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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
(Mark One)
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 27, 2015
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-34115
SONUS NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE
 
04-3387074
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)

4 Technology Park Drive, Westford, Massachusetts 01886
(Address of principal executive offices) (Zip code)

(978) 614-8100
(Registrant's telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
Accelerated filer o
 
Non-accelerated filer o
 (Do not check if a smaller
reporting company)
 
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No x

As of April 21, 2015, there were 49,444,160 shares of the registrant's common stock, $0.001 par value, outstanding.
 



SONUS NETWORKS, INC.
FORM 10-Q
QUARTER ENDED MARCH 27, 2015
TABLE OF CONTENTS

Item
 
Page
 
PART I FINANCIAL INFORMATION
 
 
 
 
 
 
 
PART II OTHER INFORMATION
 
 
 



Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the U.S. Private Securities Litigation Reform Act of 1995, which are subject to a number of risks and uncertainties. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, business strategy, plans and objectives of management for future operations, plans for future cost reductions and plans for future product development and manufacturing are forward-looking statements. Without limiting the foregoing, the words "anticipates", "believes", "could", "estimates", "expects", "intends", "may", "plans", "seeks" and other similar language, whether in the negative or affirmative, are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We therefore caution you against relying on any of these forward-looking statements.
Important factors that could cause actual results to differ materially from those in these forward-looking statements are discussed in Part I, Items 2 and 3, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosures About Market Risk," respectively, and Part II, Item 1A, "Risk Factors," of this Quarterly Report on Form 10-Q. Also, any forward-looking statement made by us in this Quarterly Report on Form 10-Q speaks only as of the date on which this Quarterly Report on Form 10-Q was first filed. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.
References in this Quarterly Report on Form 10-Q to “Sonus,” “Sonus Networks,” “Company,” “we,” “us,” and “our” are to Sonus Networks, Inc. and its subsidiaries, collectively, unless the context requires otherwise.



3


PART I FINANCIAL INFORMATION


Item 1. Financial Statements
SONUS NETWORKS, INC.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
(unaudited)


 
March 27,
2015
 
December 31,
2014
Assets
Current assets:
 
 
 
Cash and cash equivalents
$
18,092

 
$
41,157

Marketable securities
65,708

 
64,443

Accounts receivable, net of allowance for doubtful accounts of $46 at March 27, 2015 and $58 at December 31, 2014
55,612

 
62,943

Inventory
25,147

 
22,114

Deferred income taxes
1,037

 
991

Other current assets
15,085

 
15,239

Total current assets
180,681

 
206,887

Property and equipment, net
18,329

 
17,845

Intangible assets, net
31,547

 
22,594

Goodwill
40,310

 
39,263

Investments
29,045

 
42,407

Deferred income taxes
1,001

 
1,043

Other assets
3,081

 
2,596

 
$
303,994

 
$
332,635

Liabilities and Stockholders' Equity
Current liabilities:
 
 
 
Accounts payable
$
5,322

 
$
7,497

Accrued expenses
22,254

 
32,149

Current portion of deferred revenue
40,386

 
36,967

Current portion of long-term liabilities
750

 
794

Total current liabilities
68,712

 
77,407

Deferred revenue
8,207

 
8,009

Deferred income taxes
1,802

 
1,623

Other long-term liabilities
4,042

 
5,246

Total liabilities
82,763

 
92,285

Commitments and contingencies (Note 15)

 

Stockholders' equity:
 
 
 
Preferred stock, $0.01 par value per share; 5,000,000 shares authorized, none issued and outstanding

 

Common stock, $0.001 par value per share; 120,000,000 shares authorized; 49,443,729 shares issued and outstanding at March 27, 2015; 49,357,033 shares issued and outstanding at December 31, 2014
49

 
49

Additional paid-in capital
1,226,319

 
1,226,226

Accumulated deficit
(1,010,706
)
 
(991,347
)
Accumulated other comprehensive income
5,569

 
5,422

Total stockholders' equity
221,231

 
240,350

 
$
303,994

 
$
332,635


See notes to the unaudited condensed consolidated financial statements.

4


SONUS NETWORKS, INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)


 
Three months ended
 
March 27,
2015
 
March 28,
2014
Revenue:
 
 
 
Product
$
24,865

 
$
45,140

Service
25,280

 
25,602

Total revenue
50,145

 
70,742

Cost of revenue:
 
 
 
Product
11,648

 
13,663

Service
9,267

 
10,656

Total cost of revenue
20,915

 
24,319

Gross profit
29,230

 
46,423

Operating expenses:
 
 
 
Research and development
19,339

 
18,972

Sales and marketing
19,765

 
19,581

General and administrative
9,224

 
11,186

Acquisition-related
107

 
1,306

Restructuring
(339
)
 
1,169

Total operating expenses
48,096

 
52,214

Loss from operations
(18,866
)
 
(5,791
)
Interest income, net
28

 
35

Other income, net
45

 
2,335

Loss before income taxes
(18,793
)
 
(3,421
)
Income tax provision
(566
)
 
(532
)
Net loss
$
(19,359
)
 
$
(3,953
)
Loss per share
 
 
 
Basic
$
(0.39
)
 
$
(0.07
)
Diluted
$
(0.39
)
 
$
(0.07
)
Shares used to compute loss per share:
 
 
 
Basic
49,423

 
53,080

Diluted
49,423

 
53,080


See notes to the unaudited condensed consolidated financial statements.


5


SONUS NETWORKS, INC.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)


 
Three months ended
 
March 27,
2015
 
March 28,
2014
Net loss
$
(19,359
)
 
$
(3,953
)
Other comprehensive income (loss), net of tax:
 
 
 
Foreign currency translation adjustments
42

 
94

Unrealized gain (loss) on available-for sale marketable securities, net of tax
105

 
(10
)
Other comprehensive income, net of tax
147

 
84

Comprehensive loss, net of tax
$
(19,212
)
 
$
(3,869
)

See notes to the unaudited condensed consolidated financial statements.


6


SONUS NETWORKS, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)


 
Three months ended
 
March 27,
2015
 
March 28,
2014
Cash flows from operating activities:
 
 
 
Net loss
$
(19,359
)
 
$
(3,953
)
Adjustments to reconcile net loss to cash flows provided by operating activities:
 
 
 
Depreciation and amortization of property and equipment
2,575

 
2,917

Amortization of intangible assets
1,647

 
1,029

Stock-based compensation
4,820

 
5,774

Loss on disposal of property and equipment
12

 
55

Deferred income taxes
155

 
176

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
7,302

 
22,973

Inventory
(3,034
)
 
2,337

Other operating assets
(75
)
 
(259
)
Accounts payable
(2,115
)
 
(1,551
)
Accrued expenses and other long-term liabilities
(13,014
)
 
(7,754
)
Deferred revenue
3,610

 
(538
)
Net cash (used in) provided by operating activities
(17,476
)
 
21,206

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(2,512
)
 
(3,287
)
Business acquisition, net of cash acquired
(10,147
)
 
(34,010
)
Purchases of marketable securities
(1,649
)
 

Maturities/sales of marketable securities
13,518

 
87,646

Net cash (used in) provided by investing activities
(790
)
 
50,349

Cash flows from financing activities:
 
 
 
Proceeds from sale of common stock in connection with employee stock purchase plan
1,668

 
1,197

Proceeds from exercise of stock options
1,687

 
3,444

Payment of tax withholding obligations related to net share settlements of restricted stock awards
(1,995
)
 
(1,530
)
Repurchase of common stock
(6,084
)
 
(75,385
)
Principal payments of capital lease obligations
(20
)
 
(24
)
Net cash used in financing activities
(4,744
)
 
(72,298
)
Effect of exchange rate changes on cash and cash equivalents
(55
)
 
91

Net decrease in cash and cash equivalents
(23,065
)
 
(652
)
Cash and cash equivalents, beginning of year
41,157

 
72,423

Cash and cash equivalents, end of period
$
18,092

 
$
71,771

Supplemental disclosure of cash flow information:
 
 
 
Interest paid
$
8

 
$
2

Income taxes paid
$
151

 
$
751

Income tax refunds received
$
20

 
$

Supplemental disclosure of non-cash investing activities:
 
 
 
Capital expenditures incurred, but not yet paid
$
881

 
$
384

Business acquisition purchase consideration - assumed equity awards
$

 
$
1,671


See notes to the unaudited condensed consolidated financial statements.

7


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)

(1) BASIS OF PRESENTATION

Business

Sonus Networks, Inc. (“Sonus” or the “Company”) is a leading provider of networked solutions for communications service providers (e.g., telecommunications, wireless and cable service providers) and enterprises to help them advance, protect and unify their communications and improve collaboration. Sonus helps many of the world's leading communications service providers and enterprises embrace the next generation of Session Initiation Protocol ("SIP") and 4G/LTE (Long Term Evolution)-based solutions, including Voice over IP ("VoIP") video and Unified Communications ("UC") through secure, reliable and scalable Internet Protocol ("IP") networks. Sonus' products include session border controllers ("SBCs"), diameter signaling controllers ("DSCs"), policy/routing servers, media and signaling gateways and network analytics tools.

The Company utilizes both direct and indirect sales channels to reach its target customers. Customers and prospective customers in the service provider space are traditional and emerging communications service providers, including long distance carriers, local exchange carriers, Internet service providers, wireless operators, cable operators, international telephone companies and carriers that provide services to other carriers. Enterprise customers and target enterprise customers include financial institutions, retailers, state and local governments, and other multinational corporations.

Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring items, necessary for their fair presentation with accounting principles generally accepted in the United States of America ("GAAP") and with the rules and regulations of the U.S. Securities and Exchange Commission ("SEC").

Interim results are not necessarily indicative of results for a full year or any future interim period. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2014 (the "Annual Report") filed with the SEC on February 25, 2015.

We effected a one-for-five reverse stock split of our issued, outstanding and authorized common stock, which became effective as of the commencement of trading on the NASDAQ Global Select Market on January 30, 2015. Unless otherwise indicated, all references herein to shares outstanding and share issuances have been adjusted to give effect to our January 2015 reverse stock split.

On January 2, 2015 (the "Treq Asset Acquisition Date"), the Company acquired from Treq Labs, Inc. ("Treq") certain assets related to Treq's business of designing, developing, marketing, selling, servicing and maintaining software defined networking ("SDN") technology, SDN controller software and SDN management software (the "SDN Business"). The financial results of the SDN Business are included in the Company's condensed consolidated financial statements starting on the Treq Asset Acquisition Date.

On February 19, 2014 (the "PT Acquisition Date"), the Company completed the acquisition of Performance Technologies, Incorporated ("PT"). The financial results of PT are included in the Company's condensed consolidated financial statements starting on the PT Acquisition Date.

Significant Accounting Policies

The Company's significant accounting policies are disclosed in Note 2 to the Consolidated Financial Statements included in the Annual Report. There were no material changes to the significant accounting policies during the three months ended March 27, 2015.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of Sonus and its wholly-owned subsidiaries. Intercompany transactions and balances have been eliminated in consolidation.

8


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)


Use of Estimates and Judgments

The preparation of financial statements in conformity with GAAP 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 revenues and expenses during the reporting periods. Significant estimates and judgments relied upon in preparing these consolidated financial statements include accounting for business combinations, revenue recognition for multiple element arrangements, inventory valuations, assumptions used to determine the fair value of stock-based compensation, intangible assets and goodwill valuations, including impairments, legal contingencies and recoverability of Sonus' net deferred tax assets and the related valuation allowances. Sonus regularly assesses these estimates and records changes in estimates in the period in which they become known. Sonus bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results could differ from those estimates.

