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EX-31.2 - EXHIBIT 31.2 - Sonus, Inc.sons-ex31220150925.htm
EX-32.1 - EXHIBIT 32.1 - Sonus, Inc.sons-ex32120150925.htm
EX-31.1 - EXHIBIT 31.1 - Sonus, Inc.sons-ex31120150925.htm
EX-32.2 - EXHIBIT 32.2 - Sonus, Inc.sons-ex32220150925.htm

 


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 September 25, 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 October 23, 2015, there were 49,739,312 shares of the registrant's common stock, $0.001 par value, outstanding.
 



SONUS NETWORKS, INC.
FORM 10-Q
QUARTERLY PERIOD ENDED SEPTEMBER 25, 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)


 
September 25,
2015
 
December 31,
2014
Assets
Current assets:
 
 
 
Cash and cash equivalents
$
44,773

 
$
41,157

Marketable securities
65,082

 
64,443

Accounts receivable, net of allowance for doubtful accounts of $10 at September 25, 2015 and $58 at December 31, 2014
51,278

 
62,943

Inventory
24,187

 
22,114

Deferred income taxes
1,022

 
991

Other current assets
15,389

 
15,239

Total current assets
201,731

 
206,887

Property and equipment, net
14,793

 
17,845

Intangible assets, net
28,219

 
22,594

Goodwill
40,310

 
39,263

Investments
17,067

 
42,407

Deferred income taxes
990

 
1,043

Other assets
2,082

 
2,596

 
$
305,192

 
$
332,635

Liabilities and Stockholders' Equity
Current liabilities:
 
 
 
Accounts payable
$
5,184

 
$
7,497

Accrued expenses
30,404

 
32,149

Current portion of deferred revenue
41,087

 
36,967

Current portion of long-term liabilities
711

 
794

Total current liabilities
77,386

 
77,407

Deferred revenue
7,254

 
8,009

Deferred income taxes
2,162

 
1,623

Other long-term liabilities
2,922

 
5,246

Total liabilities
89,724

 
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; 49,737,550 shares issued and outstanding at September 25, 2015; 49,357,033 shares issued and outstanding at December 31, 2014
50

 
49

Additional paid-in capital
1,237,817

 
1,226,226

Accumulated deficit
(1,027,945
)
 
(991,347
)
Accumulated other comprehensive income
5,546

 
5,422

Total stockholders' equity
215,468

 
240,350

 
$
305,192

 
$
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
 
Nine months ended
 
September 25,
2015
 
September 26,
2014
 
September 25,
2015
 
September 26,
2014
Revenue:
 
 
 
 
 
 
 
Product
$
42,230

 
$
44,900

 
$
94,137

 
$
135,885

Service
25,632

 
28,316

 
78,571

 
83,643

Total revenue
67,862

 
73,216

 
172,708

 
219,528

Cost of revenue:
 
 
 
 
 
 
 
Product
13,158

 
15,074

 
36,075

 
45,548

Service
8,992

 
10,240

 
27,277

 
32,367

Total cost of revenue
22,150

 
25,314

 
63,352

 
77,915

Gross profit
45,712

 
47,902

 
109,356

 
141,613

Operating expenses:
 
 
 
 
 
 
 
Research and development
19,335

 
20,693

 
58,642

 
60,586

Sales and marketing
16,507

 
20,350

 
53,812

 
58,713

General and administrative
11,074

 
10,901

 
30,742

 
34,082

Acquisition-related

 

 
131

 
1,306

Restructuring
158

 
673

 
1,306

 
2,233

Total operating expenses
47,074

 
52,617

 
144,633

 
156,920

Loss from operations
(1,362
)
 
(4,715
)
 
(35,277
)
 
(15,307
)
Interest income (expense), net
82

 
(35
)
 
90

 
50

Other income, net
133

 
5

 
183

 
2,330

Loss before income taxes
(1,147
)
 
(4,745
)
 
(35,004
)
 
(12,927
)
Income tax provision
(749
)
 
(468
)
 
(1,594
)
 
(1,736
)
Net loss
$
(1,896
)
 
$
(5,213
)
 
$
(36,598
)
 
$
(14,663
)
Loss per share:
 
 
 
 
 
 
 
Basic
$
(0.04
)
 
$
(0.11
)
 
$
(0.74
)
 
$
(0.29
)
Diluted
$
(0.04
)
 
$
(0.11
)
 
$
(0.74
)
 
$
(0.29
)
Shares used to compute loss per share:
 
 
 
 
 
 
 
Basic
49,625

 
49,291

 
49,512

 
50,561

Diluted
49,625

 
49,291

 
49,512

 
50,561


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
 
Nine months ended
 
September 25,
2015
 
September 26,
2014
 
September 25,
2015
 
September 26,
2014
Net loss
$
(1,896
)
 
$
(5,213
)
 
$
(36,598
)
 
$
(14,663
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
59

 
(159
)
 
11

 
(98
)
Unrealized gain (loss) on available-for sale marketable securities, net of tax
33

 
(81
)
 
113

 
(153
)
Other comprehensive income (loss), net of tax
92

 
(240
)
 
124

 
(251
)
Comprehensive loss, net of tax
$
(1,804
)
 
$
(5,453
)
 
$
(36,474
)
 
$
(14,914
)

See notes to the unaudited condensed consolidated financial statements.


