0001105472-17-000033.txt : 20171027 0001105472-17-000033.hdr.sgml : 20171027 20171026194841 ACCESSION NUMBER: 0001105472-17-000033 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 69 CONFORMED PERIOD OF REPORT: 20170930 FILED AS OF DATE: 20171027 DATE AS OF CHANGE: 20171026 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SONUS NETWORKS INC CENTRAL INDEX KEY: 0001105472 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 043387074 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-34115 FILM NUMBER: 171157611 BUSINESS ADDRESS: STREET 1: 4 TECHNOLOGY PARK DRIVE CITY: WESTFORD STATE: MA ZIP: 01886 BUSINESS PHONE: 9786148100 MAIL ADDRESS: STREET 1: 4 TECHNOLOGY PARK DRIVE CITY: WESTFORD STATE: MA ZIP: 01886 10-Q 1 sons9301710-q.htm 10-Q Document


 

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 30, 2017
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, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer x
 
Non-accelerated filer o
 (Do not check if a smaller
reporting company)
 
Smaller reporting company o
 
 
 
 
 
 
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act) 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 18, 2017, there were 50,071,956 shares of the registrant's common stock, $0.001 par value, outstanding.
 




SONUS NETWORKS, INC.
FORM 10-Q
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017
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, statements about the completion, timing and impact of the transactions described herein, 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.

This document also contains statements about Sonus' agreement to effect a strategic combination with GENBAND Holdings Company ("GENBAND") resulting in a new combined company ("NewCo") (collectively, the "Transaction"). Many risks and uncertainties could cause actual results to differ materially from these forward-looking statements with respect to the Transaction, and these risks, as well as other risks associated with the pending merger, are more fully disclosed in the joint proxy statement/prospectus that is included in the registration statement on Form S-4 (File No. 333-219008) that was filed with the U.S. Securities and Exchange Commission in connection with the pending merger.

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 30,
2017
 
December 31,
2016
Assets
Current assets:
 
 
 
Cash and cash equivalents
$
51,280

 
$
31,923

Marketable securities
53,272

 
61,836

Accounts receivable, net of allowance for doubtful accounts of $317 at September 30, 2017 and $10 at December 31, 2016
51,637

 
53,862

Inventory
16,282

 
18,283

Other current assets
14,314

 
12,010

Total current assets
186,785

 
177,914

Property and equipment, net
9,742

 
11,741

Intangible assets, net
23,352

 
30,197

Goodwill
49,891

 
49,393

Investments
27,018

 
32,371

Deferred income taxes
1,570

 
1,542

Other assets
4,086

 
4,901

 
$
302,444

 
$
308,059

Liabilities and Stockholders' Equity
Current liabilities:
 
 
 
Accounts payable
$
6,947

 
$
6,525

Accrued expenses
23,771

 
25,886

Current portion of deferred revenue
48,182

 
43,504

Current portion of long-term liabilities
707

 
1,154

Total current liabilities
79,607

 
77,069

Deferred revenue
6,777

 
7,188

Deferred income taxes
3,687

 
3,047

Other long-term liabilities
1,791

 
1,633

Total liabilities
91,862

 
88,937

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; 49,945,286 shares issued and outstanding at September 30, 2017; 49,041,881 shares issued and outstanding at December 31, 2016
50

 
49

Additional paid-in capital
1,261,627

 
1,250,744

Accumulated deficit
(1,056,712
)
 
(1,037,174
)
Accumulated other comprehensive income
5,617

 
5,503

Total stockholders' equity
210,582

 
219,122

 
$
302,444

 
$
308,059


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 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Revenue:
 
 
 
 
 
 
 
Product
$
44,120

 
$
38,601

 
$
98,305

 
$
108,719

Service
30,509

 
26,410

 
85,425

 
76,300

Total revenue
74,629

 
65,011

 
183,730

 
185,019

Cost of revenue:
 
 
 
 
 
 
 
Product
9,708

 
12,285

 
28,748

 
35,230

Service
10,374

 
9,140

 
30,285

 
27,572

Total cost of revenue
20,082

 
21,425

 
59,033

 
62,802

Gross profit
54,547

 
43,586

 
124,697

 
122,217

Operating expenses:
 
 
 
 
 
 
 
Research and development
20,798

 
18,230

 
61,071

 
53,005

Sales and marketing
17,454

 
18,103

 
47,850

 
50,890

General and administrative
10,833

 
8,998

 
27,993

 
26,656

Acquisition-related
1,543

 
951

 
6,278

 
951

Restructuring

 
1,620

 
1,071

 
1,620

Total operating expenses
50,628

 
47,902

 
144,263

 
133,122

Income (loss) from operations
3,919

 
(4,316
)
 