Fair Value of Financial Instruments

The carrying amounts of the Company's financial instruments, which include cash equivalents, marketable securities, investments, accounts receivable, accounts payable, convertible subordinated debt and other long-term liabilities, approximate their fair values.

Operating Segments

The Company operates in a single segment. 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 in making decisions regarding resource allocation and assessing performance. To date, the chief operating decision maker has made such decisions and assessed performance at the company level, as one segment. The Company's chief operating decision maker is its President and Chief Executive Officer.

Recent Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern ("ASU 2014-15"). ASU 2014-15 provides guidelines determining when and how to disclose going concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity's ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity's ability to continue as a going concern. ASU 2014-15 applies to all entities and is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. The adoption of ASU 2014-15 is not expected to have a material impact on the Company's consolidated financial statements.

In June 2014, the FASB issued ASU 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force) (“ASU 2014-12”). ASU 2014-12 clarifies that entities should treat performance targets that can be met after the requisite service period of a share-based payment award as performance conditions that affect vesting. Therefore, an entity would not record compensation expense (measured as of the grant date without taking into account the effect of the performance target) related to an award for which transfer to the employee is contingent upon the entity’s satisfaction of a performance target until it becomes probable that the performance target will be met. ASU 2014-12 does not contain any new disclosure requirements. ASU 2014-12 was effective for the Company on January 1, 2015. The adoption of ASU 2014-12 did not have a material impact on the Company's condensed consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”) its final standard on revenue from contracts with customers. ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance,

9


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the revenue model to contracts within its scope, an entity identifies the contract(s) with a customer, identifies the performance obligations in the contract, determines the transaction price, allocates the transaction price to the performance obligations in the contract and recognizes revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 applies to all contracts with customers that are within the scope of other topics in the FASB Accounting Standards Codification ("ASC"). Certain of ASU 2014-09’s provisions also apply to transfers of nonfinancial assets, including in-substance nonfinancial assets that are not an output of an entity’s ordinary activities (i.e., property plant and equipment; real estate; or intangible assets). Existing accounting guidance applicable to these transfers has been amended or superseded. In April 2015, the FASB tentatively decided to defer the original effective date of interim and annual reporting periods beginning after December 15, 2015 by one year. As a result, public entities would not be required to apply the new revenue standard until annual reporting periods beginning after December 15, 2017. The Company is currently assessing the potential impact of the adoption of ASU 2014-09 on its condensed consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”), which amends the definition of discontinued operations in ASC 205-20 and requires entities to provide additional disclosures about discontinued operations as well as disposal transactions that do not meet the discontinued operations criteria. The new guidance eliminates the previous criteria that the operations and cash flows of the component that have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction. The new guidance also eliminates the previous criteria that the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. Instead, ASU 2014-08 requires discontinued operations treatment for disposals of a component or group of components that represents a strategic shift that has or will have a major impact on an entity’s operations or financial results. ASU 2014-08 requires entities to reclassify assets and liabilities of a discontinued operation for all comparative periods presented in the statement of financial position. In addition, ASU 2014-08 requires that an entity disclose in its statement of cash flows, for all periods presented, either: (1) operating and investing cash flows or (2) depreciation and amortization, capital expenditures and significant operating and investing non-cash items related to the discontinued operation. ASU 2014-08 was effective prospectively for all disposals (except disposals classified as held for sale before the adoption date) or components initially classified as held for sale in periods beginning on or after December 15, 2014. The adoption of ASU 2014-08 did not have a material impact on the Company's condensed consolidated financial statements.



10


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

(2) BUSINESS ACQUISITIONS

Treq Labs, Inc.

On the Treq Asset Acquisition Date, the Company acquired from Treq its SDN Business.. The SDN Business provides solutions that optimize networks for voice, video and UC for both enterprise and service provider customers. The Company believes that the acquisition of the SDN Business will accelerate Sonus' delivery of its SDN strategy. In consideration for the acquisition of the SDN Business, Sonus paid $10.1 million in cash at the Treq Asset Acquisition Date, with an additional consideration payment of $750,000 due on July 2, 2015 and a second additional consideration payment of $750,000 due on January 4, 2016. The Company also entered into an Earn-Out Agreement, dated as of January 2, 2015, with Treq and Karl F. May, the seller representative in the transaction (the "Earn-Out Agreement"), under which the Company has agreed to issue up to an aggregate of 1.3 million shares of common stock over a three-year period subsequent to the Treq Asset Acquisition Date if aggregate revenue thresholds of at least $60 million are achieved by the SDN Business during that period, and up to an aggregate of an additional 2.2 million shares (3.5 million shares in total) if aggregate revenue thresholds of at least $150 million are achieved by the SDN Business during that period. If the initial revenue thresholds are not met, no shares will be issued. Based on historical and forecasted sales, no incremental contingent consideration was recorded initially as of the Treq Asset Acquisition Date or through March 27, 2015. Any shares issued pursuant to the Earn-Out Agreement will be issued in reliance on the exemption from registration available under Section 4(a)(2) of the Securities Act of 1933, as amended (the "Securities Act") and will be subsequently registered for resale under the Securities Act by the Company.

The transaction has been accounted for as a business combination and the financial results of the SDN Business have been included in the Company's condensed consolidated financial statements for the period subsequent to its acquisition.

As of March 27, 2015, the valuation of the identifiable intangible assets remained preliminary. The Company is in the process of finalizing its valuation, which it plans to complete in the second quarter of fiscal 2015. Based on the preliminary purchase price allocation, the Company recorded $1.0 million of goodwill, primarily due to expected synergies between the combined companies and expanded market opportunities. The goodwill is not deductible for tax purposes.

A summary of the preliminary purchase consideration for the SDN Business is as follows (in thousands):

Fair value of consideration transferred:
 
  Cash, net of cash acquired
$
10,147

  Unpaid purchase consideration
1,500

    Fair value of total consideration
$
11,647

Fair value of assets acquired and liabilities assumed:
 
  Intangible assets:
 
    In-process research and development
$
9,100

    Developed technology
1,500

  Goodwill
1,047

 
$
11,647



The valuation of the acquired intangible assets is inherently subjective and relies on significant unobservable inputs. The Company used an income approach to preliminarily value the acquired in-process research and development and developed technology intangible assets. The valuation for each of these intangible assets was based on estimated projections of expected cash flows to be generated by the assets, discounted to the present value at discount rates commensurate with perceived risk. The valuation assumptions take into consideration the Company's estimates of technology attrition and revenue growth projections. The Company will begin to amortize the in-process research and development intangible asset at the time that the related products become generally available. Once the products become generally available, the Company will amortize the identifiable intangible assets in relation to the expected cash flows from the individual intangible assets over their respective useful lives (see Note 6).


11


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

The actual results of the SDN Business for the period since the Treq Asset Acquisition Date were not material to the Company's financial results. The Company has not provided pro forma information as the results of the SDN Business are not material to the Company's financial results.

Performance Technologies, Incorporated

On the PT Acquisition Date, the Company acquired all of the outstanding common stock of PT for cash consideration of $35.0 million, or $3.75 per share of PT common stock. This acquisition has enabled Sonus to expand its solutions portfolio with signaling technology and acquire expertise to enable mobile service providers to offer new real-time multimedia services through their mobile infrastructure. Delivering these services across the LTE next-generation mobile networks will require adoption of the next-generation signaling technology known in the industry as Diameter Signal. The acquisition of PT has allowed Sonus to diversify its product portfolio with an integrated, virtualized Diameter and SIP-based solution and deliver strategic value to service providers seeking to offer new multimedia services through mobile, cloud-based, real-time communications.

The transaction has been accounted for as a business combination and the financial results of PT have been included in the Company's condensed consolidated financial statements starting on the PT Acquisition Date.

The Company finalized the valuation of acquired assets, identifiable intangible assets and certain accrued liabilities in the fourth quarter of 2014. The Company recorded $8.8 million of goodwill, primarily due to expected synergies between the combined companies and expanded market opportunities. The goodwill is not deductible for tax purposes.

A summary of the allocation of the purchase consideration for PT is as follows (in thousands):
Fair value of consideration transferred:
 
  Cash, net of cash acquired
$
35,022

  Fair value of equity awards assumed
1,671

    Fair value of total consideration
$
36,693

Fair value of assets acquired and liabilities assumed:
 
  Marketable securities
$
2,315

  Other current assets
9,337

  Property and equipment
2,251

  Intangible assets:
 
    Developed technology
13,200

    Customer relationships
3,900

  Goodwill
8,781

  Current liabilities
(2,762
)
  Other long-term liabilities
(329
)
 
$
36,693


The valuation of the acquired intangible assets is inherently subjective and relies on significant unobservable inputs. The Company used an income approach to preliminarily value the acquired customer relationships and developed technology intangible assets. The valuation for each of these intangible assets was based on estimated projections of expected cash flows to be generated by the assets, discounted to the present value at discount rates commensurate with perceived risk. The valuation assumptions take into consideration the Company's estimates of contract renewal, technology attrition and revenue growth projections. The Company is amortizing the identifiable intangible assets in relation to the expected cash flows from the individual intangible assets over their respective useful lives (see Note 6).

The Company has not provided pro forma information as the results of PT are not material to the Company's financial results.
 
Acquisition-Related Expenses

Acquisition-related expenses include those expenses related to acquisitions that would otherwise not have been incurred by

12


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

the Company. These expenses include professional and services fees, such as legal, audit, consulting, paying agent and other fees. These expenses also include cash payments to certain former PT executives under their respective PT change of control agreements. The amount recorded in the three months ended March 27, 2015 relates to professional fees in connection with the acquisition of the SDN Business. The amount recorded in the three months ended March 28, 2014 represents professional and services fees and expenses related to cash payments to certain former PT executives under their respective PT change of control agreements in connection with the PT acquisition.

The components of acquisition-related costs included in the Company's results of operations for the three months ended March 27, 2015 and March 28, 2014 are as follows (in thousands):
 
Three months ended
 
March 27, 2015
 
March 28, 2014
Professional and services fees
$
107

 
$
1,057

Change of control agreements

 
249

 
$
107

 
$
1,306



Sale of Multi-Protocol Server Business

On June 20, 2014 (the "MPS Sale Date"), the Company sold its PT Multi-Protocol Server ("MPS") business for $2.0 million to an affiliate of Sunhillo Corporation, comprised of $0.2 million of inventory, $0.1 million of fixed assets, $0.2 million of deferred revenue and $1.9 million of PT goodwill allocable to the MPS business. The Company had acquired the MPS business in connection with the acquisition of PT. The results of operations of the MPS business are excluded from the Company's condensed consolidated results after the MPS Sale Date.


(3) EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares outstanding during the period. For periods in which the Company reports net income, diluted net income per share is determined by using the weighted average number of common and dilutive common equivalent shares outstanding during the period unless the effect is antidilutive.

The calculations of shares used to compute basic and diluted loss per share are as follows (in thousands):
 
 
Three months ended
 
 
March 27,
2015
 
March 28,
2014
Weighted average shares outstanding—basic
 
49,423

 
53,080

Potential dilutive common shares
 

 

Weighted average shares outstanding—diluted
 
49,423

 
53,080



Options to purchase the Company's common stock, unvested shares of restricted stock, unvested performance-based stock awards and shares in connection with future purchases under the Company's Amended and Restated 2000 Employee Stock Purchase Plan, as amended (the "ESPP"), aggregating 9.4 million shares for the three months ended March 27, 2015 and 9.1 million shares for the three months ended March 28, 2014 have not been included in the computation of diluted loss per share because their effect would have been antidilutive.



