensation..................................... (16,604) (31,697)
Treasury stock, at cost; 772,500 common shares............ -- (65)
-------- --------
Total stockholders' equity (deficit).................. (25,199) 150,706
-------- --------
$ 30,782 $194,835
======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-3
SONUS NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
------------------------------
1998 1999 2000
-------- -------- --------
REVENUES.................................................... $ -- $ -- $ 51,770
Manufacturing and product costs (1)......................... -- 1,861 27,848
------- -------- --------
GROSS PROFIT (LOSS)......................................... -- (1,861) 23,922
OPERATING EXPENSES:
Research and development (1).............................. 5,824 10,780 26,430
Sales and marketing (1)................................... 426 5,606 21,569
General and administrative (1)............................ 919 1,723 5,477
Stock-based compensation.................................. 59 4,404 26,729
------- -------- --------
Total operating expenses................................ 7,228 22,513 80,205
------- -------- --------
LOSS FROM OPERATIONS........................................ (7,228) (24,374) (56,283)
Interest expense............................................ (78) (224) (209)
Interest income............................................. 392 711 6,454
------- -------- --------
NET LOSS.................................................... (6,914) (23,887) (50,038)
Beneficial conversion feature of Series C preferred stock... -- (2,500) --
------- -------- --------
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS.................. $(6,914) $(26,387) $(50,038)
======= ======== ========
NET LOSS PER SHARE (Note 1(o)):
Basic and diluted......................................... $ (1.42) $ (1.84) $ (0.52)
======= ======== ========
Pro forma basic and diluted............................... $ (0.25) $ (0.37)
======== ========
SHARES USED IN COMPUTING NET LOSS PER SHARE (Note 1(o)):
Basic and diluted......................................... 4,858 14,324 95,877
======= ======== ========
Pro forma basic and diluted............................... 96,188 135,057
======== ========
- ------------------------
(1) Excludes non-cash, stock-based
compensation expense as follows:
Manufacturing and product costs....................... $ -- $ 92 $ 404
Research and development.............................. 29 1,537 11,428
Sales and marketing................................... 12 2,104 12,051
General and administrative............................ 18 671 2,846
------- -------- --------
$ 59 $ 4,404 $ 26,729
======= ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-4
SONUS NETWORKS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE DATA)
REDEEMABLE CONVERTIBLE
PREFERRED STOCK COMMON STOCK CAPITAL IN
------------------------ ---------------------- EXCESS OF
REDEMPTION PAR PAR
SHARES VALUE SHARES VALUE VALUE
----------- ---------- ----------- -------- -----------
BALANCE, DECEMBER 31, 1997.................................. 7,100,000 $ 7,100 27,711,318 $ 28 $ 19
Payments on subscriptions receivable...................... -- -- -- -- --
Issuance of Series A preferred stock and issuance costs
of $2................................................... 80,000 80 -- -- --
Issuance of Series B preferred stock and issuance costs
of $40.................................................. 3,154,287 15,771 -- -- --
Issuance of common stock to officer....................... -- -- 9,637,497 10 311
Issuance of common stock to employees..................... -- -- 12,221,244 12 167
Compensation associated with the grant of stock options
and sale of restricted stock to non-employees........... -- -- -- -- 59
Net loss.................................................. -- -- -- -- --
----------- ------- ----------- ---- --------
BALANCE, DECEMBER 31, 1998.................................. 10,334,287 22,951 49,570,059 50 556
Issuance of Series B preferred stock and issuance costs
of $9................................................... 50,000 250 -- -- --
Issuance of Series C preferred stock and issuance costs
of $40.................................................. 1,939,681 22,908 -- -- --
Beneficial conversion feature of Series C preferred
stock................................................... -- -- -- -- 2,500
Payments on subscriptions receivable...................... -- -- -- -- --
Issuance of common stock to employees, officers and a
director................................................ -- -- 15,230,612 15 1,488
Exercise of stock options................................. -- -- 710,250 1 15
Compensation associated with the grant of stock options
and sale of restricted stock to non-employees........... -- -- -- -- 149
Deferred compensation related to stock option grants and
sale of restricted common stock......................... -- -- -- -- 20,859
Amortization of deferred compensation..................... -- -- -- -- --
Net loss.................................................. -- -- -- -- --
----------- ------- ----------- ---- --------
BALANCE, DECEMBER 31, 1999.................................. 12,323,968 46,109 65,510,921 66 25,567
Issuance of Series D preferred stock and issuance costs
of $46.................................................. 1,509,154 24,750 -- -- --
Issuance of common stock to public, net of issuance costs
of $10,545.............................................. -- -- 17,250,000 17 121,688
Payments on subscriptions receivable...................... -- -- -- -- --
Issuance of common stock to employees..................... -- -- 3,870,676 4 6,421
Conversion of preferred stock to common stock............. (13,833,122) (70,859) 96,957,222 97 70,762
Exercise of stock options................................. -- -- 655,655 -- 228
Repurchase of common stock................................ -- -- -- -- --
Compensation associated with the grant of stock options
and sale of restricted stock to non-employees........... -- -- -- -- 2,389
Deferred compensation related to stock option grants and
sale of restricted common stock......................... -- -- -- -- 39,433
Amortization of deferred compensation..................... -- -- -- -- --
Net loss.................................................. -- -- -- -- --
----------- ------- ----------- ---- --------
BALANCE, DECEMBER 31, 2000.................................. -- $ -- 184,244,474 $184 $266,488
=========== ======= =========== ==== ========
STOCK TREASURY STOCK
ACCUMULATED SUBSCRIPTIONS DEFERRED --------------------
DEFICIT RECEIVABLE COMPENSATION SHARES COST
----------- ------------ ------------ --------- --------
BALANCE, DECEMBER 31, 1997.................................. $ (490) $ (4) $ -- -- $ --
Payments on subscriptions receivable...................... -- 4 -- -- --
Issuance of Series A preferred stock and issuance costs
of $2................................................... (2) -- -- -- --
Issuance of Series B preferred stock and issuance costs
of $40.................................................. (40) -- -- -- --
Issuance of common stock to officer....................... -- (257) -- -- --
Issuance of common stock to employees..................... -- -- -- -- --
Compensation associated with the grant of stock options
and sale of restricted stock to non-employees........... -- -- -- -- --
Net loss.................................................. (6,914) -- -- -- --
-------- ------- -------- --------- -----
BALANCE, DECEMBER 31, 1998.................................. (7,446) (257) -- -- --
Issuance of Series B preferred stock and issuance costs
of $9................................................... (9) -- -- -- --
Issuance of Series C preferred stock and issuance costs
of $40.................................................. (40) -- -- -- --
Beneficial conversion feature of Series C preferred
stock................................................... (2,500) -- -- -- --
Payments on subscriptions receivable...................... -- 21 -- -- --
Issuance of common stock to employees, officers and a
director................................................ -- (110) -- -- --
Exercise of stock options................................. -- -- -- -- --
Compensation associated with the grant of stock options
and sale of restricted stock to non-employees........... -- -- -- -- --
Deferred compensation related to stock option grants and
sale of restricted common stock......................... -- -- (20,859) -- --
Amortization of deferred compensation..................... -- -- 4,255 -- --
Net loss.................................................. (23,887) -- -- -- --
-------- ------- -------- --------- -----
BALANCE, DECEMBER 31, 1999.................................. (33,882) (346) (16,604) -- --