6


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


 
Nine months ended
 
September 25,
2015
 
September 26,
2014
Cash flows from operating activities:
 
 
 
Net loss
$
(36,598
)
 
$
(14,663
)
Adjustments to reconcile net loss to cash flows provided by operating activities:
 
 
 
Depreciation and amortization of property and equipment
9,646

 
8,708

Amortization of intangible assets
4,975

 
3,402

Stock-based compensation
16,902

 
19,213

Loss on disposal of property and equipment
112

 
252

Deferred income taxes
514

 
677

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
11,623

 
9,225

Inventory
(2,076
)
 
5,865

Other operating assets
1,282

 
2,120

Accounts payable
(2,329
)
 
(4,314
)
Accrued expenses and other long-term liabilities
(5,733
)
 
(16
)
Deferred revenue
3,379

 
(2,387
)
Net cash provided by operating activities
1,697

 
28,082

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(6,417
)
 
(7,886
)
Business acquisition, net of cash acquired
(10,897
)
 
(35,022
)
Divestiture of business

 
2,000

Purchases of marketable securities
(25,577
)
 
(84,226
)
Maturities/sales of marketable securities
49,328

 
155,036

Proceeds from the sale of fixed assets

 
266

Net cash provided by investing activities
6,437

 
30,168

Cash flows from financing activities:
 
 
 
Proceeds from sale of common stock in connection with employee stock purchase plan
2,378

 
2,882

Proceeds from exercise of stock options
1,757

 
9,314

Payment of tax withholding obligations related to net share settlements of restricted stock awards
(2,314
)
 
(1,711
)
Repurchase of common stock
(6,083
)
 
(89,919
)
Principal payments of capital lease obligations
(62
)
 
(64
)
Net cash used in financing activities
(4,324
)
 
(79,498
)
Effect of exchange rate changes on cash and cash equivalents
(194
)
 
(257
)
Net increase (decrease) in cash and cash equivalents
3,616

 
(21,505
)
Cash and cash equivalents, beginning of year
41,157

 
72,423

Cash and cash equivalents, end of period
$
44,773

 
$
50,918

Supplemental disclosure of cash flow information:
 
 
 
Interest paid
$
46

 
$
45

Income taxes paid
$
833

 
$
1,738

Income tax refunds received
$
312

 
$
37

Supplemental disclosure of non-cash investing activities:
 
 
 
Capital expenditures incurred, but not yet paid
$
556

 
$
90

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, network intelligence applications (VellOS, which is designed to provide Network-as-a-Service ("NaaS")), 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.

During the preparation of the Company's consolidated financial statements for the three month period ended June 26, 2015, the Company identified an error related to the historical foreign translation of depreciation expense on certain foreign fixed assets that resulted in a historical understatement of expense in prior fiscal years totaling $1.4 million on a cumulative basis. There is no tax effect on these expenses as the amounts were calculated in the appropriate foreign currencies. The Company does not believe this error is material to its previously issued historical consolidated financial statements for any of the periods impacted and accordingly, has not adjusted its historical financial statements. The Company recorded the cumulative impact of the adjustment in the three months ended June 26, 2015. This adjustment resulted in a one-time $1.4 million overstatement of depreciation expense, which is included in the Company's condensed consolidated statement of operations for the nine months ended September 25, 2015. The Company does not believe this adjustment is material to its condensed consolidated financial statements for the periods presented.

The Company effected a one-for-five reverse stock split of its 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 the Company's 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.


8


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

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 or nine months ended September 25, 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.

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 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 September 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-16, Simplifying the Accounting for Measurement-Period Adjustments ("ASU 2015-16"), which eliminates the requirement to restate prior periods to reflect adjustments made to provisional amounts recognized in a business combination. Under ASU 2015-16, an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, rather than retrospectively, as had previously been required. ASU 2015-16 also requires acquirers to present separately on the face of the income statement, or disclose in the notes, the portion of the amount recorded in current period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. ASU 2015-16 is effective for the Company beginning January 1, 2016. The adoption of ASU 2015-16 is not expected to have a material impact on the Company's consolidated financial statements.


9


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

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory ("ASU 2015-11"). ASU 2015-11 simplifies the measurement of inventory by requiring entities to measure most inventory at the lower of cost and net realizable value, replacing the previous requirement to measure most inventory at the lower of cost or market. ASU 2015-11 does not apply to inventories that are measured by using either the last-in, first-out method or the retail inventory method. ASU 2015-11 is effective for the Company for both interim and annual reporting periods beginning January 1, 2017. The adoption of ASU 2015-11 is not expected to have a material impact on the Company's consolidated financial statements.

In August 2014, the FASB issued 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 for 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 is effective for the Company 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 is effective for the Company beginning January 1, 2016. The adoption of ASU 2014-12 is not expected to have a material impact on the Company's 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 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 August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the original effective date of interim and annual reporting periods 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 consolidated financial statements.


(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 on the Treq Asset Acquisition Date, with an additional

10


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

consideration payment of $750,000 paid 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 either initially as of the Treq Asset Acquisition Date or through September 25, 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. The Company finalized its valuation of the identifiable intangible assets in the second quarter of fiscal 2015. Based on the 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 deductible for tax purposes.