13


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

(4) CASH EQUIVALENTS AND INVESTMENTS

The Company invests in debt instruments, primarily U.S. government-backed, municipal and corporate obligations, which management believes to be high quality (investment grade) credit instruments.

During the three months ended March 28, 2014, the Company sold $45.9 million of its available-for-sale securities and realized gross gains aggregating $46,000, which are included as a component of Other income (expense), net, in the Company's condensed consolidated statement of operations for that period. The Company did not realize any gross losses on these sales. In addition, $41.7 million of the Company's available-for-sale securities matured during the three months ended March 28, 2014 and were redeemed upon maturity. The Company did not sell any of its available-for-sale securities during the three months ended March 27, 2015.

Investments with continuous unrealized losses for one year or greater at March 27, 2015 were nominal. Since the Company currently does not intend to sell these securities and does not believe it will be required to sell any securities before they recover in value, it does not believe these declines are other-than-temporary.

On a quarterly basis, the Company reviews its marketable securities and investments to determine if there have been any events that could create a credit impairment. Based on its reviews, the Company does not believe that any impairment existed with its current holdings at March 27, 2015.

The amortized cost, gross unrealized gains and losses and fair value of the Company's marketable debt securities and investments at March 27, 2015 and December 31, 2014 were comprised of the following (in thousands):

 
March 27, 2015
 
Amortized
cost
 
Unrealized
gains
 
Unrealized
losses
 
Fair
value
Cash equivalents
$
1,391

 
$

 
$

 
$
1,391

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
1,523

 
$
1

 
$

 
$
1,524

U.S. government agency notes
4,154

 
1

 

 
4,155

Corporate debt securities
45,325

 
4

 
(40
)
 
45,289

Commercial paper
8,190

 

 

 
8,190

Certificates of deposit
6,550

 

 

 
6,550

 
$
65,742

 
$
6

 
$
(40
)
 
$
65,708

Investments
 
 
 
 
 
 
 
Municipal obligations
$
2,197

 
$
3

 
$
(1
)
 
$
2,199

U.S. government agency notes
2,300

 
2

 

 
2,302

Corporate debt securities
24,051

 
14

 
(21
)
 
24,044

Certificates of deposit
500

 

 

 
500

 
$
29,048

 
$
19

 
$
(22
)
 
$
29,045




14


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

 
December 31, 2014
 
Amortized
cost
 
Unrealized
gains
 
Unrealized
losses
 
Fair
value
Cash equivalents
$
11,653

 
$

 
$

 
$
11,653

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
1,273

 
$
1

 
$
(1
)
 
$
1,273

U.S. government agency notes
4,016

 

 

 
4,016

Corporate debt securities
40,921

 
2

 
(59
)
 
40,864

Commercial paper
9,340

 

 

 
9,340

Certificates of deposit
8,950

 

 

 
8,950

 
$
64,500

 
$
3

 
$
(60
)
 
$
64,443

Investments
 
 
 
 
 
 
 
Municipal obligations
$
2,702

 
$
1

 
$
(3
)
 
$
2,700

U.S. government agency notes
2,300

 

 
(1
)
 
2,299

Corporate debt securities
35,897

 
4

 
(86
)
 
35,815

Commercial paper
1,093

 

 

 
1,093

Certificates of deposit
500

 

 

 
500

 
$
42,492

 
$
5

 
$
(90
)
 
$
42,407



The Company's available-for-sale debt securities classified as Investments in the condensed consolidated balance sheets at March 27, 2015 and December 31, 2014 had maturity dates after one year but within two years or less from the balance sheet date.

Fair Value Hierarchy

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. The three-tier fair value hierarchy is based on the level of independent, objective evidence surrounding the inputs used to measure fair value. A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is as follows:

Level 1. Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.

Level 2. Level 2 applies to assets or liabilities for which there are inputs that are directly or indirectly observable in the marketplace, such as quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets).

Level 3. Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.

The following table shows the fair value of the Company's financial assets at March 27, 2015 and December 31, 2014. These financial assets are comprised of the Company's available-for-sale debt securities and reported under the captions Cash and cash equivalents, Short-term investments and Investments in the condensed consolidated balance sheets (in thousands):

15


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

 
 
 
Fair value measurements at
March 27, 2015 using:
 
Total carrying
value at
March 27,
2015
 
Quoted prices
in active
markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash equivalents
$
1,391

 
$
1,391

 
$

 
$

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
1,524

 
$

 
$
1,524

 
$

U.S. government agency notes
4,155

 

 
4,155

 

Corporate debt securities
45,289

 

 
45,289

 

Commercial paper
8,190

 

 
8,190

 

Certificates of deposit
6,550

 

 
6,550

 

 
$
65,708

 
$

 
$
65,708

 
$

Investments
 
 
 
 
 
 
 
Municipal obligations
$
2,199

 
$

 
$
2,199

 
$

U.S. government agency notes
2,302

 

 
2,302

 

Corporate debt securities
24,044

 

 
24,044

 

Certificates of deposit
500

 

 
500

 

 
$
29,045

 
$

 
$
29,045

 
$



 
 
 
Fair value measurements at
December 31, 2014 using:
 
Total carrying
value at
December 31,
2014
 
Quoted prices
in active
markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash equivalents
$
11,653

 
$
11,653

 
$

 
$

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
1,273

 
$

 
$
1,273

 
$

U.S. government agency notes
4,016

 

 
4,016

 

Corporate debt securities
40,864

 

 
40,864

 

Commercial paper
9,340

 

 
9,340

 

Certificates of deposit
8,950

 

 
8,950

 

 
$
64,443

 
$

 
$
64,443

 
$

Investments
 
 
 
 
 
 
 
Municipal obligations
$
2,700

 
$

 
$
2,700

 
$

U.S. government agency notes
2,299

 

 
2,299

 

Corporate debt securities
35,815

 

 
35,815

 

Commercial paper
1,093

 

 
1,093

 

Certificates of deposit
500

 

 
500

 

 
$
42,407

 
$

 
$
42,407

 
$



The Company's investments have been valued with the assistance of valuations provided by third-party pricing services, as derived from such services' pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, broker/dealer quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security. The Company is ultimately responsible for the condensed consolidated financial statements and underlying estimates. Accordingly, the Company assesses the reasonableness of the valuations provided by the third-party pricing services by

16


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

reviewing actual trade data, broker/dealer quotes and other similar data, which are obtained from quoted market prices or other sources.


(5) INVENTORY

Inventory consists of the following (in thousands):
 
March 27,
2015
 
December 31,
2014
On-hand final assemblies and finished goods inventories
$
22,312

 
$
19,285

Deferred cost of goods sold
2,835

 
2,829

 
$
25,147

 
$
22,114



(6) INTANGIBLE ASSETS AND GOODWILL

The Company's intangible assets at March 27, 2015 and December 31, 2014 consist of the following (dollars in thousands):
March 27, 2015
Weighted average amortization period
(years)
 
Cost
 
Accumulated
amortization
 
Net
carrying value
In-process research and development
7.00
 
$
9,100

 
$

 
$
9,100

Intellectual property
5.00
 
999

 
999

 

Developed technology
6.24
 
23,780

 
6,300

 
17,480

Customer relationships
5.57
 
10,040

 
5,174

 
4,866

Internal use software
3.00
 
730

 
629

 
101

 
6.05
 
$
44,649

 
$
13,102

 
$
31,547


December 31, 2014
Weighted average amortization period
(years)
 
Cost
 
Accumulated
amortization
 
Net
carrying value
Intellectual property
5.00
 
$
999

 
$
999

 
$

Developed technology
6.18
 
22,280

 
5,193

 
17,087

Customer relationships
5.57
 
10,040

 
4,695

 
5,345

Internal use software
3.00
 
730

 
568

 
162

 
5.75
 
$
34,049

 
$
11,455

 
$
22,594



Amortization expense for intangible assets for the three months ended March 27, 2015 and March 28, 2014 was as follows (in thousands):
 
Three months ended
 
Statement of operations classification
 
March 27,
2015
 
March 28,
2014
 
Developed technology
$
1,107

 
$
570

 
Cost of revenue - product
Customer relationships
479

 
398

 
Sales and marketing
Internal use software
61

 
61

 
Cost of revenue - product
 
$
1,647

 
$
1,029

 
 



17


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

The Company did not record amortization expense in connection with the in-process research and development intangible asset because the related products were not yet generally available. The Company will begin to amortize the in-process research and development intangible asset at the time that the related products become generally available and will amortize the identifiable intangible assets in relation to the expected cash flows from the individual intangible assets over their respective useful lives; the Company will begin to amortize this intangible asset at the time that the related products become generally available, which the Company expects will occur in the second and fourth quarters of 2015. Estimated future amortization expense for the Company's intangible assets at March 27, 2015 is as follows (in thousands):

Years ending December 31,
 
Remainder of 2015
$
5,895

2016
7,001

2017
7,338

2018
4,589

2019
3,554

Thereafter
3,170

 
$
31,547



The changes in the carrying value of the Company's goodwill in the three months ended March 27, 2015 and March 28, 2014 were as follows (in thousands):
 
 
Balance at January 1, 2015
 
  Goodwill
$
42,369

  Accumulated impairment losses
(3,106
)
 
39,263

Acquisition of SDN Business
1,047

Balance at March 27, 2015
$
40,310

 
 
Balance at March 27, 2015
 
  Goodwill
$
43,416

  Accumulated impairment losses
(3,106
)
 
$
40,310



 
 
Balance at January 1, 2014
 
  Goodwill
$
35,485

  Accumulated impairment losses
(3,106
)
 
32,379

Acquisition of PT
8,193

Balance at March 28, 2014
$
40,572

 
 
Balance at March 28, 2014
 
  Goodwill
$
43,678

  Accumulated impairment losses
(3,106
)
 
$
40,572





18


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

(7) ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
 
March 27,
2015
 
December 31,
2014
Employee compensation and related costs
$
10,246

 
$
20,042

Other
12,008

 
12,107

 
$
22,254

 
$
32,149



(8) RESTRUCTURING ACCRUAL

The Company recorded a credit of $0.3 million to restructuring expense in the three months ended March 27, 2015 that it had previously accrued in connection with its earlier restructuring initiative. The reversal of approximately $272,000 for facilities was recorded in connection with the settlement with the landlord of the Company's Dulles, Virginia facility for an amount that was lower than had previously been accrued. The Company also reversed approximately $67,000 in connection with changes in the amounts of severance ultimately paid to certain individuals.

The Company recorded $1.2 million of restructuring expense in the three months ended March 28, 2014 for severance and related costs in connection with reducing its workforce.

The table below summarizes the restructuring accrual activity for the three months ended March 27, 2015 (in thousands):
 
Balance at
January 1,
2015
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at
March 27,
2015
Severance
$
1,682

 
$
(67
)
 
$
(1,290
)
 
$
325

Facilities
3,652

 
(272
)
 
(1,135
)
 
2,245

 
$
5,334

 
$
(339
)
 
$
(2,425
)
 
$
2,570



The Company expects to complete the restructuring payments related to severance in the fourth quarter of fiscal 2015 and the payments related to facilities in fiscal 2016. The current portion of the restructuring accrual is included as a component of Accrued expenses in the Company's condensed consolidated balance sheets. The portion of restructuring payments due more than one year from the balance sheet date is included in Other long-term liabilities in the Company's condensed consolidated balance sheets. The long-term portions of accrued restructuring were $0.9 million at March 27, 2015 and $1.9 million at December 31, 2014.