Issuance of Series D preferred stock and issuance costs
of $46.................................................. (46) -- -- -- --
Issuance of common stock to public, net of issuance costs
of $10,545.............................................. -- -- -- -- --
Payments on subscriptions receivable...................... -- 108 -- -- --
Issuance of common stock to employees..................... -- -- -- -- --
Conversion of preferred stock to common stock............. -- -- -- -- --
Exercise of stock options................................. -- -- -- -- --
Repurchase of common stock................................ -- -- -- 772,500 (65)
Compensation associated with the grant of stock options
and sale of restricted stock to non-employees........... -- -- -- -- --
Deferred compensation related to stock option grants and
sale of restricted common stock......................... -- -- (39,433) -- --
Amortization of deferred compensation..................... -- -- 24,340 -- --
Net loss.................................................. (50,038) -- -- -- --
-------- ------- -------- --------- -----
BALANCE, DECEMBER 31, 2000.................................. $(83,966) $ (238) $(31,697) 772,500 $ (65)
======== ======= ======== ========= =====
TOTAL
STOCKHOLDERS'
EQUITY
(DEFICIT)
-----------
BALANCE, DECEMBER 31, 1997.................................. $ (447)
Payments on subscriptions receivable...................... 4
Issuance of Series A preferred stock and issuance costs
of $2................................................... (2)
Issuance of Series B preferred stock and issuance costs
of $40.................................................. (40)
Issuance of common stock to officer....................... 64
Issuance of common stock to employees..................... 179
Compensation associated with the grant of stock options
and sale of restricted stock to non-employees........... 59
Net loss.................................................. (6,914)
--------
BALANCE, DECEMBER 31, 1998.................................. (7,097)
Issuance of Series B preferred stock and issuance costs
of $9................................................... (9)
Issuance of Series C preferred stock and issuance costs
of $40.................................................. (40)
Beneficial conversion feature of Series C preferred
stock................................................... --
Payments on subscriptions receivable...................... 21
Issuance of common stock to employees, officers and a
director................................................ 1,393
Exercise of stock options................................. 16
Compensation associated with the grant of stock options
and sale of restricted stock to non-employees........... 149
Deferred compensation related to stock option grants and
sale of restricted common stock......................... --
Amortization of deferred compensation..................... 4,255
Net loss.................................................. (23,887)
--------
BALANCE, DECEMBER 31, 1999.................................. (25,199)
Issuance of Series D preferred stock and issuance costs
of $46.................................................. (46)
Issuance of common stock to public, net of issuance costs
of $10,545.............................................. 121,705
Payments on subscriptions receivable...................... 108
Issuance of common stock to employees..................... 6,425
Conversion of preferred stock to common stock............. 70,859
Exercise of stock options................................. 228
Repurchase of common stock................................ (65)
Compensation associated with the grant of stock options
and sale of restricted stock to non-employees........... 2,389
Deferred compensation related to stock option grants and
sale of restricted common stock......................... --
Amortization of deferred compensation..................... 24,340
Net loss.................................................. (50,038)
--------
BALANCE, DECEMBER 31, 2000.................................. $150,706
========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-5
SONUS NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1999 2000
-------- -------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $ (6,914) $(23,887) $ (50,038)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 466 1,632 5,112
Stock-based compensation to non-employees............... 59 149 2,389
Stock-based compensation to employees................... -- 4,255 24,340
Changes in current assets and liabilities:
Accounts receivable................................... -- -- (14,100)
Inventories........................................... -- (2,210) (18,458)
Other current assets.................................. (132) (136) (2,595)
Accounts payable...................................... 193 990 12,027
Accrued expenses...................................... 394 2,201 13,548
Deferred revenue...................................... -- 1,031 13,420
-------- -------- ---------
Net cash used in operating activities............... (5,934) (15,975) (14,355)
-------- -------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (1,577) (4,151) (14,832)
Maturities of marketable securities....................... 7,295 22,020 32,262
Purchases of marketable securities........................ (20,212) (23,784) (72,538)
Other assets.............................................. (292) (436) (681)
-------- -------- ---------
Net cash used in investing activities............... (14,786) (6,351) (55,789)
-------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sale of common stock.................... 243 1,393 128,130
Proceeds from exercise of stock options................... -- 16 228
Net proceeds from issuance of preferred stock............. 15,809 23,109 24,704
Payment of stock subscriptions receivable................. 4 21 108
Proceeds from long-term obligations....................... 1,749 3,609 405
Payments on long-term obligations......................... (107) (521) (5,143)
Repurchase of common stock................................ -- -- (65)
-------- -------- ---------
Net cash provided by financing activities........... 17,698 27,627 148,367
-------- -------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ (3,022) 5,301 78,223
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 6,606 3,584 8,885
-------- -------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 3,584 $ 8,885 $ 87,108
======== ======== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest.................... $ 78 $ 208 $ 225
======== ======== =========
SUPPLEMENTARY DISCLOSURE OF NON-CASH TRANSACTIONS:
Issuance of common stock for subscriptions receivable..... $ 257 $ 110 $ --
======== ======== =========
Conversion of redeemable convertible preferred stock into
common stock............................................ $ -- $ -- $ 70,859
======== ======== =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-6
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
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 enable voice services to be delivered over packet-based networks. Sonus was
in the development stage through December 31, 1999 and was principally engaged
in research and development, raising capital and hiring its management team.
Sonus is subject to risks common to technology-based companies including,
but not limited to, the development of new technology, development of markets
and distribution channels, dependence on key personnel and the ability to obtain
additional capital as needed to meet its product plans. Sonus has a limited
operating history and has incurred significant operating losses since inception.
The accompanying consolidated financial statements reflect the application
of certain significant accounting policies as described in this note and
elsewhere in the accompanying consolidated financial statements and notes.
(A) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Sonus and its wholly owned subsidiaries. All material intercompany transactions
and balances have been eliminated.
(B) CASH EQUIVALENTS AND MARKETABLE SECURITIES
Cash equivalents are stated at cost plus accrued interest, which
approximates market value, and have maturities of three months or less at the
date of purchase.
Marketable securities are classified as held-to-maturity, as Sonus has the
intent and ability to hold to maturity. Marketable securities are reported at
amortized cost. Cash equivalents and marketable securities are invested in high
quality credit instruments, primarily U.S. Government obligations and corporate
obligations with contractual maturities of less than one year. There have been
no gains or losses to date.