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

Fair value of consideration transferred:
 
  Cash, net of cash acquired
$
10,897

  Unpaid purchase consideration
750

    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. During the three months ended September 25, 2015, the Company began to record amortization expense in connection with certain of the in-process research and development intangible assets related to a product that became generally available in the quarter and accordingly, reclassified the asset with a cost basis of $7.5 million to its developed technology intangible assets. The Company will begin to amortize the remaining in-process research and development intangible asset at the time that the related product becomes 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).

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 and accordingly, the Company has not provided pro forma information.

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 and diversify its overall portfolio to include both legacy signaling and an integrated, virtualized Diameter and SIP-based signaling technology and acquire expertise to enable mobile service providers to offer new real-time multimedia services through their mobile, cloud-

11


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

based infrastructure. Delivering these services across the LTE next-generation mobile networks requires adoption of the next-generation signaling technology known in the industry as Diameter Signal.

The transaction has been accounted for as a business combination. 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 the Company. These expenses include professional and services fees, such as legal, audit, consulting, paying agent and other fees, as well as cash payments to certain employees of acquired companies in connection with change of control agreements. The amount recorded in the nine months ended September 25, 2015 relates to professional fees in connection with the acquisition of the SDN Business. The amount recorded in the nine months ended September 26, 2014 represents professional and services fees and expenses related to cash payments to certain former PT executives under their respective change of control agreements in connection with the PT acquisition.


12


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

The components of acquisition-related costs included in the Company's results of operations for the nine months ended September 25, 2015 and September 26, 2014 are as follows (in thousands):
 
Nine months ended
 
September 25,
2015
 
September 26,
2014
Professional and services fees
$
131

 
$
1,057

Change of control agreements

 
249

 
$
131

 
$
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
 
Nine months ended
 
September 25,
2015
 
September 26,
2014
 
September 25,
2015
 
September 26,
2014
Weighted average shares outstanding—basic
49,625

 
49,291

 
49,512

 
50,561

Potential dilutive common shares

 

 

 

Weighted average shares outstanding—diluted
49,625

 
49,291

 
49,512

 
50,561



Options to purchase the Company's common stock, unvested shares of restricted stock, unvested shares of performance-based stock and shares in connection with future purchases under the Company's Amended and Restated 2000 Employee Stock Purchase Plan, as amended (the "ESPP"), aggregating 8.6 million shares for the three and nine months ended September 25, 2015 and 8.4 million shares for the three and nine months ended September 26, 2014 have not been included in the computation of diluted loss per share because their effect would have been antidilutive.


(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 the nine months ended September 26, 2014. 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 or nine months ended September 25, 2015 or the three months ended September 26, 2014.

13


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


Investments with continuous unrealized losses for one year or greater at September 25, 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 September 25, 2015.

The amortized cost, gross unrealized gains and losses and fair value of the Company's marketable debt securities and investments at September 25, 2015 and December 31, 2014 were comprised of the following (in thousands):

 
September 25, 2015
 
Amortized
cost
 
Unrealized
gains
 
Unrealized
losses
 
Fair
value
Cash equivalents
$
12,583

 
$

 
$

 
$
12,583

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
4,227

 
$
2

 
$
(1
)
 
$
4,228

U.S. government agency notes
4,450

 
3

 

 
4,453

Corporate debt securities
51,329

 
13

 
(28
)
 
51,314

Commercial paper
3,587

 

 

 
3,587

Certificates of deposit
1,500

 

 

 
1,500

 
$
65,093

 
$
18

 
$
(29
)
 
$
65,082

Investments
 
 
 
 
 
 
 
Municipal obligations
$
2,131

 
$
2

 
$

 
$
2,133

U.S. government agency notes
999

 
1

 

 
1,000

Corporate debt securities
13,955

 
1

 
(22
)
 
13,934

 
$
17,085

 
$
4

 
$
(22
)
 
$
17,067



 
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




14


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

The Company's available-for-sale debt securities classified as Investments in the condensed consolidated balance sheets at September 25, 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 September 25, 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, Marketable securities and Investments in the condensed consolidated balance sheets (in thousands):
 
 
 
Fair value measurements at
September 25, 2015 using:
 
Total carrying
value at
September 25,
2015
 
Quoted prices
in active
markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash equivalents
$
12,583

 
$
12,583

 
$

 
$

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
4,228

 
$

 
$
4,228

 
$

U.S. government agency notes
4,453

 

 
4,453

 

Corporate debt securities
51,314

 

 
51,314

 

Commercial paper
3,587

 

 
3,587

 

Certificates of deposit
1,500

 

 
1,500

 

 
$
65,082

 
$

 
$
65,082

 
$

Investments
 
 
 
 
 
 
 
Municipal obligations
$
2,133

 
$

 
$
2,133

 
$

U.S. government agency notes
1,000

 

 
1,000

 

Corporate debt securities
13,934

 

 
13,934

 

 
$
17,067

 
$

 
$
17,067

 
$




15


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

 
 
 
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 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):
 
September 25,
2015
 
December 31,
2014
On-hand final assemblies and finished goods inventories
$
19,928

 
$
19,285

Deferred cost of goods sold
4,259

 
2,829

 
$
24,187

 
$
22,114




16


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

(6) INTANGIBLE ASSETS AND GOODWILL

The Company's intangible assets at September 25, 2015 and December 31, 2014 consist of the following (dollars in thousands):
September 25, 2015
Weighted average amortization period
(years)
 
Cost
 
Accumulated
amortization
 
Net
carrying value
In-process research and development
*
 
$
1,600

 
$

 
$
1,600

Intellectual property
5.00
 
999

 
999

 

Developed technology
6.42
 
31,280

 
8,698

 
22,582

Customer relationships
5.57
 
10,040

 
6,003

 
4,037

Internal use software
3.00
 
730

 
730

 

 
6.05
 
$
44,649

 
$
16,430

 
$
28,219


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


________________
* An in-process research and development intangible asset has an indefinite life until the product is generally available, at which time such asset is reclassified to developed technology.