(9) DEBT

On June 27, 2014, the Company entered into a credit agreement (the "Credit Agreement") by and among the Company, as Borrower, Bank of America, N.A. ("Bank of America"), as Administrative Agent, Swing Line Lender and L/C Issuer, and the other lenders from time to time party thereto. The Credit Agreement provides for a revolving credit facility of up to $40 million and provides that the Company may select the interest rates under the credit facility equal to (1) the Eurodollar Rate (which is defined as the rate per annum equal to the London Interbank Offered Rate plus 1.5% per annum) for a Eurodollar Rate Loan; and (2) the highest of (a) the Federal Funds Rate plus 1/2 of 1%, (b) the rate of interest in effect on the borrowing date as publicly announced from time to time by Bank of America as its prime rate, and (c) the monthly Eurodollar Rate plus 1%. The Company will pay a 0.15% commitment fee on the unused commitments available for borrowing.

The obligations of the Company under the Credit Agreement are guaranteed by Sonus International, Inc., Sonus Federal, Inc., Network Equipment Technologies, Inc. ("NET") and PT (collectively, together with the Company, the "Loan Parties") pursuant to a Master Continuing Guaranty and are secured by the assets of the Loan Parties pursuant to a Security and Pledge Agreement.

19


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)


The credit facility will become due on June 27, 2015, subject to acceleration upon certain specified events of default. The Company did not have any amounts outstanding under the Credit Agreement at March 27, 2015.


(10) COMMON STOCK REPURCHASES AND UNDERWRITTEN OFFERING

Stock Buyback Program

On July 29, 2013, the Company announced that its Board of Directors had authorized a stock buyback program to repurchase up to $100 million of the Company's common stock from time to time on the open market or in privately negotiated transactions. The timing and amount of any shares repurchased will be determined by the Company's management based on its evaluation of market conditions and other factors. The Company may elect to implement a 10b5-1 repurchase program, which would permit shares to be repurchased when the Company might otherwise be precluded from doing so under insider trading laws. The Company has not implemented such a 10b5-1 repurchase program to date. The stock buyback program may be suspended or discontinued at any time. The stock buyback program is being funded using the Company's working capital. During the three months ended March 27, 2015, the Company spent $6.1 million, including transaction fees, to repurchase and retire 0.4 million shares of its common stock under the stock buyback program. During the three months ended March 28, 2014, the Company spent $0.1 million, including transaction fees, to repurchase and retire 7,700 shares of its common stock under the stock buyback program. At March 27, 2015, the Company had $16.8 million remaining under the stock buyback program for future repurchases.

Underwritten Offering

On March 20, 2014, the Company announced the commencement of an underwritten public offering of 7.5 million shares of its common stock on behalf of Galahad Securities Limited and its affiliated entities (collectively, the "Legatum Group"). The underwriter of the offering was granted a 30-day option to purchase up to 1.125 million additional shares from the Legatum Group. The Legatum Group received all the proceeds from the underwritten offering; no shares in the underwritten offering were sold by Sonus or any of its officers or directors. Sonus purchased 4.3 million shares of its common stock from the underwriter for $17.4410 per share, the price equal to the price paid by the underwriter to the Legatum Group in the underwritten offering, for a total of $75.3 million, including transaction fees of $0.3 million. This repurchase was not completed under the Company's stock buyback program. Sonus funded the share repurchase with cash on hand. The repurchased shares were retired upon completion of the transaction.


(11) STOCK-BASED COMPENSATION PLANS

Stock Incentive Plan

The Company's 2007 Stock Incentive Plan, as amended (the "2007 Plan"), provides for the award of options to purchase the Company's common stock ("stock options"), stock appreciation rights ("SARs"), restricted common stock awards ("RSAs"), restricted common stock units ("RSUs"), performance-based stock awards ("PSAs"), performance-based stock units ("PSUs") and other stock-based awards to employees, officers, directors (including those directors who are not employees or officers of the Company), consultants and advisors of the Company and its subsidiaries.

Executive and Board of Directors Equity Arrangements

In connection with the Company's annual incentive program, 22 executives of the Company were given the choice to receive all or half of their fiscal year 2015 bonuses (the "2015 Bonus"), if any are earned, in the form of shares of the Company's common stock (the "2015 Bonus Shares"). Each executive could also elect not to participate in this program and to earn his or her 2015 Bonus, if any, in the form of cash. The amount of the 2015 Bonus, if any, for each executive shall be determined by the Compensation Committee of the Board of Directors of the Company (the "Compensation Committee"). The number of shares of the Company's common stock that will be granted to those executives who elected to receive their 2015 Bonus entirely in the form of shares of common stock will be calculated by dividing an amount equal to 1.5 times each

20


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

executive's 2015 Bonus earned by $20.55, the closing price of the Company's common stock on January 2, 2015. The number of shares of the Company's common stock that will be granted to those executives who elected to receive one-half of their 2015 Bonus in the form of shares of common stock will be calculated by dividing an amount equal to 1.5 times one-half of each executive's 2015 Bonus earned by $20.55, with the cash portion equal 50% of their respective 2015 Bonus earned. The 2015 Bonus, if any, will be granted and/or paid on a date concurrent with the timing of the payout of bonuses under the Company-wide incentive bonus program and will be fully vested on the date of grant. Of the eligible executives, 16 elected to receive their entire 2015 Bonus in shares of common stock, five elected to receive 50% of their 2015 Bonus in shares of common stock and 50% in cash and one elected not to participate and instead to receive his entire 2015 Bonus in cash. As of March 27, 2015, the Company determined that the grant date criteria for the 2015 Bonus Shares had not been met; accordingly, the Company is marking to market the 2015 Bonus Shares expected to be earned and recording expense based on the aggregate fair value of the 2015 Bonus Shares at March 27, 2015. The Company did not record expense related to the 2015 Bonus Shares in the three months ended March 27, 2015 as it did not believe that any 2015 Bonus Shares would be earned. Since the 2015 Bonus Shares will not be granted until the date of the 2015 Bonus payment, there are no shares related to the 2015 Bonus reported in the restricted stock grant table below.

On January 22, 2014, 21 executives of the Company were given the choice to receive all or half of their fiscal year 2014 bonuses (the "2014 Bonus"), if any were earned, in the form of shares of the Company's common stock (the "2014 Bonus Shares"). Of the eligible executives, 17 elected to receive their entire 2014 Bonus in shares of common stock, while 4 elected to receive 50% of their 2014 Bonus in shares of common stock and 50% in cash. The 2014 Bonus Shares were granted on February 20, 2015 and vested immediately. The Company granted approximately 266,000 2014 Bonus Shares, with the number of shares granted calculated by dividing amounts equal to 1.5 times each executive's 2014 Bonus earned, as determined by the Compensation Committee, by $15.40, the closing price of the Company's common stock on January 2, 2014. The Company recorded stock-based compensation expense for the 2014 Bonus Shares from January 1, 2014 through the grant date. These shares are reported as both "Granted" and "Vested" in the RSA table below.

On March 16, 2015, the Company granted 131,250 PSUs in the aggregate to eight of its executives with both market and service conditions. The terms of the PSUs are such that up to one-third of the shares subject to the PSUs will vest on each of the first, second and third anniversaries of the date of grant (collectively, the "Vesting Dates") to the extent of achievement of the Company's total shareholder return ("TSR") compared to the TSR of the companies included in the NASDAQ Telecommunications Index for the same Performance Period, measured by the Compensation Committee at the end of each of the 2015, 2016 and 2017 fiscal years, respectively (each, a "Performance Period"). The shares determined to be earned will vest on the anniversary of the grant date following each Performance Period. Shares subject to the PSUs that fail to be earned will be forfeited. The PSUs include a market condition which requires the use of a Monte Carlo simulation approach to model future stock price movements based upon the risk-free rate of return, the volatility of each entity, and the pair-wise covariance between each entity. These results were then used to calculate the grant date fair values of the PSUs. The Company is recording expense for the PSUs through the final Vesting Date of March 16, 2018. The PSUs are reported as "Granted" in the performance-based awards table below.


21


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

Stock Options

The activity related to the Company's outstanding stock options during the three months ended March 27, 2015 is as follows:
 
Number of
Shares
 
Weighted
Average
Exercise Price
 
Weighted
Average
Remaining
Contractual Term
(years)
 
Aggregate
Intrinsic Value
(in thousands)
Outstanding at January 1, 2015
7,521,432

 
$
16.47

 
 
 
 
Granted
279,930

 
$
16.28

 
 
 
 
Exercised
(143,320
)
 
$
11.19

 
 
 
 
Forfeited
(82,773
)
 
$
15.85

 
 
 
 
Expired
(43,013
)
 
$
24.12

 
 
 
 
Outstanding at March 27, 2015
7,532,256

 
$
16.53

 
6.79
 
$
317

Vested or expected to vest at March 27, 2015
7,083,866

 
$
16.52

 
6.68
 
$
310

Exercisable at March 27, 2015
4,175,385

 
$
16.88

 
5.47
 
$
263



The grant date fair values of options to purchase common stock granted in the three months ended March 27, 2015 were estimated using the Black-Scholes valuation model with the following assumptions:
 
 
Three months ended
 
 
March 27,
2015
Risk-free interest rate
 
1.46% - 1.74%
Expected dividends
 
Weighted average volatility
 
54.3%
Expected life (years)
 
5.0 - 6.0


Additional information regarding the Company's stock options for the three months ended March 27, 2015 is as follows:
 
 
Three months ended
 
 
March 27,
2015
Weighted average grant date fair value of stock options granted
 
$
8.25

Total intrinsic value of stock options exercised (in thousands)
 
$
902

Cash received from the exercise of stock options (in thousands)
 
$
1,687



Restricted Stock Awards and Units

The activity related to the Company's RSAs for the three months ended March 27, 2015 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2015
370,182

 
$
16.74

Granted
1,411,099

 
$
16.45

Vested
(287,176
)
 
$
17.76

Forfeited
(950
)
 
$
16.05

Unvested balance at March 27, 2015
1,493,155

 
$
16.28



22


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)


The activity related to the Company's unvested RSUs for the three months ended March 27, 2015 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2015

 
$

Granted
120,215

 
$
16.05

Vested

 
$

Forfeited

 
$

Unvested balance at March 27, 2015
120,215

 
$
16.05



The total fair value of shares of restricted stock that vested during the three months ended March 27, 2015 was $5.1 million.

Performance-Based Stock Awards and Units

The activity related to the Company's PSAs for the three months ended March 27, 2015 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2015
34,235

 
$
13.60

Granted

 
$

Vested
(28,610
)
 
$
13.60

Forfeited

 
$

Unvested balance at March 27, 2015
5,625

 
$
13.60



The activity related to the Company's PSUs for the three months ended March 27, 2015 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2015


$

Granted
131,250

14.68

$
14.68

Vested


$

Forfeited


$

Unvested balance at March 27, 2015
131,250

14.68

$
14.68



Employee Stock Purchase Plan

The Company's ESPP provides for six-month offering periods with the purchase price of the stock equal to 85% of the lesser of the market price on the first or last day of the offering period. The maximum number of shares of common stock an employee may purchase during each offering period is 500, subject to certain adjustments pursuant to the ESPP.