(C) CONCENTRATIONS OF CREDIT RISK, SIGNIFICANT CUSTOMERS AND LIMITED
SUPPLIERS
The financial instruments that potentially subject Sonus to concentrations
of credit risk are cash, marketable securities and receivables. Sonus has no
significant off-balance-sheet concentrations such as foreign exchange contracts,
options contracts or other foreign hedging arrangements. Sonus' cash holdings
are diversified between three financial institutions.
For the year ended December 31, 2000, three customers, each of whom
contributed more than 10% of revenues, accounted for an aggregate of 70% of
revenues. As of December 31, 2000, two customers accounted for an aggregate of
80% of Sonus' accounts receivable balance. Certain components and software
licenses from third-parties used in Sonus' products are procured from a single
source. The failure of a supplier, including a subcontractor, to deliver on
schedule could delay or interrupt Sonus' delivery of products and thereby
adversely affect Sonus' revenues and operating results.
(D) INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out basis) or
market.
F-7
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(E) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation
and amortization. Expenditures for maintenance and repairs are charged to
expense as incurred, whereas major betterments are capitalized as additions to
property and equipment. Sonus provides for depreciation and amortization using
the straight-line method and charges to operations amounts estimated to allocate
the cost of the assets over their estimated useful lives.
(F) OTHER ASSETS
Other assets include licenses for certain technology embedded in Sonus
products. These licenses are amortized over the lesser of their useful lives or
the term of the license.
(G) REVENUE RECOGNITION
Sonus recognizes revenue from product sales to end users, resellers and
distributors upon shipment, provided there are no uncertainties regarding
acceptance, persuasive evidence of an arrangement exists, the sales price is
fixed or determinable and collection of the related receivable is probable. If
uncertainties exist, Sonus recognizes revenue when those uncertainties are
resolved. In multiple element arrangements, in accordance with Statement of
Position 97-2 and 98-9, Sonus uses the residual method when vendor-specific
objective evidence does not exist for one of the delivered elements in the
arrangement. Service revenue is recognized as the services are provided. Revenue
from support arrangements is recognized ratably over the term of the support
contracts. Amounts collected prior to satisfying the revenue recognition
criteria are reflected as deferred revenue. Warranty costs are estimated and
recorded by Sonus at the time of product revenue recognition.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS.
This bulletin established guidelines for revenue recognition. Sonus' revenue
recognition policy complies with this pronouncement.
(H) SOFTWARE DEVELOPMENT COSTS
Sonus accounts for its software development costs in accordance with
Statement of Financial Accounting Standards (SFAS) No. 86, ACCOUNTING FOR THE
COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED.
Accordingly, the costs for the development of new software and substantial
enhancements to existing software are expensed as incurred until technological
feasibility has been established, at which time any additional costs would be
capitalized. Sonus has determined that technological feasibility is established
at the time a working model of the software is completed. Because Sonus believes
its current process for developing software is essentially completed
concurrently with the establishment of technological feasibility, no costs have
been capitalized to date.
(I) STOCK-BASED COMPENSATION
Sonus uses the intrinsic value-based method of Accounting Principles Board
(APB) Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, to account for
all of its employee stock-based compensation plans and uses the fair value
method to account for all non-employee stock-based compensation.
F-8
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(J) COMPREHENSIVE LOSS
Sonus applies Financial Accounting Standards Board (FASB) SFAS No. 130,
REPORTING COMPREHENSIVE INCOME. The comprehensive loss for the years ended
December 31, 1998, 1999 and 2000 does not differ from the reported loss.
(K) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of Sonus' financial instruments, which include cash
equivalents, marketable securities, stock subscriptions receivable, accounts
payable, accrued expenses and long-term obligations, approximate their fair
value.
(L) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of expenses during the reporting period.
Actual results could differ from those estimates.
(M) NEW PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES, as amended by SFAS No. 138, which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. Pursuant to SFAS No. 137, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES--DEFERRAL OF THE EFFECTIVE DATE OF FASB NO. 133, SFAS
No. 133 is effective in fiscal year 2001. SFAS No. 133 is not expected to have a
material impact on Sonus' financial condition or results of operations.
In March 2000, the FASB issued Interpretation No. 44, ACCOUNTING FOR CERTAIN
TRANSACTIONS INVOLVING STOCK COMPENSATION--AN INTERPRETATION OF ACCOUNTING
PRINCIPLES BOARD OPINION NO. 25 (Interpretation No. 44). Interpretation No. 44
clarifies the application of APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES. Interpretation No. 44 is effective July 1, 2000 but is retroactive
for certain events occurring after December 15, 1998. Interpretation No. 44 did
not have a material impact on Sonus' consolidated financial condition or results
of operations.
(N) DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE
SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, establishes standards for reporting information regarding operating
segments and establishes standards for related disclosures about products and
services and geographic areas. Operating segments are identified as components
of an enterprise about which separate discrete financial information is
available for evaluation by the chief operating decision maker, or decision
making group, in making decisions regarding resource allocation and assessing
performance. To date, Sonus has viewed its operations and manages its business
as principally one operating segment.
F-9
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(O) NET LOSS PER SHARE
Basic net loss per share is computed by dividing the net loss applicable to
common stockholders for the period by the weighted average number of
unrestricted common shares outstanding during the period. Diluted net loss per
share is computed by dividing the net loss applicable to common stockholders for
the period by the weighted average number of unrestricted common shares and
potential common stock outstanding during the period, if dilutive. Potential
common stock consists of restricted shares of common stock and the incremental
common shares issuable upon the exercise of stock options as calculated under
the treasury stock method. Shares of common stock issuable upon the conversion
of Sonus' redeemable convertible preferred stock have been excluded. In
accordance with SAB No. 98, EARNINGS PER SHARE IN AN INITIAL PUBLIC OFFERING,
Sonus determined there were no nominal issuances of Sonus' stock prior to Sonus'
initial public offering (IPO).
Restricted common stock and options to purchase 1,672,500, 3,052,743 and
17,725,526 shares of common stock have not been included in the computation of
diluted net loss per share for the years ended December 31, 1998, 1999 and 2000,
respectively, as their effects would have been anti-dilutive (see Note 10(g)).
Pro forma basic and diluted net loss per share for the years ended
December 31, 1999 and 2000 are computed using the weighted average number of
unrestricted common shares outstanding, including the pro forma effects of the
automatic conversion of Sonus' Series A, B, C and D redeemable convertible
preferred stock into shares of Sonus' common stock, which occurred upon the
closing of Sonus' IPO in May of 2000, as if such conversion occurred at the date
of original issuance. There were no dilutive shares of potential common stock
for these periods.