Amortization expense for intangible assets for the three and nine months ended September 25, 2015 and September 26, 2014 was as follows (in thousands):
 
Three months ended
 
Nine months ended
 
Statement of operations classification
 
September 25,
2015
 
September 26,
2014
 
September 25,
2015
 
September 26,
2014
 
Developed technology
$
1,282

 
$
639

 
$
3,505

 
$
1,822

 
Cost of revenue - product
Customer relationships
414

 
494

 
1,308

 
1,397

 
Sales and marketing
Internal use software
41

 
62

 
162

 
183

 
Cost of revenue - product
 
$
1,737

 
$
1,195

 
$
4,975

 
$
3,402

 
 


During the three months ended September 25, 2015, the Company began to record amortization expense in connection with certain of the in-process research and development intangible assets related to a product that became generally available in the quarter and accordingly, reclassified the asset with a cost basis of $7.5 million to its developed technology intangible assets and determined that the reclassified asset has an estimated useful life of 7 years. The Company will begin to amortize the remaining in-process research and development intangible asset at the time that the related product becomes 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, which the Company expects will occur over the next several quarters. Estimated future amortization expense for the Company's intangible assets at September 25, 2015 is as follows (in thousands):


17


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

Years ending December 31,
 
Remainder of 2015
$
2,132

2016
7,189

2017
7,281

2018
4,644

2019
3,611

Thereafter
3,362

 
$
28,219



The changes in the carrying value of the Company's goodwill in the nine months ended September 25, 2015 and September 26, 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 September 25, 2015
$
40,310

 
 
Balance at September 25, 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
8,725

Sale of MPS business
(1,897
)
Balance at September 26, 2014
$
39,207

 
 
Balance at September 26, 2014
 
  Goodwill
$
42,313

  Accumulated impairment losses
(3,106
)
 
$
39,207



(7) ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
 
September 25,
2015
 
December 31,
2014
Employee compensation and related costs
$
18,121

 
$
20,042

Other
12,283

 
12,107

 
$
30,404

 
$
32,149




18


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

(8) RESTRUCTURING ACCRUAL

2015 Restructuring Initiative

To better align the Company's cost structure to its current revenue expectations, in April 2015, the Company announced a cost reduction review. As part of this review, on April 16, 2015, the Company initiated a restructuring plan to reduce its workforce by approximately 150 positions, or 12.5% of its worldwide workforce (the "2015 Restructuring Initiative"). In connection with the 2015 Restructuring Initiative, the Company recorded $2.9 million of restructuring expense for severance and related costs in the three months ended June 26, 2015. The Company recorded an adjustment of $0.1 million in the three months ended September 25, 2015 for changes in severance amounts paid to certain individuals. A summary of the 2015 Restructuring Initiative accrual activity for the nine months ended September 25, 2015 is as follows (in thousands):

2015 Restructuring Initiative
Balance at
January 1,
2015
 
Initiatives
charged to
expense
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at
September 25,
2015
Severance
$

 
$
2,899

 
$
63

 
$
(2,833
)
 
$
129



The Company expects that the remaining amounts accrued under the 2015 Restructuring Initiative will be paid in the fourth quarter of 2015.

2012 Restructuring Initiative

In August 2012, the Company announced that it had committed to a restructuring initiative to streamline operations and reduce operating costs by closing and consolidating certain facilities and reducing its worldwide workforce (the "2012 Restructuring Initiative"). The Company regularly reviews its restructuring accruals against expected cash expenditures to determine if adjustments are required. As a result of such reviews, the Company recorded credits to restructuring expense aggregating $1.7 million in the nine months ended September 25, 2015. This amount is comprised of a credit of $1.4 million recorded in the three months ended June 26, 2015 in connection with a settlement with the landlord of the Company's Fremont, California facility to vacate the facility without penalty or future payments and a credit of $0.3 million recorded in the three months ended March 27, 2015. The amount reversed in the three months ended March 27, 2015 is comprised of approximately $272,000 for facilities in connection with a settlement with the landlord of the Company's 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. The Company also recorded $0.1 million of restructuring expense in the three months ended September 25, 2015 related to vacating the Company's Rochester, New York facility.

The Company recorded $0.7 million of restructuring expense in the three months ended September 26, 2014 and $2.2 million in the nine months ended September 26, 2014 for severance and related costs in connection with reducing its workforce. A summary of the 2012 Restructuring Initiative accrual activity for the nine months ended September 25, 2015 is as follows (in thousands):

2012 Restructuring Initiative
Balance at
January 1,
2015
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at
September 25,
2015
Severance
$
1,682

 
$
(67
)
 
$
(1,593
)
 
$
22

Facilities
3,652

 
(1,589
)
 
(2,063
)
 

 
$
5,334

 
$
(1,656
)
 
$
(3,656
)
 
$
22



The Company expects that the remaining amounts for severance accrued under the 2012 Restructuring Initiative will be paid in the fourth quarter of 2015.