Stock-Based Compensation

The condensed consolidated statements of operations include stock-based compensation for the three months ended March 27, 2015 and March 28, 2014 as follows (in thousands):

23


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

 
 
Three months ended
 
 
March 27,
2015
 
March 28,
2014
Product cost of revenue
 
$
74

 
$
79

Service cost of revenue
 
380

 
279

Research and development
 
1,358

 
1,313

Sales and marketing
 
1,016

 
1,249

General and administrative
 
1,992

 
2,854

 
 
$
4,820

 
$
5,774


There is no income tax benefit for employee stock-based compensation expense for the three months ended March 27, 2015 or March 28, 2014 due to the valuation allowance recorded.

At March 27, 2015, there was $44.7 million, net of expected forfeitures, of unrecognized stock-based compensation expense related to unvested stock options, awards and units. This expense is expected to be recognized over a weighted average period of approximately three years.


(12) MAJOR CUSTOMERS

The following customers each contributed 10% or more of the Company's revenue in at least one of the three month periods ended March 27, 2015 and March 28, 2014:
 
 
Three months ended
 
 
 
March 27,
2015
 
March 28,
2014
 
Verizon Communications Inc.
 
15%
 
*
 
SoftBank Corporation
 
11%
 
*
 
AT&T Inc.
 
*
 
28%
 
__________________________________

* Represents less than 10% of revenue

At March 27, 2015, two customers each accounted for 10% or more of the Company's accounts receivable balance, representing approximately 26% in the aggregate of the Company's accounts receivable balance. At December 31, 2014, no customer accounted for 10% or more of the Company's accounts receivable balance. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable. The Company maintains an allowance for doubtful accounts and such losses have been within management's expectations.


(13) GEOGRAPHIC INFORMATION

The Company's classification of revenue by geographic area is determined by the location to which the product is shipped or where the services are performed. The following table summarizes revenue by geographic area as a percentage of total revenue:
 
 
Three months ended
 
 
 
March 27,
2015
 
March 28,
2014
 
United States
 
62
%
 
73
%
 
Europe, Middle East and Africa
 
14

 
13

 
Japan
 
18

 
8

 
Other Asia Pacific
 
4

 
3

 
Other
 
2

 
3

 
 
 
100
%
 
100
%
 

24


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)



International revenue, both as a percentage of total revenue and absolute dollars, may vary from one period to the next, and accordingly, historical data may not be indicative of future periods.


(14) INCOME TAXES

The Company's income tax provisions for the three months ended March 27, 2015 and March 28, 2014 reflect the Company's estimates of the effective rates expected to be applicable for the respective full years, adjusted for any discrete events, which are recorded in the period that they occur. These estimates are reevaluated each quarter based on the Company's estimated tax expense for the full year. The estimated effective rates for the three months ended March 27, 2015 and March 28, 2014 do not include any benefit for the Company's domestic losses, as the Company has concluded that a valuation allowance on any domestic benefit is required.


(15) COMMITMENTS AND CONTINGENCIES

On April 6, 2015, Ming Huang, a purported shareholder of the Company (the “Plaintiff”), filed a Class Action Complaint alleging violations of the federal securities laws (the “Complaint”) in the United States District Court for the District of New Jersey (Civil Action No. 3:15-02407), against Sonus and two of its officers, Raymond P. Dolan, the Company’s President and Chief Executive Officer, and Mark Greenquist, the Company’s Chief Financial Officer (the “Defendants”). The Plaintiff claims to represent purchasers of the Company’s common stock during the period from October 23, 2014 to March 24, 2015 and seeks unspecified damages. The principal allegation contained in the Complaint is the claim that the Defendants made misleading forward-looking statements concerning the Company’s fiscal first quarter 2015 financial performance. The Company believes that the Defendants have meritorious defenses to the allegations made in the Complaint and does not expect the results of this suit to have a material effect on its business or consolidated financial statements.

In addition, the Company is often a party to disputes and legal proceedings that it considers routine and incidental to its business. Management does not expect the results of any of these actions to have a material effect on the Company's business or consolidated financial statements.



25


SONUS NETWORKS, INC.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

(16) SUBSEQUENT EVENTS

As part of the Company's recently announced cost reduction review, on April 16, 2015, the Company initiated a restructuring plan that will reduce its workforce by approximately 150 positions, or approximately 12.5% of the Company's worldwide workforce. The Company expects to record approximately $5 million of restructuring expense for severance and related costs in the three months ending June 26, 2015. The Company expects that of this amount, $4.5 million will be paid in the three months ending June 26, 2015 and the remainder will be paid in the three months ending September 25, 2015.


Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations


The following discussion of the financial condition and results of operations of Sonus Networks, Inc. should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2014, which was filed with the U.S. Securities and Exchange Commission on February 25, 2015.

Overview

We are a leading provider of networked solutions for communications service providers (e.g., telecommunications, wireless and cable service providers) and enterprises to help them advance, protect and unify their communications and improve collaboration. We help many of the world's leading communications service providers and enterprises embrace the next generation of Session Initiation Protocol ("SIP") and 4G/LTE (Long Term Evolution)-based solutions, including Voice over IP ("VoIP") video and Unified Communications ("UC") through secure, reliable and scalable Internet Protocol ("IP") networks. Our products include session border controllers ("SBCs"), diameter signaling controllers ("DSCs"), policy/routing servers, media and signaling gateways and network analytics tools. Our solutions enable our customers to seamlessly link and leverage multivendor, multiprotocol communications systems and applications across their networks, around the world and in a rapidly changing ecosystem of IP-enabled devices such as smartphones and tablets. Our solutions help our customers realize the intended value and benefits of UC platforms by enabling disparate communications environments, commonplace in most enterprises today, to work seamlessly together. Likewise, our solutions facilitate the evolution to cloud-based delivery of UC solutions.

We utilize both direct and indirect sales channels to reach our target customers. Customers and prospective customers in the service provider space are traditional and emerging communications service providers, including long distance carriers, local exchange carriers, Internet service providers, wireless operators, cable operators, international telephone companies and carriers that provide services to other carriers. Enterprise customers and target enterprise customers include financial institutions, retailers, state and local governments, and other multinational corporations. We collaborate with our customers to identify and develop new, advanced services and applications that can help to reduce costs, improve productivity and generate new revenue.

We have traditionally sold our products principally through a global direct sales force, with additional sales support from regional channel partners throughout the world. In 2012, we launched an expanded channel partner program, the Sonus Partner Assure Program, to expand our coverage of the service provider and enterprise market opportunities. We continue to expand this program, including the introduction in 2013 of a two-tier distribution channel model.

On January 2, 2015 (the "Treq Asset Acquisition Date"), we acquired from Treq Labs, Inc. ("Treq") certain assets related to Treq's business of designing, developing, marketing, selling, servicing and maintaining software defined networking ("SDN") technology, SDN controller software and SDN management software (the "SDN Business") for $10.1 million in cash at the Treq Asset Acquisition Date, with an additional consideration payment of $750,000 due on July 2, 2015 and a second additional consideration payment of $750,000 due on January 4, 2016. The Company also entered into an Earn-Out Agreement under which we agreed to issue to the sellers up to an aggregate of 1.3 million shares of common stock over a three-year period subsequent to the Treq Asset Acquisition Date if aggregate revenue thresholds of at least $60 million are achieved by the SDN Business during that period, and up to an aggregate of an additional 2.2 million shares (3.5 million shares in total) if aggregate revenue thresholds of at least $150 million are achieved by the SDN Business during that period. If the initial revenue thresholds are not met, no shares will be issued. Based on historical and forecasted sales, no incremental contingent consideration was recorded initially as of the Treq Asset Acquisition Date or through March 27, 2015. The SDN Business provides solutions that optimize networks for voice, video and UC for both enterprise and service provider customers. We believe that the acquisition of the SDN Business will accelerate our delivery of our SDN strategy. The financial results of the SDN Business are included in our condensed consolidated financial statements for the period starting on the Treq Asset Acquisition Date.

On February 19, 2014 (the "PT Acquisition Date"), we completed the acquisition of Performance Technologies, Incorporated ("PT"), a Delaware corporation, for $3.75 per share, or approximately $35 million in cash, net of PT's cash and excluding acquisition-related costs. This acquisition has enabled us to expand and diversify our portfolio with an integrated, virtualized Diameter and SIP-based solution and deliver strategic value to service providers seeking to offer new multimedia services through mobile, cloud-based real-time communications. The financial results of PT are included in our condensed consolidated financial statements after the PT Acquisition Date.

On June 20, 2014, we sold the PT Multi-Protocol Server ("MPS") business for $2.0 million to an affiliate of Sunhillo Corporation. We had acquired the MPS business in connection with the acquisition of PT. The results of operations of the MPS business are excluded from our consolidated results after June 20, 2014.

To better align our cost structure to our current revenue expectations, we recently announced a cost reduction review. As part of this review, on April 16, 2015, we initiated a restructuring plan that will reduce our workforce by approximately 150 positions, or approximately 12.5% of our worldwide workforce. We expect to record approximately $5 million of restructuring expense for severance and related costs in the three months ending June 26, 2015. We expect that of this amount, $4.5 million

26


will be paid in the three months ending June 26, 2015 and the remainder will be paid in the three months ending September 25, 2015. As a result of our cost reduction review, we expect to realize approximately $15 million of savings in 2015, with the majority of our cost reduction actions in place by the end of the second quarter. We expect that our savings will be generated primarily from the workforce reduction described above and from reductions in other discretionary spending. These expected savings will be offset by restructuring expense of approximately $5 million for severance and related expenses described above.

Our strategy is designed to capitalize on our technology and market lead, and build a premier franchise in multimedia infrastructure solutions. We are currently focusing our major efforts on the following aspects of our business which enable next generation communications including SIP- and 4G/LTE-based networks:

expanding our communications network solutions to address emerging UC-, IP- and cloud-based enterprise and service providers;
embracing the principles outlined by 3GPP, 4GPP2 and LTE architectures and delivering the industry's most advanced IMS (IP Multimedia Subsystem)-ready SBC and DSC product suites;
leveraging our TDM (time division multiplexing)-to-IP gateway technology leadership with service providers to accelerate adoption of SIP-enabled UC services;
expanding and broadening our customer base by targeting the enterprise market for SIP trunking and access solutions;
providing an environment for our customers to enable real-time communication to embed into their presence on the worldwide web;expanding our global sales distribution, marketing and support capabilities, including continued expansion of our indirect sales channel program;
actively contributing to the SIP standards definition and adoption process;
pursuing strategic transactions and alliances;
successfully implementing our cost reduction program; and
delivering sustainable profitability by continuing to improve our overall performance.

We reported losses from operations of $18.9 million for the three months ended March 27, 2015 and $5.8 million for the three months ended March 28, 2014.

We reported net losses of $19.4 million for the three months ended March 27, 2015 and $4.0 million for the three months ended March 28, 2014.

Our revenue was $50.1 million in the three months ended March 27, 2015 and $70.7 million in the three months ended March 28, 2014.

Our gross profit was $29.2 million in the three months ended March 27, 2015 and $46.4 million in the three months ended March 28, 2014. Our gross profit as a percentage of revenue ("total gross margin") was 58.3% in the three months ended March 27, 2015 and 65.6% in the three months ended March 28, 2014.

Our operating expenses were $48.1 million in the three months ended March 27, 2015, compared to $52.2 million in the three months ended March 28, 2014. Our operating expenses for the three months ended March 27, 2015 include $0.1 million of acquisition-related expense and a credit for the reversal of $0.3 million of previously recorded restructuring accruals. Our operating expenses for the three months ended March 28, 2014 include acquisition-related expense of $1.3 million and $1.2 million of restructuring expense.