The following table sets forth the computation of basic and diluted net loss
per share and pro forma basic and diluted net loss per share:
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1999 2000
--------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
HISTORICAL--
Net loss applicable to common stockholders................ $(6,914) $(26,387) $(50,038)
======= ======== ========
Weighted average common shares outstanding................ 35,401 57,460 135,364
Less weighted average restricted common shares
outstanding............................................. (30,543) (43,136) (39,487)
------- -------- --------
Shares used in computing basic and diluted net loss per
share................................................... 4,858 14,324 95,877
======= ======== ========
Basic and diluted net loss per share...................... $ (1.42) $ (1.84) $ (0.52)
======= ======== ========
PRO FORMA--
Net loss.................................................. $(23,887) $(50,038)
======== ========
Shares used in computing historical basic and diluted net
loss per share.......................................... 14,324 95,877
Weighted average number of common shares assumed to be
issued upon conversion of redeemable convertible
preferred stock......................................... 81,864 39,180
-------- --------
Shares used in computing pro forma basic and diluted net
loss per share.......................................... 96,188 135,057
======== ========
Pro forma basic and diluted net loss per share............ $ (0.25) $ (0.37)
======== ========
F-10
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) ACQUISITION OF TELECOM TECHNOLOGIES, INC.
On January 18, 2001, Sonus acquired privately-held telecom
technologies, inc. (TTI). Upon the closing of this acquisition, an aggregate of
10,800,000 shares of Sonus common stock (Merger Shares) were exchanged for all
outstanding shares of TTI Class A and Class B common stock. Of the 10,800,000
shares issued to the TTI stockholders, 1,200,000 shares were placed into escrow
as security for TTI's indemnity obligations under the merger agreement and will
be released to TTI stockholders upon expiration of those indemnity obligations,
expected to be on the first anniversary of the closing date. In addition to the
Merger Shares, the TTI stockholders will have the right to receive up to an
aggregate of 4,200,000 additional shares of Sonus common stock which have been
placed in escrow in the event that TTI achieves certain specified business
expansion and product development milestones from time to time prior to
December 31, 2002.
Sonus has also agreed to make contingent awards of up to 3,000,000 shares of
common stock to certain employees of TTI who became employees of Sonus as a
result of the acquisition under the 2000 Retention Plan. These awards will vest
in equal installments on each of October 31, 2002, November 30, 2002,
January 31, 2003 and February 28, 2003, if (i) the recipients do not voluntarily
terminate employment with TTI or Sonus prior to such vesting dates and (ii) the
business expansion and product development escrow release conditions are
satisfied in whole or in part. The portion of the total number of shares of
Sonus common stock awarded to each employee that will be deemed vested on each
vesting date will not exceed the proportion of all of the shares escrowed in the
acquisition subject to the satisfaction of the business expansion and product
development escrow release conditions that have been released prior to such
vesting date. Generally, any awards forfeited by employees who terminate
employment with TTI, other than a termination by Sonus or TTI without cause,
prior to the date on which they would otherwise vest, may be reallocated to
remaining TTI employees, awarded to replacement hires or returned to Sonus as
provided by the terms of the plan. The value of the 3,000,000 shares awarded
under the retention plan is expected to be expensed during the approximate two
year vesting period based upon the closing price of Sonus common stock on the
date the acquisition was consummated, $112,125,000 in the aggregate. Such value
and the related expense will be adjusted for the change in the fair value of
Sonus common stock on the date the related milestone release conditions are
satisfied.
The acquisition will be accounted for using the purchase method of
accounting in accordance with APB Opinion No. 16. Accordingly, the total
purchase price will be allocated to the assets acquired and liabilities assumed
based upon their estimated fair values. The purchase price has been determined
by using the average market value of Sonus common stock for the period from two
days before to two days after the announcement of the TTI acquisition ($41.61
per share) to value the 10,800,000 Sonus common shares issued to the TTI
stockholders at the closing date and adding the fair value of liabilities
assumed and expenses of the acquisition. The preliminary purchase price has been
computed as follows, in thousands:
Fair market value of shares issued.......................... $450,000
Estimated liabilities to be assumed......................... 21,200
Estimated acquisition expenses.............................. 6,300
--------
$477,500
========
F-11
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In accordance with APB Opinion No. 16 and with the assistance of valuation
experts, the purchase price will be allocated to the tangible and intangible
assets acquired based upon their fair values. Based upon preliminary appraisals,
the purchase price allocation is as follows, in thousands:
Tangible assets............................................. $ 6,300
Intangible assets:
Workforce, developed technology and customer list......... 32,300
In-process research and development....................... 40,000
Deferred compensation related to unvested options......... 22,600
Goodwill.................................................. 376,300
--------
$477,500
========
To the extent that any of the additional 4,200,000 escrowed shares are
released to the former TTI stockholders, the purchase price and goodwill will be
increased by the value of such shares on the date the relevant escrow release
condition is satisfied.
Sonus has engaged third-party appraisers to conduct a valuation of the
tangible and intangible assets and to assist in the determination of useful
lives for such assets. Based on the preliminary appraisal, it is anticipated
that $40,000,000 will be allocated to in-process research and development, which
will be expensed in the first quarter of fiscal 2001. The amounts allocated to
developed technology, customer list, assembled workforce and goodwill is
expected to be amortized over their estimated useful lives of three to four
years. Deferred compensation was computed based on the intrinsic value of the
unvested TTI options assumed by Sonus and will be expensed over the remaining
vesting period of up to four years.
The valuation of in-process research and development was determined using
the income method. Revenue and expense projections for the in-process
development project were prepared by the management of Sonus through 2008 and
the present value was computed using a discount rate of 22.5%. The in-process
project is not expected to reach technological feasibility until the end of
2001, at an estimated cost to complete of approximately $5,000,000. In the event
that the project is not completed and technological feasibility is not achieved,
there is no alternative future use for the in-process technology. The
assumptions used for the valuation of in-process research and development are
the responsibility of management and are subject to change.
(3) INVENTORIES
Inventories consist of the following, in thousands:
DECEMBER 31,
-------------------
1999 2000
-------- --------
Raw materials.............................................. $ 305 $ 3,082
Work in progress........................................... 941 3,021
Finished goods............................................. 964 14,565
------ -------
$2,210 $20,668
====== =======
F-12
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) PROPERTY AND EQUIPMENT
Property and equipment consist of the following, in thousands:
DECEMBER 31,
ESTIMATED -------------------
USEFUL LIFE 1999 2000
------------- -------- --------
Equipment and software...................... 2-3 years $ 5,956 $19,805
Furniture and fixtures...................... 3-5 years 69 342
Leasehold improvements...................... Life of lease 50 760
------- -------
6,075 20,907
Less accumulated depreciation and
amortization.............................. (1,806) (6,634)
------- -------
$ 4,269 $14,273
======= =======
(5) LONG-TERM OBLIGATIONS
Sonus had a $7,000,000 equipment line of credit with a bank, bearing
interest at the bank's prime rate (8.5% at December 31, 1999) plus 0.5%,
available through June 30, 2000. Under the agreement, all of Sonus' assets,
except intellectual property, had been pledged as collateral and Sonus was to
maintain a certain minimum tangible stockholders' equity and quick ratio, as
defined. As of December 31, 1999, Sonus had an outstanding balance of
$4,738,000. In June 2000, approximately $5,100,000, representing all amounts
then outstanding under this line was repaid and the equipment line of credit was
terminated.