(19,566
)
 
(10,905
)
Interest income, net
260

 
209

 
772

 
590

Other income, net
1

 
803

 
577

 
916

Income (loss) before income taxes
4,180

 
(3,304
)
 
(18,217
)
 
(9,399
)
Income tax provision
(727
)
 
(427
)
 
(1,321
)
 
(1,902
)
Net income (loss)
$
3,453

 
$
(3,731
)
 
$
(19,538
)
 
$
(11,301
)
Earnings (loss) per share:
 
 
 
 
 
 
 
Basic
$
0.07

 
$
(0.08
)
 
$
(0.39
)
 
$
(0.23
)
Diluted
$
0.07

 
$
(0.08
)
 
$
(0.39
)
 
$
(0.23
)
Shares used to compute earnings (loss) per share:
 
 
 
 
 
 
 
Basic
49,753

 
49,402

 
49,472

 
49,436

Diluted
50,131

 
49,402

 
49,472

 
49,436


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 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Net income (loss)
$
3,453

 
$
(3,731
)
 
$
(19,538
)
 
$
(11,301
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(13
)
 
49

 
102

 
484

Unrealized gain (loss) on available-for sale marketable securities, net of tax
43

 
(112
)
 
12

 
160

Reclassification adjustment for realized losses included in net loss

 

 

 
18

Other comprehensive income (loss), net of tax
30

 
(63
)
 
114

 
662

Comprehensive income (loss), net of tax
$
3,483

 
$
(3,794
)
 
$
(19,424
)
 
$
(10,639
)

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 30,
2017
 
September 30,
2016
Cash flows from operating activities:
 
 
 
Net loss
$
(19,538
)
 
$
(11,301
)
Adjustments to reconcile net loss to cash flows provided by operating activities:
 
 
 
Depreciation and amortization of property and equipment
5,255

 
5,914

Amortization of intangible assets
6,845

 
5,493

Stock-based compensation
11,387

 
15,464

Loss on disposal of property and equipment
10

 
29

Gain on sale of IP addresses
(576
)
 
(800
)
Deferred income taxes
687

 
763

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
2,360

 
9,287

Inventory
1,806

 
2,756

Other operating assets
(545
)
 
(798
)
Accounts payable
384

 
(2,904
)
Accrued expenses and other long-term liabilities
(3,028
)
 
(12,032
)
Deferred revenue
4,000

 
(1,823
)
Net cash provided by operating activities
9,047

 
10,048

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(3,265
)
 
(3,637
)
Business acquisition, net of cash acquired

 
(20,669
)
Purchases of marketable securities
(28,731
)
 
(62,468
)
Maturities/sales of marketable securities
41,964

 
65,327

Proceeds from the sale of IP addresses
576

 
800

Net cash provided by (used in) investing activities
10,544

 
(20,647
)
Cash flows from financing activities:
 
 
 
Proceeds from sale of common stock in connection with employee stock purchase plan
1,252

 
1,360

Proceeds from exercise of stock options
149

 
135

Payment of tax withholding obligations related to net share settlements of restricted stock awards
(1,904
)
 
(1,538
)
Repurchase of common stock

 
(7,130
)
Principal payments of capital lease obligations
(30
)
 
(33
)
Net cash used in financing activities
(533
)
 
(7,206
)
Effect of exchange rate changes on cash and cash equivalents
299

 
260

Net increase (decrease) in cash and cash equivalents
19,357

 
(17,545
)
Cash and cash equivalents, beginning of year
31,923

 
50,111

Cash and cash equivalents, end of period
$
51,280

 
$
32,566

Supplemental disclosure of cash flow information:
 
 
 
Interest paid
$
84

 
$
27

Income taxes paid
$
1,198

 
$
1,024

Income tax refunds received
$
91

 
$
275

Supplemental disclosure of non-cash investing activities:
 
 
 
Capital expenditures incurred, but not yet paid
$
301

 
$
444

Property and equipment acquired under capital lease
$

 
$
36

Fair value of contingent consideration related to acquisition
$

 
$
10,000


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 secure and unify their real-time communications infrastructures. 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"), Voice over WiFi ("VoWiFi"), 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") and VoWiFi solutions, which are supported by a global services team with experience in the design, deployment and maintenance of the world's largest IP networks.

Sonus' communications solutions provide a secure way for its customers to 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. Sonus' solutions help realize the intended value and benefits of UC platforms by allowing disparate communications environments, commonplace in most enterprises today, to work seamlessly together. Likewise, Sonus' solutions facilitate the evolution to cloud-based delivery of UC solutions.