19


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

Balance Sheet Classification of Restructuring Accruals

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. At September 25, 2015, all of the restructuring accrual was included in Accrued expenses, as there was no long-term portion. The long-term portion of accrued restructuring was $1.9 million at December 31, 2014.


(9) DEBT

The Company entered into a 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 on June 27, 2014, which agreement was amended by a First Amendment to Credit Agreement on June 26, 2015 (the "Credit Agreement"). The Credit Agreement provides for a revolving credit facility of up to $15 million with a maturity date of June 30, 2016 and provides that the Company can select the interest rates under the credit facility from among the following options: (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 Credit Agreement also provides that the Company pays 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. and Network Equipment Technologies, Inc. ("NET") (collectively 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.

The Company did not have any amounts outstanding under the Credit Agreement at September 25, 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 nine months ended September 25, 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 nine months ended September 26, 2014, the Company spent $14.7 million, including transaction fees, to repurchase and retire 0.8 million shares of its common stock under the stock buyback program. At September 25, 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 the Company or any of its officers or directors. The Company 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

20


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

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. The Company 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.

At its June 11, 2015 annual meeting of stockholders, the Company's stockholders approved amendments to the 2007 Plan to, among other things:

Increase the number of shares available for future grant by 1.4 million shares; and
Revise the rate at which restricted stock, restricted stock units, performance awards and other stock unit awards are counted against the shares of common stock available for issuance under the 2007 Plan from 1.57 shares for every one share issued in connection with such award to 1.61 shares for every one share issued in connection with such award. Shares of common stock subject to awards that were granted under the two previous ratios of 1.57 and 1.5 will return to the 2007 Plan upon forfeiture of such awards at the respective previous ratios.

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 were 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. Under this program, the amount of the 2015 Bonus, if any, for each executive would 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 would be granted to those executives who elected to receive their 2015 Bonus entirely in the form of shares of common stock would be calculated by dividing an amount equal to 1.5 times each 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 would be granted to those executives who elected to receive one-half of their 2015 Bonus in the form of shares of common stock would 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. Under this program, the 2015 Bonus, if any, would 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 would 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 September 25, 2015, four participants in the 2015 Bonus program had separated from the Company and accordingly, forfeited any 2015 Bonus Shares they might otherwise have earned, subject to the terms of their respective employment agreements. The Company determined that the grant date criteria for the 2015 Bonus Shares was met on July 2, 2015, and accordingly, recorded stock-based compensation expense based on the grant date fair value of $6.79 per share. Subsequent to that date, in September 2015, the Compensation Committee considered the impact on employee retention and incentive compensation caused by the drop in the price of the Company's common stock since January 2, 2015, and indicated its intent to pay all such executives their 2015 Bonus, if any is earned, in cash. As a result, as of September 25, 2015, the Company reclassified the stock-based compensation expense recorded through that date in connection with the 2015 Bonus Shares aggregating $1.0 million from Additional paid-in capital to Accrued expenses. In addition, the Company recorded incremental bonus expense of $1.3 million related to the estimated 2015 Bonus payment, which the Company expects to pay in March 2016. The Company will not record any additional stock-based compensation expense in subsequent periods in connection with the 2015 Bonus Shares, but will instead record bonus expense through

21


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

December 31, 2015.

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 four 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 an aggregate of 131,250 PSUs with both market and service conditions to eight of its executives. 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 that 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.

In connection with the separation of two executives from the Company during the second quarter of 2015 and in accordance with their respective employment agreements with the Company, the Company accelerated the vesting of certain unvested stock options, RSAs and PSUs. These RSAs and PSUs are reported as "Vested" in the respective tables below.

Stock Options

The activity related to the Company's outstanding stock options during the nine months ended September 25, 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
314,690

 
$
15.30

 
 
 
 
Exercised
(155,293
)
 
$
10.78

 
 
 
 
Forfeited
(500,302
)
 
$
16.35

 
 
 
 
Expired
(544,387
)
 
$
21.06

 
 
 
 
Outstanding at September 25, 2015
6,636,140

 
$
16.18

 
6.38
 
$
88

Vested or expected to vest at September 25, 2015
6,378,795

 
$
16.17

 
6.31
 
$
87

Exercisable at September 25, 2015
4,340,084

 
$
16.21

 
5.43
 
$
65



The grant date fair values of options to purchase common stock granted in the three and nine months ended September 25, 2015 were estimated using the Black-Scholes valuation model with the following assumptions:

22


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

 
Three months ended
 
Nine months ended
 
September 25,
2015
 
September 25,
2015
Risk-free interest rate
1.57%
 
1.46% - 1.74%
Expected dividends
 
Weighted average volatility
54.5%
 
54.3%
Expected life (years)
5.0
 
5.0 - 6.0


Additional information regarding the Company's stock options for the three and nine months ended September 25, 2015 is as follows:
 
Three months ended
 
Nine months ended
 
September 25,
2015
 
September 25,
2015
Weighted average grant date fair value of stock options granted
$
3.45

 
$
7.73

Total intrinsic value of stock options exercised (in thousands)
$
8

 
$
926

Cash received from the exercise of stock options (in thousands)
$
18

 
$
1,757



Restricted Stock Awards and Units

The activity related to the Company's RSAs for the nine months ended September 25, 2015 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2015
370,182

 
$
16.74

Granted
1,933,051

 
$
14.06

Vested
(476,646
)
 
$
17.42

Forfeited
(211,440
)
 
$
15.22

Unvested balance at September 25, 2015
1,615,147

 
$
13.53



The activity related to the Company's unvested RSUs for the nine months ended September 25, 2015 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2015

 
$

Granted
120,215

 
$
16.05

Vested

 
$

Forfeited
(15,844
)
 
$
16.05

Unvested balance at September 25, 2015
104,371

 
$
16.05



The total fair value of shares of restricted stock that vested during the nine months ended September 25, 2015 was $8.3 million.