(6) OTHER BALANCE SHEET DATA
(A) ACCRUED EXPENSES
Accrued expenses consist of the following, in thousands:
DECEMBER 31,
-------------------
1999 2000
-------- --------
Employee compensation and related costs.................... $1,381 $ 3,121
Employee stock purchase plan............................... -- 3,108
Professional fees.......................................... 609 817
Royalties.................................................. 91 3,613
Other...................................................... 610 5,580
------ -------
$2,691 $16,239
====== =======
(B) VALUATION OF QUALIFYING ACCOUNTS
The following table sets forth activity in Sonus' allowance for doubtful
accounts, in thousands:
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
OF YEAR EXPENSES ACCOUNTS DEDUCTIONS YEAR
---------- ---------- ---------- ---------- ----------
Year ended December 31, 2000..... $ -- 1,000 -- -- $1,000
F-13
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) INCOME TAXES
Sonus provides for income taxes in accordance with SFAS No. 109, ACCOUNTING
FOR INCOME TAXES. Deferred tax assets and liabilities are determined based on
differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts for income tax purposes. A valuation allowance has been
recorded for the net deferred tax asset due to the uncertainty of realizing the
benefit of this asset.
The following is a summary of the significant components of Sonus' deferred
tax assets and liabilities, in thousands:
DECEMBER 31,
-------------------
1999 2000
-------- --------
Net operating loss carryforwards........................ $ 9,204 $ 15,924
Tax credit carryforwards................................ 761 1,779
Start-up costs.......................................... 485 363
Deferred revenue........................................ 412 --
Other temporary differences............................. 560 4,669
Valuation allowance..................................... (11,422) (22,735)
-------- --------
$ -- $ --
======== ========
As of December 31, 2000, Sonus has net operating loss carryforwards for
federal income tax purposes of approximately $40,000,000, which expire through
2020. Sonus also has available research and development credit carryforwards of
approximately $1,780,000 that expire through 2020. The Internal Revenue Code
contains provisions that limit the net operating loss and tax credit
carryforwards available to be used in any given year in the event of certain
circumstances, including significant changes in ownership interests. Sonus has
completed several financings since inception and has incurred ownership changes.
Sonus does not believe that these changes will have a material impact on its
ability to use its net operating loss and tax credit carryforwards.
(8) LEASE COMMITMENTS
Sonus leases its facilities under operating leases, which expire through
March 2004. Rent expense was approximately $150,000, $537,000 and $1,310,000 for
the years ended December 31, 1998, 1999 and 2000, respectively. Sonus is
responsible for certain real estate taxes, utilities and maintenance costs under
these leases. The future minimum payments under operating lease arrangements,
including those leases assumed as part of the acquisition of TTI, as of
December 31, 2000, are as follows: $3,355,000 in 2001; $3,393,000 in 2002;
$2,253,000 in 2003; and $447,000 in 2004.
Sonus also assumed certain capital leases as part of the acquisition of TTI.
The future minimum payments under these capital leases, as of December 31, 2000,
are as follows: $657,000 in 2001; $640,000 in 2002; $536,000 in 2003; $195,000
in 2004; and $30,000 in 2005.
F-14
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) REDEEMABLE CONVERTIBLE PREFERRED STOCK
Prior to the closing of our IPO in May 2000, Sonus had authorized 17,000,000
shares of preferred stock, $0.01 par value, and designated four series of
redeemable convertible preferred stock: 7,220,000 shares of Series A preferred
stock; 3,247,857 shares of Series B preferred stock; 2,153,072 shares of
Series C preferred stock; and 1,585,366 shares of Series D preferred stock. In
connection with our IPO in May 2000, all redeemable convertible preferred stock
was converted into an aggregate of 96,957,222 shares of common stock. A summary
of the redeemable convertible preferred stock issuances from inception and
redemption value as of the closing of our IPO in May 2000 are as follows:
NUMBER OF PRICE PER REDEMPTION
DESCRIPTION DATE SHARES SHARE VALUE
- --------------------- ---------------------------------------------------- ---------- --------- --------------
(IN THOUSANDS)
Series A...... November 1997 and July 1998 7,180,000 $ 1.00 $ 7,180
Series B...... September and December 1998, May 1999 3,204,287 5.00 16,021
Series C...... September, November and December 1999 1,939,681 11.81 22,908
Series D...... March 2000 1,509,154 16.40 24,750
---------- -------
13,833,122 $70,859
========== =======
The rights, preferences and privileges of the Series A, Series B, Series C
and Series D redeemable convertible preferred stock are as follows:
CONVERSION
Each share of Series A, B and C preferred stock was convertible into 7.5
shares of common stock and each share of Series D preferred stock was
convertible into three shares of common stock, each adjustable for certain
dilutive events. Conversion was at the option of the holder, but became
automatic upon the closing of an IPO for the Series A, B and C preferred stock
in which at least $10,000,000 of net proceeds shall be received by Sonus at a
price of at least $2.67 per share and for the Series D preferred stock with at
least $25,000,000 of net proceeds at a price of at least $6.56 per share.
Redemption if requested prior to the redemption dates specified below by holders
of 66 2/3% of the then outstanding Series A, B, C and D preferred stock, Sonus
was required to redeem such stock at $1.00, $5.00, $11.81 and $16.40 per share,
respectively, as adjusted in the event of future dilution, plus declared but
unpaid dividends as follows:
PERCENTAGE OF THEN
OUTSTANDING
SERIES A, B AND C SERIES D PREFERRED SHARES TO
REDEMPTION DATE REDEMPTION DATE BE REDEEMED
- --------------------- --------------- --------------------
November 18, 2002.... March 9, 2005 33.33%
November 18, 2003 March 9, 2006 50.00%
November 18, 2004 March 9, 2007 All shares then held
DIVIDENDS
Series A, B, C and D preferred stockholders were entitled to receive any
cash dividend declared on common stock equal to the amount they would be
entitled to if such preferred stock had been converted into common stock. In
connection with the sale of an aggregate of 211,688 shares of Series C preferred
stock in November and December 1999, Sonus recorded a charge to accumulated
deficit of $2,500,000. This amount represents the beneficial conversion feature
of the Series C preferred stock. This amount has been accounted for as a
dividend to preferred stockholders and as a result, increased Sonus' capital in
excess of par value, net loss applicable to common stockholders and the related
net loss per share.