Pending Merger

On May 23, 2017, Sonus entered into an Agreement and Plan of Merger (the “Merger Agreement”) with (i) Solstice Sapphire Investments, Inc. ("NewCo") and its wholly-owned subsidiaries and (ii) GENBAND Holdings Company ("GENBAND") and its two related holding companies such that, following a series of merger transactions (collectively, the "Mergers"), both the Company and GENBAND will each become a wholly-owned subsidiary of NewCo. Former stockholders of the Company will own approximately 50%, and former shareholders of GENBAND and the two related holding companies will own approximately 50%, of the shares of NewCo common stock issued and outstanding immediately following the consummation of the Mergers.

GENBAND is a Cayman Islands exempted company limited by shares that was formed on April 7, 2010.  Through its wholly owned operating subsidiaries, GENBAND creates rapid communications and applications for service providers, enterprises, independent software vendors, system integrators and developers globally. A majority of GENBAND's shares are held by funds affiliated with One Equity Partners. GENBAND shares are not listed on an exchange or quoted on any automated services, and there is no established trading market for GENBAND shares.

The Company believes that Sonus' and GENBAND's complementary products, solutions and strategies position the combined company to deliver comprehensive solutions to service providers and enterprises migrating to a virtualized all-IP environment in an expanded customer and global footprint.

Pursuant to the Merger Agreement, NewCo will issue shares to the GENBAND equity holders, with the number of shares issued in the aggregate to the GENBAND equity holders equal to the number of shares of the Company’s common stock outstanding immediately prior to the closing date of the Mergers. In addition, NewCo will repay GENBAND’s long-term debt, including both principal and unpaid interest, to a related party totaling approximately $48 million and repay GENBAND’s management fees due to a representative of a majority shareholder totaling $10.3 million. NewCo will also pay an estimated $9.0 million of NewCo's transaction fees incurred in connection with the Mergers and issue a promissory note for $22.5 million to certain GENBAND equity holders.

NewCo will assume the liability under GENBAND's revolving credit facility with Silicon Valley Bank (the "GENBAND facility"), which had outstanding borrowings and letters of credit totaling $18.0 million and $2.9 million, respectively, at October 26, 2017. At October 26, 2017, the outstanding borrowings had an average interest rate of 4.67%.

The Company's Board of Directors unanimously approved the Merger Agreement and the transactions contemplated thereby. The Company held a special meeting of the Company's stockholders (the “Special Stockholders’ Meeting”) on

8



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

Thursday, October 26, 2017, at which the Company's stockholders voted to, among other things, adopt the Merger Agreement. The Company expects that the Mergers will be consummated on Friday, October 27, 2017.

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, 2016 (the "Annual Report"), which was filed with the SEC on February 27, 2017.

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 either the three or nine months ended September 30, 2017.

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

Any forward-looking statements regarding the potential impact of recent accounting pronouncements do not include the potential impact of the pending merger with GENBAND.

In May 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting ("ASU 2017-09"), which amends the scope of modification accounting for share-based payment arrangements. ASU 2017-09 provides guidance on the types of

9



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

changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under Accounting Standards Codification ("ASC") 718. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions and classification of the awards are the same immediately before and after the modification. ASU 2017-09 is effective for the Company beginning January 1, 2018 for both interim and annual reporting periods, with early adoption permitted. The Company does not expect the adoption of ASU 2017-09 will have a material impact on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04"), which removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of step two of the goodwill impairment test. As a result, under ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, ASU 2017-04 clarifies the requirements for excluding and allocating foreign currency translation adjustments to reporting units in connection with an entity's testing of reporting units for goodwill impairment; clarifies that an entity should consider income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable; and makes minor changes to other related guidance within the ASC. ASU 2017-04 is effective prospectively for the Company beginning January 15, 2020, with early adoption permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company elected to early-adopt ASU 2017-04 as of January 1, 2017; such early adoption did not have a material impact on the Company's consolidated financial results.