We recorded stock-based compensation expense of $4.8 million in the three months ended March 27, 2015, compared to $5.8 million in the three months ended March 28, 2014.

See "Results of Operations" in this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") for a discussion of these changes in our revenue and expenses.

In March 2014, we reached a settlement agreement for $2.25 million to recover a portion of our losses related to the impairment of certain prepaid royalties which we had written off in fiscal 2012. This amount is included in Other income in our condensed consolidated statement of operations for the three months ended March 28, 2014.

On January 2, 2014, Raymond P. Dolan, our President and Chief Executive Officer elected to accept shares of restricted stock in lieu of base salary for the period from January 1, 2014 through December 31, 2014. Effective September 16, 2014, Mr. Dolan's annual base salary was increased from $500,000 to $600,000. For the remainder of 2014, such increase was prorated and paid in cash and was not subject to any stock-for-cash election. We recorded stock-based compensation expense related to the 2014 Dolan Salary Shares ratably for the period of January 1, 2014 through December 31, 2014. Mr. Dolan did not elect to

27


receive his salary in shares of our common stock for 2015.

In connection with our Company-wide annual incentive bonus program, 22 of our executives were given the choice to receive all or half of their fiscal year 2015 bonuses (the "2015 Bonus"), if any are earned, in the form of shares of our common stock (the "2015 Bonus Shares"). Each executive could also elect not to participate in this program and to earn his or her 2015 Bonus, if any, in the form of cash. The amount of the 2015 Bonus, if any, for each executive shall be determined by the Compensation Committee of our Board of Directors (the "Compensation Committee"). The number of shares of common stock that will be granted to those executives who elected to receive their 2015 Bonus entirely in the form of shares of common stock will be calculated by dividing an amount equal to 1.5 times each executive's 2015 Bonus earned by $20.55, the closing price of our common stock on January 2, 2015. The number of shares of our common stock that will be granted to those executives who elected to receive one-half of their 2015 Bonus in the form of shares of common stock will be calculated by dividing an amount equal to 1.5 times one-half of each executive's 2015 Bonus earned by $20.55, with the cash portion equal 50% of their respective 2015 Bonus earned. The 2015 Bonus, if any, will be granted and/or paid on a date concurrent with the timing of the payout of bonuses under our Company-wide incentive bonus program and will be fully vested on the date of grant. Of the eligible executives, 16 elected to receive their entire 2015 Bonus in shares of common stock, five elected to receive 50% of their 2015 Bonus in shares of common stock and 50% in cash, and one elected not to participate and instead to receive his entire 2015 Bonus in cash. As of March 27, 2015, we determined that the grant date criteria for the 2015 Bonus Shares had not been met; accordingly, we are marking to market the 2015 Bonus Shares expected to be earned and recording expense based on the aggregate fair value of the 2015 Bonus Shares at March 27, 2015. We did not record expense related to the 2015 Bonus Shares in the three months ended March 27, 2015 as we did not believe that any 2015 Bonus Shares would be earned.

On January 22, 2014, 21 of our executives were given the choice to receive all or half of their fiscal year 2014 bonuses (the "2014 Bonus"), if any were earned, in the form of shares of our common stock (the "2014 Bonus Shares"). Of the eligible executives, 17 elected to receive their entire 2014 Bonus in shares of common stock and 4 elected to receive 50% of their 2014 Bonus in shares of common stock and 50% in cash. The 2014 Bonus Shares were granted on February 20, 2015 and vested immediately. We granted approximately 266,000 2014 Bonus Shares, with the number of shares granted calculated by dividing amounts equal to 1.5 times each executive's 2014 Bonus earned, as determined by the Compensation Committee, by $15.40, the closing price of our common stock on January 2, 2014. We recorded stock-based compensation expense for the 2014 Bonus Shares from January 1, 2014 through the grant date.

On March 16, 2015, we granted 131,250 performance-based stock units ("PSUs") in the aggregate to eight of our executives with both market and service conditions. The terms of the PSUs are such that up to one-third of the shares subject to the PSUs will vest on each of the first, second and third anniversaries of the date of grant (collectively, the "Vesting Dates") to the extent of achievement of our total stockholder return ("TSR") to the TSR of the companies included in the NASDAQ Telecommunications Index for the same Performance Period, measured by our Compensation Committee at the end of each of the 2015, 2016 and 2017 fiscal years, respectively (each, a "Performance Period"). The shares determined to be earned will vest on the anniversary of the grant date following each Performance Period. Shares subject to the PSUs that fail to be earned will be forfeited. We are recording expense for the PSUs through the final Vesting Date of March 16, 2018.

Critical Accounting Policies and Estimates

Management's discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates and judgments on historical experience, knowledge of current conditions and beliefs of what could occur in the future given available information. We consider the following accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment. If actual results differ significantly from management's estimates and projections, there could be a material effect on our condensed consolidated financial statements. The significant accounting policies that we believe are the most critical include the following:

Revenue recognition;
Valuation of inventory;
Loss contingencies and reserves;
Stock-based compensation;
Business combinations;
Goodwill and intangible assets; and
Accounting for income taxes.

28



For a further discussion of our critical accounting policies and estimates, please refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2014. There were no significant changes to our critical accounting policies from December 31, 2014 through March 27, 2015.

Results of Operations

Three months ended March 27, 2015 and March 28, 2014

Revenue. Revenue for the three months ended March 27, 2015 and March 28, 2014 was as follows (in thousands, except percentages):

 
Three months ended
 
Decrease
from prior year
 
March 27,
2015
 
March 28,
2014
 
$
 
%
Product
$
24,865

 
$
45,140

 
$
(20,275
)
 
(44.9
)%
Service
25,280

 
25,602

 
(322
)
 
(1.3
)%
Total revenue
$
50,145

 
$
70,742

 
$
(20,597
)
 
(29.1
)%

 
 
 
 
 
 
 
 

Product revenue is comprised of sales of our communication infrastructure products. The decrease in product revenue in the current year quarter compared to the prior year quarter was primarily the result of lower revenue recognized from sales to one of our historically largest customers due to their reduction in capital expenditures, lower sales to federal agencies and the loss of revenue related to our divestiture of the MPS division of PT in 2014.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
In the three months ended March 27, 2015, approximately 24% of product revenue was from indirect sales through our channel program, compared to approximately 18% in the three months ended March 28, 2014.

In the three months ended March 27, 2015, our product revenue from sales to enterprise customers was approximately 15% of our total product revenue, compared to approximately 19% in the three months ended March 28, 2014. These sales were made both through our direct sales team and indirect sales channel partners.

We recognized product revenue totaling $2.7 million from 168 new customers in the three months ended March 27, 2015 and $3.3 million from 173 new customers in the three months ended March 28, 2014. New customers are those from whom we recognize revenue for the first time in a reporting period, although we may have had outstanding orders from such customers for several years, especially for certain multi-year projects. The timing of the completion of customer projects, revenue recognition criteria satisfaction and customer payments included in multiple element arrangements may cause our product revenue to fluctuate from one period to the next.

We expect that our product revenue in 2015 will decrease from 2014 levels, primarily due to the delayed timing of orders, lower capital expenditures by our customers and longer RFP decision cycles by our customers as they take time to determine their future network architectures. Despite our expected 2015 product revenue decrease compared to 2014, we continue to believe that our new product portfolio and increased focus on expanding our product offerings to address the emerging UC and IP-based markets, such as SBC, in both the enterprise and service provider markets is aligned with the technology strategies of our customers.

Service revenue is primarily comprised of hardware and software maintenance and support (“maintenance revenue”) and network design, installation and other professional services (“professional services revenue”).

Service revenue for the three months ended March 27, 2015 and March 28, 2014 was comprised of the following (in thousands, except percentages):

29


 
Three months ended
 
Increase (decrease)
from prior year
 
March 27,
2015
 
March 28,
2014
 
$
 
%
Maintenance
$
20,083

 
$
20,525

 
$
(442
)
 
(2.2
)%
Professional services
5,197

 
5,077

 
120

 
2.4
 %
 
$
25,280

 
$
25,602

 
$
(322
)
 
(1.3
)%

 
 
 
 
 
 
 
 
Our maintenance revenue decreased slightly in the three months period ended March 27, 2015 compared to the three months ended March 28, 2014, primarily due to customer mix, including merger activity of certain of our customers, and the timing of shipments in the current year quarter. The timing of the completion of projects for revenue recognition, customer payments and maintenance contracts may cause our services revenue to fluctuate from one period to the next. We expect that our service revenue in fiscal 2015 will decrease from fiscal 2014 levels as a result of the aforementioned customer merger activities and lower expected product sales, partially offset by the continued growth of our installed customer base.

The following customers each contributed 10% or more of our revenue in at least one of the three month periods ended March 27, 2015 and March 28, 2014:
 
 
Three months ended
Customer
 
March 27,
2015
 
March 28,
2014
Verizon Communications Inc.
 
15%
 
*
SoftBank Corporation
 
11%
 
*
AT&T Inc.
 
*
 
28%

* Represents less than 10% of revenue

International revenue was approximately 38% of revenue in the three months ended March 27, 2015 and approximately 27% of revenue in the three months ended March 28, 2014. Due to the timing of project completions, we expect that the domestic and international components as a percentage of our revenue will fluctuate from quarter to quarter and year to year.

Our deferred product revenue was $4.8 million at March 27, 2015 and $9.1 million at December 31, 2014. Our deferred service revenue was $43.8 million at March 27, 2015 and $35.9 million at December 31, 2014. Our deferred revenue balance may fluctuate as a result of the timing of revenue recognition, customer payments, maintenance contract renewals, contractual billing rights and maintenance revenue deferrals included in multiple element arrangements.

Cost of Revenue/Gross Margin. Our cost of revenue consists primarily of amounts paid to third-party manufacturers for purchased materials and services, royalties, manufacturing and professional services personnel and related costs, and provision for inventory obsolescence. Our cost of revenue and gross margins for the three months ended March 27, 2015 and March 28, 2014 were as follows (in thousands, except percentages):
 
Three months ended
 
Decrease
from prior year
 
March 27,
2015
 
March 28,
2014
 
$
 
%
Cost of revenue
 
 
 
 
 
 
 
Product
$
11,648

 
$
13,663

 
$
(2,015
)
 
(14.7
)%
Service
9,267

 
10,656

 
(1,389
)
 
(13.0
)%
Total cost of revenue
$
20,915

 
$
24,319

 
$
(3,404
)
 
(14.0
)%
Gross margin
 
 
 
 
 
 
 
Product
53.2
%
 
69.7
%
 
 
 
 
Service
63.3
%
 
58.4
%
 
 
 
 
Total gross margin
58.3
%
 
65.6
%
 
 
 
 
 
 
 
 
 
 
 
 
The decrease in product gross margin in the three months ended March 27, 2015 compared to the three months ended March 28, 2014 was primarily due to lower product revenue against certain fixed costs coupled with the impact of $2.7 million of reserves recorded for excess and obsolete inventory in the three months ended March 27, 2015, which decreased our product gross margin in the aggregate by approximately fifteen percentage points, and product and customer mix, which decreased our product gross margin by approximately one percentage point.

30



The increase in service gross margin in the three months ended March 27, 2015 compared to the three months ended March 28, 2014 was primarily due to lower fixed service costs, which increased our service gross margin by approximately four percentage points and lower third-party service costs, which increased our service gross margin by approximately one percentage point.

We believe that our total gross margin over the next few years will be greater than 60%.