F-15
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
LIQUIDATION PREFERENCE
In the event of liquidation of Sonus and before any distribution to common
stockholders, the Series A, B, C, and D preferred stockholders were entitled to
share pro rata, $1.00, $5.00, $11.81 and $16.40 per share, respectively, plus
all declared but unpaid dividends.
VOTING RIGHTS
Series A, B, C, and D preferred stockholders were entitled to one vote per
common share equivalent on all matters voted on by holders of common stock. In
addition, the Series A preferred stockholders were entitled to elect 40% of the
board members as long as 1,775,000 shares of such preferred stock were
outstanding.
(10) STOCKHOLDERS' EQUITY (DEFICIT)
(A) AUTHORIZED CAPITAL STOCK
In May 2000, Sonus' stockholders approved an increase in the authorized
shares of common stock to 300,000,000 shares and authorized and approved
5,000,000 shares of $0.01 par value undesignated preferred stock that may be
issued by the Board of Directors from time to time in one or more series.
(B) STOCK SPLIT
On October 6, 2000, Sonus effected a three-for-one stock split in the form
of a stock dividend. All common shares, common stock options and per share
amounts in the accompanying financial statements and footnotes have been
retroactively adjusted to reflect the stock split.
(C) INITIAL PUBLIC OFFERING
On May 31, 2000, Sonus completed its IPO of 17,250,000 shares of common
stock, which includes the exercise of the underwriters' over allotment option of
2,250,000 shares, at $7.67 per share. The proceeds from the IPO were
$121,705,000, after deducting the underwriting discount and commissions and
offering expenses of $10,545,000.
(D) STOCK SUBSCRIPTIONS RECEIVABLE
On November 4, 1998, Sonus entered into a stock subscription agreement for
$257,000 from an officer that bears interest at 8%. The note is secured by
7,710,000 shares of Sonus' restricted common stock and is due upon the earlier
of November 4, 2003 or 180 days after such shares are eligible for public sale.
The interest payments on the note are unconditional and are not limited to the
aforementioned stock. As of December 31, 2000, this note due Sonus had a
remaining principal balance of $238,000.
On September 1, 1999, Sonus entered into a stock subscription agreement for
$110,250 from an officer that bears interest at 8%. The full recourse note was
secured by 1,687,500 shares of Sonus' restricted common stock and was due upon
the earlier of September 1, 2004 or 180 days after such shares were eligible for
public sale. As of December 31, 2000, this note had been repaid.
F-16
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(E) COMMON STOCK PURCHASE RIGHT
In November 1999, Sonus signed a definitive purchase and license agreement
(the Agreement) with a customer to provide certain Sonus products. Under the
terms of the Agreement, the customer also had the right to purchase shares of
common stock in Sonus' IPO at the IPO price. The number of shares equaled 5% of
the dollar value of the customer's accumulated purchases of Sonus' products and
services as of the date of the IPO divided by the IPO per share price, but in no
event more than 5% of the shares offered in the IPO. The ability of the customer
to exercise its right to purchase such shares was contingent upon the closing of
our IPO on a national exchange. In connection with our IPO in May 2000, the
customer exercised their right and purchased shares in the IPO.
(F) RESTRICTED COMMON STOCK
Sonus issued 24,615,693 and 262,500 shares of restricted common stock
outside of the 1997 Stock Incentive Plan (the Plan) in the period ended
December 31, 1997 and in the year ended December 31, 1999, respectively. These
shares are subject to repurchase agreements which expire over a five-year
period. Sonus may repurchase any remaining restricted shares of common stock
held by these individuals upon termination of employment at their original
purchase price ranging from $0.0001 to $0.001 per share. All shares of common
stock subject to repurchase restrictions contain the same rights and privileges
as unrestricted shares of common stock and are presented as outstanding as of
the date of issuance. As of December 31, 2000, 6,458,605 of these common shares
were restricted and subject to Sonus' repurchase.
(G) 1997 STOCK INCENTIVE PLAN
The Plan, which is administered by the Board of Directors, permits Sonus to
sell or award restricted common stock or to grant incentive and non-qualified
stock options for the purchase of common stock to employees, directors and
consultants. In March, 2000, Sonus' stockholders increased the shares authorized
under the Plan from 48,750,000 to 81,000,000. On January 1 of each year,
commencing with January 2001, the aggregate number of shares of common stock
available for purchase under the Plan shall increase by the lesser of (i) 5% of
the outstanding shares on December 31 of the preceding year or (ii) an amount
determined by the Board of Directors. At December 31, 2000, 18,887,915 shares
were available under the Plan for future sale of restricted common stock or
grant of stock options.
Sonus issued shares of restricted common stock to employees and consultants
which are subject to repurchase agreements and generally vest over a four or
five-year period. If the employee leaves or if the services are not performed,
Sonus may repurchase any restricted shares of common stock held by these
individuals at their original purchase price ranging from $0.01 to $4.67 per
share. All shares of common stock subject to repurchase restrictions contain the
same rights and privileges as unrestricted shares of common stock and are
presented as outstanding as of the date of issuance. As of December 31, 2000,
25,700,769 shares of the outstanding common stock issued under the Plan were
restricted and subject to Sonus' repurchase.