Performance-Based Stock Awards and Units

The activity related to the Company's PSAs for the nine months ended September 25, 2015 is as follows:

23


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

 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2015
34,235

 
$
13.60

Granted

 
$

Vested
(34,235
)
 
$
13.60

Forfeited

 
$

Unvested balance at September 25, 2015

 
$



The activity related to the Company's PSUs for the nine months ended September 25, 2015 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2015

 
$

Granted
131,250

 
$
14.68

Vested
(11,666
)
 
$
14.18

Forfeited
(8,334
)
 
$
15.38

Unvested balance at September 25, 2015
111,250

 
$
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 and nine months ended September 25, 2015 and September 26, 2014 as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 25,
2015
 
September 26,
2014
 
September 25,
2015
 
September 26,
2014
Product cost of revenue
$
81

 
$
104

 
$
238

 
$
287

Service cost of revenue
378

 
381

 
1,155

 
1,072

Research and development
1,349

 
1,521

 
4,152

 
4,583

Sales and marketing
1,282

 
1,747

 
4,150

 
4,299

General and administrative
2,183

 
2,748

 
7,207

 
8,972

 
$
5,273

 
$
6,501

 
$
16,902

 
$
19,213


There is no income tax benefit for employee stock-based compensation expense for the nine months ended September 25, 2015 or September 26, 2014 due to the valuation allowance recorded.

At September 25, 2015, there was $34.1 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 two years.



24


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

(12) MAJOR CUSTOMERS

The following customers contributed 10% or more of the Company's revenue in each of the three and nine month periods ended September 25, 2015 and September 26, 2014:
 
Three months ended
 
Nine months ended
 
 
September 25,
2015
 
September 26,
2014
 
September 25,
2015
 
September 26,
2014
 
AT&T Inc.
15%
 
17%
 
14%
 
22%
 
Inteliquent
14%
 
*
 
*
 
*
 
CenturyLink
11%
 
17%
 
*
 
*
 
_______________________
* Represents less than 10% of revenue


There were no other customers who contributed 10% or more of the Company's revenue in any of the three or nine month periods ended September 25, 2015 and September 26, 2014.

At September 25, 2015, two customers each accounted for 10% or more of the Company's accounts receivable balance, representing approximately 31% 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
 
Nine months ended
 
 
September 25,
2015
 
September 26,
2014
 
September 25,
2015
 
September 26,
2014
 
United States
77
%
 
70
%
 
71
%
 
71
%
 
Europe, Middle East and Africa
11

 
10

 
12

 
12

 
Japan
5

 
11

 
10

 
9

 
Other Asia Pacific
4

 
8

 
4

 
6

 
Other
3

 
1

 
3

 
2

 
 
100
%
 
100
%
 
100
%
 
100
%
 


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 nine months ended September 25, 2015 and September 26, 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 nine months ended September 25, 2015 and September 26, 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.


25


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


(15) COMMITMENTS AND CONTINGENCIES

As previously reported in the Company's Quarterly Reports on Form 10-Q, Part II, Item 1., for the fiscal quarters ended March 27, 2015 and June 26, 2015, Ming Huang, a purported shareholder of the Company, filed a Class Action Complaint (Civil Action No. 3:15-02407) on April 6, 2015, alleging violations of the federal securities laws (the “Complaint”) in the United States District Court for the District of New Jersey (the "Court"), against the Company and two of its officers, Raymond P. Dolan, the Company’s President and Chief Executive Officer, and Mark T. Greenquist, the Company’s Chief Financial Officer (collectively, the “Defendants”). On September 21, 2015, in response to motions subsequently filed with the Court by four other purported shareholders of the Company seeking status as lead plaintiff, the Court appointed Richard Sousa as lead plaintiff (the "Plaintiff") in this case. 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 that the Defendants made misleading forward-looking statements concerning the Company’s fiscal first quarter of 2015 financial performance. On September 22, 2015, the Company filed a Motion to Transfer this case to the United States District Court for the District of Massachusetts (the "Motion to Transfer"). The Plaintiff filed his opposition to the Motion to Transfer on October 5, 2015, and the Company filed its reply to the Motion to Transfer on October 13, 2015. 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 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, network intelligence applications (VellOS, which is designed to provide Network-as-a-Service ("NaaS")), 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 allowing 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

26


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. In 2013, we introduced 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 its 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 on the Treq Asset Acquisition Date, with an additional consideration payment of $750,000 paid on July 2, 2015 and a second additional consideration payment of $750,000 due on January 4, 2016. We 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 September 25, 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 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 overall portfolio to include both legacy signaling and 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 starting on 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, in April 2015, we announced a cost reduction review. As part of this review, on April 16, 2015, we initiated a restructuring plan to reduce our workforce by approximately 150 positions, or 12.5% of our worldwide workforce (the "2015 Restructuring Initiative"). As a result of our cost reduction review, we expect to realize approximately $15 million of savings in 2015. 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 the restructuring expense recorded in the period.