Research and Development Expenses. Research and development expenses consist primarily of salaries and related personnel expenses and prototype costs related to the design, development, testing and enhancement of our products. Research and development expenses for the three months ended March 27, 2015 and March 28, 2014 were as follows (in thousands, except percentages):
 
 
 
Increase
from prior year
 
March 27,
2015
 
March 28,
2014
 
$
 
%
Three months ended
$
19,339

 
$
18,972

 
$
367

 
1.9
%


The increase in research and development expenses in the three months ended March 27, 2015 compared to the three months ended March 28, 2014 is attributable to $0.5 million of higher facility expenses and $0.2 million of higher product development (third-party development, prototype and equipment) expenses, partially offset by $0.1 million of lower employee-related expenses and $0.2 million of net decreases in other research and development expenses. The decrease in employee-related expenses in the three months ended March 27, 2015 is the net result of $1.3 million of lower expense related to our Company-wide cash bonus program, partially offset by $1.2 million of higher salary and related expenses.

Some aspects of our research and development efforts require significant short-term expenditures, the timing of which may cause significant variability in our expenses. Rapid technological innovation is critical to our long-term success, and we believe that we are tailoring our investments to meet the requirements of our customers and market. We anticipate that our research and development expenses for fiscal 2015 will decrease from fiscal 2014 levels due to certain cost reduction initiatives, partially offset by our continued focus on new product development.

Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries and related personnel costs, commissions, travel and entertainment expenses, promotions, customer trial and evaluations inventory and other marketing and sales support expenses. Sales and marketing expenses for the three months ended March 27, 2015 and March 28, 2014 were as follows (in thousands, except percentages):
 
 
 
Increase
from prior year
 
March 27,
2015
 
March 28,
2014
 
$
 
%
Three months ended
$
19,765

 
$
19,581

 
$
184

 
0.9
%


The increase in sales and marketing expenses in the three months ended March 27, 2015 compared to the three months ended March 28, 2014 is attributable to $0.5 million of higher consulting expense and $0.2 million of higher expense related to evaluation equipment at customer sites. These increases were partially offset by $0.2 million of lower employee-related expenses, $0.2 million of lower marketing expenses and $0.1 million of net decreases in other sales and marketing expenses. The decrease in employee-related expenses was the result of $0.2 million of lower stock-based compensation and $0.2 million of lower expense related to our Company-wide cash bonus program, partially offset by $0.1 million of higher salary and commissions and related expenses and $0.1 million of net increases in other employee-related expenses.

We believe that our sales and marketing expenses will decrease in fiscal 2015 from fiscal 2014 levels, primarily attributable to certain cost reduction initiatives, coupled with lower commissions expense driven by our anticipated lower revenue.

General and Administrative Expenses. General and administrative expenses consist primarily of salaries and related personnel costs for executive and administrative personnel, recruiting expenses and audit and professional fees. General and administrative expenses for the three months ended March 27, 2015 and March 28, 2014 were as follows (in thousands,

31


except percentages):
 
 
 
Decrease
from prior year
 
March 27,
2015
 
March 28,
2014
 
$
 
%
Three months ended
$
9,224

 
$
11,186

 
$
(1,962
)
 
(17.5
)%


The decrease in general and administrative expenses in the three months ended March 27, 2015 compared to the three months ended March 28, 2014 is attributable to $1.4 million of lower employee-related expenses, $0.2 million of lower professional fees, $0.1 million of lower expense related to foreign currency translation and $0.3 million of net decreases in other general and administrative expenses. The decrease in employee-related expenses resulted from $0.9 million of lower stock-based compensation expense and $0.5 million of lower expense related to our Company-wide cash bonus program.

We believe that our general and administrative expenses will decrease in fiscal 2015 compared to fiscal 2014 levels, primarily due to the expected impact of certain cost reduction initiatives.

Acquisition-Related Expenses. Acquisition-related expenses include those costs related to the acquisitions of the SDN Business in January 2015 and of PT in February 2014 that would otherwise not have been incurred by us. We recorded acquisition-related expenses of $0.1 million in the three months ended March 27, 2015 for professional fees, primarily legal fees. We recorded $1.3 million of acquisition-related expenses in the three months ended March 28, 2014, comprised of $1.1 million of professional and service fees and $0.2 million related to change of control agreements with certain PT executives.

Restructuring Expense. We reversed $0.3 million of restructuring expense in the three months ended March 27, 2015. This reversal is comprised of approximately $272,000 in connection with the settlement with the landlord of our Dulles, Virginia facility for an amount that was lower than had previously been accrued and approximately $67,000 in connection with changes in the amounts of severance ultimately paid to certain individuals.

We expect to record approximately $5 million of restructuring expense in the three months ending June 26, 2015 for severance and related costs in connection with a restructuring initiative implemented on April 16, 2015 to eliminate approximately 150 positions, or approximately 12.5% of our worldwide workforce. We expect that of this amount, $4.5 million will be paid in the three months ending June 26, 2015 and the remainder will be paid in the three months ending September 25, 2015.

Interest Income, Net. Interest income and interest expense for the three months ended March 27, 2015 and March 28, 2014 were as follows (in thousands, except percentages):
 
Three months ended
 
Increase (decrease)
from prior year
 
March 27,
2015
 
March 28,
2014
 
$
 
%
Interest expense
$
(76
)
 
$
(25
)
 
$
51

 
204.0
 %
Interest income
104

 
60

 
44

 
73.3
 %
Interest income, net
$
28

 
$
35

 
$
(7
)
 
(20.0
)%

 
 
 
 
 
 
 
 
Interest expense in the three months ended March 27, 2015 primarily relates to the amortization of debt issuance costs in connection with our revolving credit facility. Interest expense in the three months ended March 28, 2014 primarily relates to interest on the debt assumed in connection with the acquisition of Network Equipment Technologies, Inc. ("NET"). Interest income consists of interest earned on our cash equivalents, marketable debt securities and long-term investments. The decrease in interest income, net, in the current year periods compared to the prior year periods is attributable to a lower average portfolio yield on lower amounts available to invest in the current year.

Other Income, Net. We recorded $2.25 million of income in the three months ended March 28, 2014 related to the settlement of a litigation matter in March 2014 in which we recovered a portion of our losses related to the impairment of certain prepaid royalties which we had written off in fiscal 2012. This amount is included in Other income, net, for the three months ended March 28, 2014.

Income Taxes. We recorded provisions for income taxes of $0.6 million in the three months ended March 27, 2015 and

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$0.5 million in the three months ended March 28, 2014. These amounts reflect our estimates of the effective rates expected to be applicable for the respective full fiscal years, adjusted for any discrete events, which are recorded in the period that they occur. These estimates are reevaluated each quarter based on our estimated tax rate for the full fiscal year. The estimated amounts recorded do not include any benefit for our domestic losses, as we have concluded that a valuation allowance on any domestic benefit is required.


Off-Balance Sheet Arrangements

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

Liquidity and Capital Resources

Our consolidated statements of cash flows are summarized as follows (in thousands):
 
Three months ended
 
 
 
March 27,
2015
 
March 28,
2014
 
Change
Net loss
$
(19,359
)
 
$
(3,953
)
 
$
(15,406
)
Adjustments to reconcile net loss to cash flows provided by operating activities
9,209

 
9,951

 
(742
)
Changes in operating assets and liabilities
(7,326
)
 
15,208

 
(22,534
)
Net cash (used in) provided by operating activities
$
(17,476
)
 
$
21,206

 
$
(38,682
)
Net cash (used in) provided by investing activities
$
(790
)
 
$
50,349

 
$
(51,139
)
Net cash used in financing activities
$
(4,744
)
 
$
(72,298
)
 
$
67,554



Our cash, cash equivalents, and short- and long-term investments totaled $112.8 million at March 27, 2015 and $148.0 million at December 31, 2014. We had cash and short-term investments held by our foreign subsidiaries aggregating approximately $6 million at March 27, 2015 and approximately $5 million at December 31, 2014. We do not intend to repatriate these funds, and as such, they are not available to fund our domestic operations. If we were to repatriate the funds, they would likely be treated as income for U.S. tax purposes, fully offset by our net operating losses. We do not believe this has a material impact on our liquidity.

On June 27, 2014, we entered into a credit agreement (the "Credit Agreement") by and among us, as Borrower, Bank of America, N.A. ("Bank of America"), as Administrative Agent, Swing Line Lender and L/C Issuer, and the other lenders from time to time party thereto. The Credit Agreement provides for a revolving credit facility of up to $40 million and provides that we may select the interest rates under the credit facility equal to (1) the Eurodollar Rate (which is defined as the rate per annum equal to the London Interbank Offered Rate ("LIBOR") plus 1.5% per annum) for a Eurodollar Rate Loan; and (2) the highest of (a) the Federal Funds Rate plus 1/2 of 1%, (b) the rate of interest in effect on the borrowing date as publicly announced from time to time by Bank of America as its prime rate, and (c) the monthly Eurodollar Rate plus 1%. We will pay a 0.15% commitment fee on the unused commitments available for borrowing. Borrowings under the Credit Agreement may be used for the general corporate purposes of the Company and its subsidiaries, including, without limitation, working capital, acquisitions, dividends and stock repurchases, to the extent permitted under the Credit Agreement. Our obligations under the Credit Agreement are guaranteed by Sonus International, Inc., Sonus Federal, Inc., NET and PT (collectively, together with us, the "Loan Parties") pursuant to a Master Continuing Guaranty and are secured by the assets of the Loan Parties pursuant to a Security and Pledge Agreement. The Credit Agreement contains affirmative, negative and financial covenants customary for financings of this type. The negative covenants include limitations on liens, indebtedness, fundamental changes, dispositions, restricted payments, investments, transactions with affiliates, certain restrictive agreements and compliance with sanctions laws and regulations. The amount of cash and cash equivalents of the Loan Parties, subject to certain exclusions, cannot be less than an aggregate amount of $100 million at any time. The credit facility will become due on June 27, 2015, subject to acceleration upon certain specified events of default, including, without limitation, payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy and insolvency-related defaults, defaults relating to judgments, an ERISA Event (as defined in the Credit Agreement), the failure to pay specified indebtedness and a change of control default. We did not have any amounts outstanding under the Credit Agreement at March 27, 2015.


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On July 29, 2013, we announced that our Board of Directors had authorized a stock buyback program to repurchase up to $100 million of our common stock from time to time on the open market or in privately negotiated transactions. The stock buyback program is being funded using our working capital. During the three months ended March 27, 2015, we repurchased and retired 0.4 million shares under our stock buyback program for approximately $6.1 million in the aggregate, including transaction fees. This amount is included in financing activities in our condensed consolidated statement of cash flows for the three months ended March 27, 2015.

On March 20, 2014, we announced the commencement of an underwritten public offering of 7.5 million shares of our common stock on behalf of Galahad Securities Limited and its affiliated entities (collectively, the "Legatum Group"). The underwriter of the offering was granted a 30-day option to purchase up to 1.125 million additional shares from the Legatum Group. The Legatum Group received all the proceeds from the underwritten offering; no shares in the underwritten offering were sold by us or any of our officers or directors. We purchased 4.3 million shares from the underwriter for $75.3 million in the aggregate, including $0.3 million of transaction fees. We funded the share repurchase with cash on hand. The repurchased shares were retired upon completion of the transaction.

Our operating activities used $17.5 million of cash in the three months ended March 27, 2015 and $21.2 million of cash in the three months ended March 28, 2014.