F-17
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of activity under the Plan for the years ended December 31, 1998,
1999 and 2000, is as follows:
RESTRICTED COMMON STOCK ISSUANCES
WEIGHTED
AVERAGE
NUMBER OF PURCHASE PURCHASE
SHARES PRICE PRICE
---------- ------------------- --------
Outstanding, December 31, 1997............................. 3,095,625 $ 0.01 $0.01
Issued................................................... 21,858,741 0.01-0.07 0.02
----------
Outstanding, December 31, 1998............................. 24,954,366 0.01-0.07 0.02
Issued................................................... 14,968,116 0.07-0.22 0.10
----------
Outstanding, December 31, 1999............................. 39,922,482 0.01-0.22 0.05
Issued................................................... 3,870,672 0.22-4.67 1.88
Repurchased.............................................. (772,500) 0.07-0.22 0.08
----------
Outstanding, December 31, 2000............................. 43,020,654 $ 0.01-4.67 $0.21
========== =================== =====
Unrestricted common stock, December 31, 2000............... 17,319,885 $ 0.01-4.67 $0.05
========== =================== =====
COMMON STOCK OPTION GRANTS
WEIGHTED
AVERAGE
NUMBER OF EXERCISE EXERCISE
SHARES PRICE PRICE
---------- ------------------- --------
Outstanding, December 31, 1997............................. 375,000 $ 0.001 $0.001
Granted.................................................. 1,335,000 0.01-0.07 0.05
Canceled................................................. (37,500) 0.07 0.07
----------
Outstanding, December 31, 1998............................. 1,672,500 0.001-0.07 0.04
Granted.................................................. 2,090,493 0.07-0.22 0.13
Exercised................................................ (710,250) 0.001-0.07 0.02
----------
Outstanding, December 31, 1999............................. 3,052,743 0.01-0.22 0.11
Granted.................................................. 15,531,937 0.67-22.25 10.39
Canceled................................................. (203,499) 0.01-3.33 1.75
Exercised................................................ (655,655) 0.07-7.67 0.31
----------
Outstanding, December 31, 2000............................. 17,725,526 $ 0.01-22.25 $ 9.07
========== =================== ======
Exercisable, December 31, 2000............................. 783,589 $ 0.01-22.25 $ 1.35
========== =================== ======
F-18
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information relating to currently outstanding
and exercisable options as of December 31, 2000:
OUTSTANDING EXERCISABLE
-------------------------------------------- ------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER OF CONTRACTUAL EXERCISE NUMBER OF EXERCISE
PRICES SHARES LIFE (YEARS) PRICE SHARES PRICE
- ------------------ ---------- ------------ -------- --------- --------
$0.01-0.22......... 2,347,585 8.39 $ 0.12 674,338 $ 0.10
0.67.............. 1,199,152 9.05 0.67 31,251 0.67
3.33-4.67......... 8,039,189 9.26 3.87 33,600 3.70
7.67-22.25........ 6,139,600 9.92 20.96 44,400 18.90
---------- -------
17,725,526.. $ 9.07 783,589 $ 1.35
========== ====== ======= ======
(H) STOCK-BASED COMPENSATION
Stock-based compensation expenses includes the amortization of deferred
employee compensation and other equity related expenses for non-employees.
In connection with certain employee stock option grants and the issuance of
employee restricted common stock during the years ended December 31, 1999 and
2000, Sonus recorded deferred stock-based compensation of $20,859,000 and
$39,433,000, respectively. This represents the aggregate difference between the
exercise price or purchase price and the fair value of the common stock on the
date of grant or sale for accounting purposes. The deferred compensation is
recognized as an expense over the vesting period of the underlying stock options
and restricted common stock. Sonus recorded stock-based compensation expense of
$4,255,000 and $24,340,000 in the years ended December 31, 1999 and 2000,
respectively, related to these options and restricted common stock.
In connection with the acquisition of TTI, Sonus expects to record deferred
stock-based compensation of $22,600,000 related to the intrinsic value of
unvested TTI options assumed by Sonus. This deferred compensation will be
recognized as an expense over the remaining vesting period of the underlying
stock options of up to four years. Additionally, Sonus expects to record
$112,125,000 of deferred stock-based compensation on up to 3,000,000 shares to
be awarded to TTI employees under the 2000 Retention Plan, based on the fair
value of the Sonus common stock on the closing date of the acquisition. This
deferred compensation will be expensed ratably over the approximate two-year
vesting period of the retention shares and will be adjusted for changes in the
fair value of Sonus common stock on the date the specific escrow release
conditions are satisfied (See Note 2).
Based on the grant of Sonus' stock options and the sale of restricted common
stock through December 31, 2000, the intrinsic value of the unvested TTI stock
options assumed by Sonus and the awards under the 2000 Retention Plan, Sonus
expects to record approximately $76,000,000, $72,300,000, $14,500,000 and
$3,600,000 in employee stock-based compensation expense in the years ending
December 31, 2001, 2002, 2003 and 2004, respectively.
Sonus granted 1,288,500 non-qualified stock options to non-employees for
services rendered in the period from inception to December 31, 2000. In 1998,
1999, and 2000 Sonus sold 414,000 shares of restricted common stock and 10,000
shares of Series B preferred stock to consultants at their then current fair
market value, subject to repurchase provisions, in the event consulting services
are no longer provided.
F-19
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Sonus has valued the stock options and the issuances of restricted common
stock and Series B preferred stock to non-employees based upon the fair market
value of the services rendered where Sonus believes the value of these services
is more readily determinable than the value of the options or restricted stock.
All other grants of options and issuances of restricted stock to non-employees
are valued based upon the Black-Scholes option pricing model. As of
December 31, 2000, Sonus has 135,000 stock options and 120,000 shares of
restricted common stock outstanding to non-employees. Sonus has recorded
stock-based compensation expense of $59,000, $149,000 and $2,389,000 for the
grant of options and issuances of restricted stock to non-employees for the
years ended December 31, 1998, 1999 and 2000, respectively. In accordance with
Emerging Issues Task Force 96-18, Sonus will record the value at the time the
services are provided.
The value of the options granted to employees as calculated under SFAS
No. 123 for the year ended December 31, 1998 was immaterial to the consolidated
financial statements. Sonus has computed the pro forma disclosures required
under SFAS No. 123 for options granted to employees for the years ended
December 31, 1999 and 2000, using the Black-Scholes option pricing model with an
assumed risk-free interest rate of 5%, 60% volatility in 1999 and 80% volatility
in 2000 and an expected life ranging from 2-5 years with the assumption that no
dividends will be paid. Had compensation expense for Sonus' stock option plan
been determined consistent with SFAS No. 123, the pro forma net loss and pro
forma net loss per share would have been as follows:
YEAR ENDED DECEMBER 31,
-------------------------
1999 2000
-------- --------
Net loss applicable to common stockholders, in
thousands--
As reported....................................... $(26,387) $(50,038)
Pro forma......................................... (26,400) (55,980)
Basic and diluted net loss per share--
As reported....................................... $ (1.84) $ (0.52)
Pro forma......................................... (1.84) (0.58)
(I) 2000 EMPLOYEE STOCK PURCHASE PLAN
In March 2000, the stockholders approved the 2000 Employee Stock Purchase
Plan. A total of 3,600,000 shares of common stock have been reserved for
issuance under this plan. The plan consists of a series of overlapping 24-month
offering periods. Each offering period generally consists of four consecutive
6-month purchase periods. Eligible employees may purchase common stock at a
price equal to 85% of the lower of the fair market value of the common stock at
the beginning of each offering period or end of each purchase period.
Participation is limited to 20% of an employee's eligible compensation not to
exceed amounts allowed by the Internal Revenue Code. On January 1 of each year,
commencing with January 2001, the aggregate number of shares of common stock
available for purchase under the Employee Stock Purchase Plan shall increase by
the lesser of (i) 2% of the outstanding shares on December 31 of the preceding
year or (ii) an amount determined by the Board of Directors. As of December 31,
2000, Sonus has not issued any shares under the 2000 Employee Stock Purchase
Plan.