In early April 2015, Peter Polizzi agreed to step down as Vice President and General Manager, Global Services, effective May 1, 2015. Mr. Polizzi remained with the Company in an advisory role to assist our Chief Executive Officer until September 30, 2015.

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;

27


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;
actively contributing to the SIP standards definition and adoption process;
pursuing strategic transactions and alliances;
successfully implementing our cost reduction initiatives; and
delivering sustainable profitability by continuing to improve our overall performance.

We reported losses from operations of $1.4 million for the three months ended September 25, 2015 and $4.7 million for the three months ended September 26, 2014. We reported losses from operations of $35.3 million for the nine months ended September 25, 2015 and $15.3 million for the nine months ended September 26, 2014.

We reported net losses of $1.9 million for the three months ended September 25, 2015 and $5.2 million for the three months ended September 26, 2014. We reported net losses of $36.6 million for the nine months ended September 25, 2015 and $14.7 million for the nine months ended September 26, 2014.

Our revenue was $67.9 million in the three months ended September 25, 2015 and $73.2 million in the three months ended September 26, 2014. Our revenue was $172.7 million in the nine months ended September 25, 2015 and $219.5 million in the nine months ended September 26, 2014.

Our gross profit was $45.7 million in the three months ended September 25, 2015 and $47.9 million in the three months ended September 26, 2014. Our gross profit was $109.4 million for the nine months ended September 25, 2015, compared to $141.6 million for the nine months ended September 26, 2014. Our gross profit as a percentage of revenue ("total gross margin") was 67.4% in the three months ended September 25, 2015 and 65.4% in the three months ended September 26, 2014. Our total gross margin was 63.3% for the nine months ended September 25, 2015 and 64.5% for the nine months ended September 26, 2014.

Our operating expenses were $47.1 million in the three months ended September 25, 2015, compared to $52.6 million in the three months ended September 26, 2014. Our operating expenses for the three months ended September 25, 2015 include $0.2 million of net restructuring expense. Our operating expenses for the three months ended September 26, 2014 include $0.7 million of restructuring expense.

Our operating expenses were $144.6 million in the nine months ended September 25, 2015, compared to $156.9 million in the nine months ended September 26, 2014. Our operating expenses for the nine months ended September 25, 2015 include $0.1 million of acquisition-related expense and $1.3 million of net restructuring expense. Our operating expenses for the nine months ended September 26, 2014 include $1.3 million of acquisition-related expense and $2.2 million of restructuring expense.

We recorded stock-based compensation expense of $5.3 million in the three months ended September 25, 2015, compared to $6.5 million in the three months ended September 26, 2014. We recorded $16.9 million and $19.2 million of stock-based compensation expense in the nine months ended September 25, 2015 and September 26, 2014, respectively.

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 that we had written off in fiscal 2012. This amount is included in Other income (expense), net in our condensed consolidated statement of operations for the nine months ended September 26, 2014.

On January 2, 2014, Raymond P. Dolan, our President and Chief Executive Officer elected to accept shares of restricted stock (the "2014 Dolan Salary Shares") 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, was 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 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 were 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

28


her 2015 Bonus, if any, in the form of cash. Under this program, the amount of the 2015 Bonus, if any, for each executive would be determined by the Compensation Committee of our Board of Directors (the "Compensation Committee"). The number of shares of common stock that would be granted to those executives who elected to receive their 2015 Bonus entirely in the form of shares of common stock would 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 would be granted to those executives who elected to receive one-half of their 2015 Bonus in the form of shares of common stock would 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. Under this program, the 2015 Bonus, if any, would 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 would 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 September 25, 2015, four participants in the 2015 Bonus separated from the Company and accordingly, forfeited any 2015 Bonus Shares they might otherwise have earned, subject to the terms of their respective employment agreements. We determined that the grant date criteria for the 2015 Bonus Shares were met on July 2, 2015 and accordingly, we recorded stock-based compensation expense based on the grant date fair value of $6.79 per share. Subsequent to that date, in September 2015, the Compensation Committee considered the impact on employee retention and incentive compensation caused by the drop in the price of our common stock since January 2, 2015, and indicated its intention to pay all such executives their 2015 Bonus, if any is earned, in cash. As a result, as of September 25, 2015, we reclassified the stock-based compensation expense recorded through that date in connection with the 2015 Bonus Shares aggregating $1.0 million from Additional paid-in capital to Accrued expenses. In addition, we recorded incremental bonus expense of $1.3 million related to the estimated 2015 Bonus payment, which we expect to pay in March 2016. We will not record any additional stock-based compensation expense in subsequent periods in connection with the 2015 Bonus Shares, but will instead record bonus expense through December 31, 2015.

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 four 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 an aggregate of 131,250 performance-based stock units ("PSUs") with both market and service conditions to eight of our executives. 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.

In connection with the separation of two executives from the Company during the second quarter of 2015 and in accordance with their respective employment agreements with the Company, the Company accelerated the vesting of certain unvested stock options, RSAs and PSUs.

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:


29


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

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 September 25, 2015.