Cash used in operating activities in the three months ended March 27, 2015 was primarily the result of lower accrued expenses and other long-term liabilities and accounts payable, coupled with increases in inventory and other operating assets. These amounts were partially offset by lower accounts receivable and higher deferred revenue. The decrease in accrued expenses and other long-term liabilities was primarily related to employee compensation and related costs, including payments in connection with our Company-wide cash bonus program and payments in connection with our ongoing restructuring initiatives. The increase in our inventory primarily reflects our reduced product sales in the current year quarter compared to original projections. Our lower accounts receivable reflects collections on sales made in the prior year, coupled with lower revenue recorded in the current year quarter. Our net loss, adjusted for non-cash items such as depreciation, amortization, impairment charges and stock-based compensation, used $10.2 million of cash.

Cash provided by operating activities in the three months ended March 28, 2014 was primarily the result of lower accounts receivable and inventory, excluding the impact of acquired balances in connection with the PT acquisition. These amounts were partially offset by lower accrued expenses and other long-term liabilities, accounts payable and deferred revenue, as well as an increase in other operating assets. Our lower accounts receivable balance primarily reflects payments in the quarter as a result of our continuing focus on cash collections. Our increased focus on maintaining appropriate inventory levels was the primary contributor to lower inventory levels. The decrease in accrued expenses and other long-term liabilities was primarily related to employee compensation and related costs, including payments in connection with our Company-wide cash bonus program. Our net loss, adjusted for non-cash items such as depreciation, amortization and stock-based compensation, provided $6.0 million of cash.

Our investing activities used $0.8 million of cash in the three months ended March 27, 2015, comprised of $10.1 million of cash paid, net of cash acquired, for the acquisition of the SDN Business and $2.5 million of investments in property and equipment, partially offset by $11.9 million of aggregate maturities and sales of marketable securities.

Our investing activities provided $50.3 million of cash in the three months ended March 28, 2014, comprised of $87.6 million of maturities of marketable securities, partially offset by $34.0 million of cash paid, net of cash acquired, for the acquisition of PT on February 19, 2014 (the portion of the total cash consideration of $35.0 million that was paid through March 28, 2014) and $3.3 million of investments in property and equipment.

Our financing activities used $4.7 million of cash in the three months ended March 27, 2015, comprised of $6.1 million, including transaction fees, for the repurchase of common stock, $2.0 million used to pay withholding obligations related to the net share settlement of restricted stock awards upon vesting and $20,000 for payments on our capital leases for office equipment. These amounts were partially offset by $1.7 million of proceeds from the exercise of stock options and $1.7 million of proceeds from the sale of our common stock in connection with our Amended and Restated 2000 Employee Stock Purchase Plan, as amended ("ESPP").

Our financing activities used $72.3 million of cash in the three months ended March 28, 2014, comprised of $75.4 million, including transaction fees, for the repurchase of common stock, of which $75.3 million was used to repurchase stock in connection with the Legatum Group public offering described above and $0.1 million was used to repurchase stock under our stock buyback program, $1.5 million used to pay withholding obligations related to the net share settlement of restricted stock awards upon vesting and $24,000 for payments on our capital leases for office equipment. These amounts were partially offset

34


by $3.4 million of proceeds from the exercise of stock options and $1.2 million of proceeds from the sale of our common stock in connection with our ESPP.

Based on our current expectations, we believe our current cash, cash equivalents, marketable debt securities and long-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least twelve months, including any future stock repurchases under the aforementioned stock buyback program. It is difficult to predict future liquidity requirements with certainty. The rate at which we will consume cash will be dependent on the cash needs of future operations, including changes in working capital, which will, in turn, be directly affected by the successful implementation of our cost reduction and containment plan, the levels of demand for our products, the timing and rate of expansion of our business, the resources we devote to developing our products and any litigation settlements. We anticipate devoting substantial capital resources to continue our research and development efforts, to maintain our sales, support and marketing, to improve our controls environment, for other general corporate activities and to vigorously defend against existing and potential litigation. See Note 15 to our condensed consolidated financial statements for a description of our contingencies.

Recent Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern ("ASU 2014-15"). ASU 2014-15 provides guidelines determining when and how to disclose going concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity's ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity's ability to continue as a going concern. ASU 2014-15 applies to all entities and is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. The adoption of ASU 2014-15 is not expected to have a material impact on our consolidated financial statements.

In June, 2014, the FASB issued ASU 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force) (“ASU 2014-12”). ASU 2014-12 which clarifies that entities should treat performance targets that can be met after the requisite service period of a share-based payment award as performance conditions that affect vesting. Therefore, an entity would not record compensation expense (measured as of the grant date without taking into account the effect of the performance target) related to an award for which transfer to the employee is contingent on the entity’s satisfaction of a performance target until it becomes probable that the performance target will be met. ASU 2014-12 does not contain any new disclosure requirements. ASU 2014-12 was effective for us on January 1, 2015. The adoption of ASU 2014-12 did not have a material impact on our condensed consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”) its final standard on revenue from contracts with customers. ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying the revenue model to contracts within its scope, an entity identifies the contract(s) with a customer, identifies the performance obligations in the contract, determines the transaction price, allocates the transaction price to the performance obligations in the contract and recognizes revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 applies to all contracts with customers that are within the scope of other topics in the FASB Accounting Standards Codification ("ASC"). Certain of ASU 2014-09’s provisions also apply to transfers of nonfinancial assets, including in-substance nonfinancial assets that are not an output of an entity’s ordinary activities (i.e., property, plant and equipment; real estate; or intangible assets). Existing accounting guidance applicable to these transfers has been amended or superseded. In April 2015, the FASB tentatively decided to defer the original effective date of interim and annual reporting periods beginning after December 15, 2015 by one year. As a result, public entities would not be required to apply the new revenue standard until annual reporting periods beginning after December 15, 2017. We are currently assessing the potential impact of the adoption of ASU 2014-09 on our condensed consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”), which amends the definition of discontinued operations in ASC 205-20 and requires entities to provide additional disclosures about discontinued operations as well as disposal transactions that do not meet the discontinued operations criteria. The new guidance eliminates the previous criteria that the operations and cash flows of the component that have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction. The new guidance also eliminates the previous criteria that the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. Instead, ASU 2014-08 requires discontinued

35


operations treatment for disposals of a component or group of components that represents a strategic shift that has or will have a major impact on an entity’s operations or financial results. ASU 2014-08 requires entities to reclassify assets and liabilities of a discontinued operation for all comparative periods presented in the statement of financial position. In addition, ASU 2014-08 requires that an entity disclose in its statement of cash flows, in all periods presented, either: (1) operating and investing cash flows or (2) depreciation and amortization, capital expenditures and significant operating and investing non-cash items related to the discontinued cooperation. ASU 2014-08 was effective prospectively for all disposals (except disposals classified as held for sale before the adoption date) or components initially classified as held for sale in periods beginning on or after December 15, 2014. The adoption of ASU 2014-08 did not have a material impact on our condensed consolidated financial statements.



Item 3.    Quantitative and Qualitative Disclosures About Market Risk

We are exposed to a variety of market risks, including changes in interest rates affecting the return on our investments and foreign currency fluctuations. We do not believe that a hypothetical 10% adverse movement in interest rates and foreign currency exchange rates would have a materially different impact from what was disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014.


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Item 4.    Controls and Procedures

Disclosure Controls and Procedures

Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of March 27, 2015.

Changes in Internal Control over Financial Reporting. There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended March 27, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

Item 1.    Legal Proceedings

On April 6, 2015, Ming Huang, a purported shareholder of the Company (the “Plaintiff”), filed a Class Action Complaint alleging violations of the federal securities laws (the “Complaint”) in the United States District Court for the District of New Jersey (Civil Action No. 3:15-02407), against Sonus and two of its officers, Raymond P. Dolan, the Company’s President and Chief Executive Officer, and Mark Greenquist, the Company’s Chief Financial Officer (the “Defendants”). The Plaintiff claims to represent purchasers of the Company’s common stock during the period from October 23, 2014 to March 24, 2015 and seeks unspecified damages. The principal allegation contained in the Complaint is the claim that the Defendants made misleading forward-looking statements concerning the Company’s fiscal first quarter 2015 financial performance. The Company believes that the Defendants have meritorious defenses to the allegations made in the Complaint and does not expect the results of this suit to have a material effect on its business or consolidated financial statements.

In addition, the Company is often a party to disputes and legal proceedings that it considers routine and incidental to its business. Management does not expect the results of any of these actions to have a material effect on the Company's business or consolidated financial statements.


Item 1A.    Risk Factors

We have revised and updated our discussion of the risk factors affecting our business since those presented in our Annual Report on Form 10-K, Part I, Item 1A. for the fiscal year ended December 31, 2014.  The following discussion includes five revised risk factors: “We believe the telecommunications industry is in the early stages of a major architectural shift to the virtualization of networks. If the architectural shift does not occur, if it does not occur at the pace we predict, or if the products and services we have developed are not attractive to our customers after such shift takes place, our revenues could decline"; “Restructuring activities could adversely affect our ability to execute our business strategy”; “If in the future we do not have a sufficient number of shares available to issue to our employees, the limited number of shares we could issue may impact our ability to attract, retain and motivate key personnel”; “Our recently effected reverse stock split could impair the value of your investment or adversely affect the market liquidity of our common stock”; “Our credit agreement with Bank of America, N.A. (“Bank of America”), as Administrative Agent, Swing Line Lender and L/C Issuer, and the other lenders from time to time party thereto, dated as of June 27, 2014 (the “Credit Agreement”), contains financial and operating restrictions that may limit our access to credit. If we fail to comply with covenants in the Credit Agreement, we may be required to repay any potential indebtedness thereunder, which may have an adverse effect on our liquidity. In addition, if we are unable to extend, renew or replace the Credit Agreement by the maturity date of June 27, 2015, on favorable terms, or at all, our business, operations and financial condition may be materially adversely affected”; “We may face risks related to litigation that could result in significant legal expenses and settlement or damage awards”; and "If our goodwill or intangible assets become impaired, we may be required to record a significant charge to earnings”, which reflect material developments subsequent to the discussion of risk factors included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.  Except for the five risk factors noted above, there have been no material changes in our assessment of our risk factors from those set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014. For convenience, all of our risk factors are included below.


37


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, our business, financial condition, results of operations and cash flows could be materially adversely affected, the trading price of our common stock could decline materially and you could lose all or part of your investment.

Our quarterly revenue and operating results are unpredictable and may fluctuate significantly from quarter to quarter, which could adversely affect our business, consolidated financial statements and the trading price of our common stock.

Our revenues and operating results may 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. The primary factors that may affect our revenues and operating results include, but are not limited to, the following:

consolidation within the telecommunications industry, including acquisitions of or by our customers;
general economic conditions in our markets, both domestic and international, as well as the level of discretionary IT spending;
competitive conditions in our markets, including the effects of new entrants, consolidation, technological innovation and substantial price discounting;
fluctuation in demand for our products and services, and the timing and size of customer orders;
fluctuations in foreign exchange rates;
cancellation or deferral of existing customer orders or the renegotiation of existing contractual commitments;
mix of product configurations sold;
length and variability of the sales cycle for our products;
application of complex revenue recognition accounting rules to our customer arrangements;
timing of revenue recognition;
changes in our pricing policies, the pricing policies of our competitors and the prices of the components of our products;
market acceptance of new products, product enhancements and services that we offer;
the quality and level of our execution of our business strategy and operating plan, and the effectiveness of our sales and marketing programs;
new product announcements, introductions and enhancements by us or our competitors, which could result in deferrals of customer orders;
our ability to develop, introduce, ship and successfully deliver new products and product enhancements that meet customer requirements in a timely manner;