F-20
SONUS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(J) COMMON STOCK RESERVED
Common stock reserved for future issuance at December 31, 2000 consist of
the following:
Stock incentive plan........................................ 36,613,441
Employee stock purchase plan................................ 3,600,000
----------
40,213,441
==========
(11) EMPLOYEE BENEFIT PLAN
In 1998, Sonus adopted a savings plan for its employees, which has been
qualified under Section 401(a) of the Internal Revenue Code. Eligible employees
are permitted to contribute to the 401(k) plan through payroll deductions within
statutory and plan limits. Contributions from Sonus are made at the discretion
of the Board of Directors. Sonus has made no contributions to the 401(k) plan to
date.
(12) SUPPLEMENTARY DATA
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table presents our quarterly operating results for the years
ended December 31, 1999 and 2000. The information for each of these quarters is
unaudited and has been prepared on the same basis as the audited consolidated
financial statements. In the opinion of management, all necessary adjustments,
consisting only of normal recurring adjustments, have been included to present
fairly the unaudited consolidated quarterly results when read in conjunction
with our audited consolidated financial statements and related notes. These
operating results are not necessarily indicative of the results of any future
period.
THREE MONTHS ENDED
---------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1999 1999 1999 1999 2000 2000 2000 2000
-------- -------- --------- -------- -------- -------- --------- --------
(IN THOUSANDS)
(UNAUDITED)
CONSOLIDATED STATEMENT OF OPERATIONS
DATA:
Revenues............................ $ -- $ -- $ -- $ -- $ 1,093 $ 6,511 $ 15,568 $28,598
Manufacturing and product costs..... 223 349 519 770 1,462 4,555 8,830 13,001
------- ------- ------- -------- -------- -------- -------- -------
Gross profit (loss)................. (223) (349) (519) (770) (369) 1,956 6,738 15,597
Operating expenses:
Research and development.......... 2,684 2,387 2,434 3,275 4,844 6,355 7,032 8,199
Sales and marketing............... 438 834 1,475 2,859 3,358 4,381 5,833 7,997
General and administrative........ 301 375 438 609 713 1,277 1,763 1,724
Stock-based compensation.......... 517 564 1,090 2,233 6,979 6,386 6,982 6,382
------- ------- ------- -------- -------- -------- -------- -------
Total operating expenses............ 3,940 4,160 5,437 8,976 15,894 18,399 21,610 24,302
------- ------- ------- -------- -------- -------- -------- -------
Loss from operations................ (4,163) (4,509) (5,956) (9,746) (16,263) (16,443) (14,872) (8,705)
Interest income (expense), net...... 120 92 71 204 228 1,089 2,495 2,433
------- ------- ------- -------- -------- -------- -------- -------
Net loss............................ (4,043) (4,417) (5,885) (9,542) (16,035) (15,354) (12,377) (6,272)
Beneficial conversion feature of
Series C preferred stock.......... -- -- -- (2,500) -- -- -- --
------- ------- ------- -------- -------- -------- -------- -------
Net loss applicable to common
stockholders...................... $(4,043) $(4,417) $(5,885) $(12,042) $(16,035) $(15,354) $(12,377) $(6,272)
======= ======= ======= ======== ======== ======== ======== =======
F-21
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
3.1** Fourth Amended and Restated Certificate of Incorporation of
the Registrant.
3.2** Amended and Restated By-Laws of the Registrant.
4.1** Form of Stock Certificate representing shares of the
Registrant's Common Stock.
9.1*** Voting Agreement, dated as of November 2, 2000, among the
Registrant, the Stockholder parties thereto and telecom
technologies, inc.
10.1* Registration Rights Agreement, dated as of November 2, 2000,
by and among the Registrant and the Stockholder parties
thereto.
10.2* 2000 Retention Plan of the Registrant.
10.3* telecom technologies, inc. 1998 Amended Equity Incentive
Plan.
10.4** Amended and Restated 1997 Stock Incentive Plan of the
Registrant.
10.5** 2000 Employee Stock Purchase Plan of the Registrant.
10.6** Lease, dated January 21, 1999, as amended, between the
Registrant and Glenborough Fund V, Limited Partnership with
respect to property located at 5 Carlisle Road, Westford,
Massachusetts.
10.7* Sub-lease, dated October 20, 2000, between the Registrant
and Unisphere Networks, Inc. with respect to property
located at 5 Carlisle Road, Westford, Massachusetts.
10.8* Sub-Lease, dated October 20, 2000, between the Registrant
and Unisphere Networks, Inc. with respect to property
located at 235 Littleton Road, Westford, Massachusetts.
10.9* Lease, dated September 30, 2000, between the Registrant and
BCIA New England Holdings LLC with respect to property
located at 25 Porter Road, Littleton, Massachusetts.
10.10** Series C Preferred Stock Purchase Agreement, dated as of
September 10, 1999, by and among the Registrant and the
"Purchaser" parties thereto.
10.11** Series D Preferred Stock Purchase Agreement, dated as of
March 9, 2000, by and among the Registrant and the
"Purchaser" parties thereto.
10.12** Third Amended and Restated Investor Rights Agreement, dated
as of March 9, 2000, by and among the Registrant and the
"Purchaser" parties thereto.
10.13** Third Amended and Restated Right of First Refusal and
Co-Sale Agreement, dated as of March 9, 2000, among the
Registrant and the persons and entities listed on the
signature pages thereto.
10.14** Modification Agreement, dated as of November 29, 1999, by
and between the Registrant and Silicon Valley Bank.
10.15** Agreement of Sublease, dated April 14, 2000, between the
Registrant and Unisphere Solutions, Inc. with respect to
property located at 25 Porter Road, Littleton,
Massachusetts.
10.16** Promissory Note, dated November 4, 1998, of Hassan M. Ahmed
to the Registrant and associated Pledge Agreement.
10.17** Promissory Note, dated September 1, 1999, of Stephen J. Nill
to the Registrant and associated Pledge Agreement.
10.18*** Agreement and Plan of Merger and Reorganization, dated as of
November 2, 2000, by and among the Registrant, Storm Merger
Sub, Inc. and telecom technologies, inc.
10.19 Employment Agreement, dated November 2, 2000, among telecom
technologies, inc., Anousheh Ansari and the Registrant.
10.20 Office Lease Agreement, dated as of November 14, 2000,
between telecom technologies, inc. and TR Lookout
Partners, Ltd. with respect to property located at
1301 East Lookout Drive, Suite 3000, Richardson, Texas.
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
10.21 First Amendment to Office Lease Agreement, dated as of
January 8, 2001, between telecom technologies, inc. and
TR Lookout Partners, Ltd. with respect to property located
at 1300 East Lookout Drive, Suite 3000, Richardson, Texas.
21.1 Subsidiaries of the Registrant.
- ------------------------
* Incorporated by reference to the Registrant's Registration Statement on
Form S-4 (file No. 333-52682).
** Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (file No. 333-32206).
*** Incorporated by reference to the Registrant's Current Report on Form 8-K,
filed November 17, 2000.