Results of Operations

Three and nine months ended September 25, 2015 and September 26, 2014

Revenue. Revenue for the three and nine months ended September 25, 2015 and September 26, 2014 was as follows (in thousands, except percentages):

 
Three months ended
 
Decrease
from prior year
 
September 25,
2015
 
September 26,
2014
 
$
 
%
Product
$
42,230

 
$
44,900

 
$
(2,670
)
 
(5.9
)%
Service
25,632

 
28,316

 
(2,684
)
 
(9.5
)%
Total revenue
$
67,862

 
$
73,216

 
$
(5,354
)
 
(7.3
)%

 
 
 
 
 
 
 
 
 
Nine months ended
 
Decrease
from prior year
 
September 25,
2015
 
September 26,
2014
 
$
 
%
Product
$
94,137

 
$
135,885

 
$
(41,748
)
 
(30.7
)%
Service
78,571

 
83,643

 
(5,072
)
 
(6.1
)%
Total revenue
$
172,708

 
$
219,528

 
$
(46,820
)
 
(21.3
)%


Product revenue is comprised of sales of our communication infrastructure products. The decrease in product revenue in the three months ended September 25, 2015 compared to the three months ended September 26, 2014 was primarily the result of lower revenue recognized from sales to two of our historically largest customers and lower sales of certain products to other customers, partially offset by higher revenue recognized from sales to another large customer.

The decrease in product revenue in the nine months ended September 25, 2015 compared to the nine months ended September 26, 2014 was primarily the result of lower revenue recognized from sales to one of our historically largest customers and lower sales of certain products to other customers.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
In the three months ended September 25, 2015, approximately 22% of our total product revenue was from indirect sales through our channel program, compared to approximately 38% in the three months ended September 26, 2014. Approximately 24% of our total product revenue was from indirect sales through our channel program in the nine months ended September 25, 2015, compared to approximately 28% in the nine months ended September 26, 2014.

In the three months ended September 25, 2015, our product revenue from sales to enterprise customers was approximately 20% of our total product revenue, compared to approximately 24% in the three months ended September 26, 2014. Our product revenue from sales to enterprise customers was approximately 19% of our total product revenue in the nine months ended September 25, 2015, compared to approximately 21% in the nine months ended September 26, 2014. These sales were made both through our direct sales team and indirect sales channel partners.

30



We recognized product revenue totaling $3.5 million from 150 new customers in the three months ended September 25, 2015 and $3.2 million from 228 new customers in the three months ended September 26, 2014. We recognized product revenue totaling $8.5 million from 468 new customers in the nine months ended September 25, 2015 and $13.1 million from 628 new customers in the nine months ended September 26, 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 request-for-proposal ("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 that of 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 are 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 and nine months ended September 25, 2015 and September 26, 2014 was comprised of the following (in thousands, except percentages):
 
Three months ended
 
Decrease
from prior year
 
September 25,
2015
 
September 26,
2014
 
$
 
%
Maintenance
$
22,024

 
$
22,419

 
$
(395
)
 
(1.8
)%
Professional services
3,608

 
5,897

 
(2,289
)
 
(38.8
)%
 
$
25,632

 
$
28,316

 
$
(2,684
)
 
(9.5
)%

 
 
 
 
 
 
 
 
 
Nine months ended
 
Decrease
from prior year
 
September 25,
2015
 
September 26,
2014
 
$
 
%
Maintenance
$
65,618

 
$
65,976

 
$
(358
)
 
(0.5
)%
Professional services
12,953

 
17,667

 
(4,714
)
 
(26.7
)%
 
$
78,571

 
$
83,643

 
$
(5,072
)
 
(6.1
)%


Our maintenance revenue decreased slightly in the three months ended September 25, 2015 compared to the three months ended September 26, 2014, primarily due to customer mix, including merger activity of certain of our customers, and the timing of product shipments in the current year. These decreases were partially offset by the growth of our installed customer base and the timing of maintenance renewals.

Our maintenance revenue decreased slightly in the nine months ended September 25, 2015 compared to the nine months ended September 26, 2014, primarily due to customer mix, including merger activity of certain of our customers, and the timing of product shipments in the current year.

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 contributed 10% or more of our revenue in each of the three and nine month periods ended September 25, 2015 and September 26, 2014:

31


 
Three months ended
 
Nine months ended
Customer
September 25,
2015
 
September 26,
2014
 
September 25,
2015
 
September 26,
2014
AT&T Inc.
15%
 
17%
 
14%
 
22%
Inteliquent
14%
 
*
 
*
 
*
CenturyLink
11%
 
17%
 
*
 
*
_______________________
* Represents less than 10% of revenue


There were no other customers who contributed 10% or more of the Company's revenue in any of the three or nine month periods ended September 25, 2015 and September 26, 2014.

International revenue was approximately 23% of revenue in the three months ended September 25, 2015 and approximately 30% of revenue in the three months ended September 26, 2014. International revenue was approximately 29% of revenue in the nine months ended September 25, 2015 and approximately 29% of revenue in the nine months ended September 26, 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 $11.3 million at September 25, 2015 and $9.1 million at December 31, 2014. Our deferred service revenue was $37.0 million at September 25, 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 and nine months ended September 25, 2015 and September 26, 2014 were as follows (in thousands, except percentages):
 
Three months ended
 
Decrease
from prior year
 
September 25,
2015
 
September 26,
2014
 
$
 
%
Cost of revenue
 
 
 
 
 
 
 
Product
$
13,158

 
$
15,074

 
$
(1,916
)
 
(12.7
)%
Service