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory ("ASU 2016-16"), which removes the prohibition in ASC 740, Income Taxes, against the immediate recognition of the current and deferred income tax effects of intra-entity transfers of assets other than inventory. ASU 2016-16 is intended to reduce the complexity of GAAP and diversity in practice related to the tax consequences of certain types of intra-entity asset transfers, particularly those involving intellectual property. ASU 2016-16 is effective for the Company beginning January 1, 2019 for both interim and annual reporting periods. The Company does not believe that the adoption of ASU 2016-16 will have a material impact on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"), which amends the guidance in ASC 230 on the classification of certain cash receipts and payments in the statement of cash flows. The primary purpose of ASU 2016-15 is to reduce the diversity in practice that has resulted from the lack of consistent principles on this topic. ASU 2016-15 adds or clarifies guidance on eight cash flow issues, including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments or certain other debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for the Company beginning January 1, 2018 for both interim and annual reporting periods, with early adoption permitted. Entities must apply the guidance retrospectively to all periods presented but may apply it prospectively from the earliest date practicable if retrospective application would be impracticable. The Company does not expect the adoption of ASU 2016-15 will have a material impact on its consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which adds an impairment model that is based on expected losses rather than incurred losses. Under ASU 2016-13, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. ASU 2016-13 is effective for the Company beginning January 1, 2020 for both interim and annual reporting periods, with early adoption permitted. The Company does not expect the adoption of ASU 2016-13 will have a material impact on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"), which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 became effective for the Company beginning January 1, 2017 for both interim and annual reporting periods. Under ASU 2016-09, the Company will now recognize unrealized excess tax benefits. Due to the Company's full valuation allowance on its federal and state income taxes, the adoption of ASU 2016-09 did not have a material impact on the Company's accounting for income taxes. Without the valuation allowance, the Company would have recognized an increased deferred tax asset approximating $5 million. The Company has elected to continue to apply forfeiture rates to its expense attribution related to stock options, restricted stock

10



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

awards and restricted stock units, as the Company believes that such continued application results in more accurate expense attribution over the life of these equity grants.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) Section A - Leases: Amendments to the FASB Accounting Standards Codification ("ASU 2016-02"), its new standard on accounting for leases. ASU 2016-02 introduces a lessee model that brings most leases onto the balance sheet. The new standard also aligns many of the underlying principles of the new lessor model with those in ASC 606, the FASB's new revenue recognition standard (i.e., those related to evaluating when profit can be recognized). Furthermore, ASU 2016-02 addresses other concerns related to the current leases model. For example, ASU 2016-02 eliminates the current GAAP requirement for an entity to use bright-line tests in determining lease classification. ASU 2016-02 is effective for the Company for both interim and annual periods beginning January 1, 2019. Upon adoption of ASU 2016-02, the Company will recognize lease obligations for the right to use these assets in connection with its existing lease agreements. The Company is currently assessing the potential impact of the adoption of ASU 2016-02 on its consolidated financial statements and accordingly, such amounts to be recognized in the balance sheet have yet to be determined.

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory ("ASU 2015-11"), which 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 became effective for the Company for both interim and annual reporting periods beginning January 1, 2017. The adoption of ASU 2015-11 did not 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, along with additional ASUs which, among other things, clarified the implementation of the new revenue guidance and delayed the adoption by one year, to January 1, 2018 (collectively, the "New Revenue Standard"). The New Revenue Standard 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. The New Revenue Standard applies to all contracts with customers that are within the scope of other topics in the ASC. Certain of the New Revenue Standard'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. The Company continues to assess the potential impact of the adoption of the New Revenue Standard on its consolidated financial statements, and currently believes that such adoption will, in general, accelerate the recognition of revenue (i.e., more revenue will be recognized upon delivery than is currently recognized ratably or upon payment) compared to the current standards in effect, in particular, sales of software-only products and sales to customers currently accounted for on a cash basis. The Company currently expects to adopt the New Revenue Standard using the modified retrospective option, and is in the process of updating its revenue recognition software to comply with the New Revenue Standard. Under the modified retrospective method, the Company will apply the New Revenue Standard to all contracts not yet completed as of January 1, 2018, recognizing in beginning Accumulated deficit an adjustment for the cumulative effect of the change and providing additional disclosures comparing results to those as if the Company were still following the previous accounting standards. The Company currently expects that the adjustment to Accumulated deficit will be approximately $1 million.


(2) BUSINESS ACQUISITION

Acquisition of Taqua, LLC

On September 26, 2016 (the "Taqua Acquisition Date"), the Company acquired Taqua, LLC ("Taqua"), a leading supplier of IP communications systems, applications and services to mobile and fixed operators. Taqua enables the transformation of software-based service provider networks to deliver next-generation voice, video and messaging services, including VoIP, VoWiFi and Voice over Long-Term Evolution ("VoLTE"). The acquisition of Taqua has, among other things, accelerated the Company's mobile strategy by adding a Virtualized Mobile Core ("VMC") Platform and an IP Multimedia Subsystem ("IMS") Service Core and expanded the Company's fixed portfolio by adding a Class 5 Softswitch (the T7000) for network transformation projects and a Multimedia Controller used in IP Peering applications (the T7100), both of which are

11



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

complementary to Sonus' current product offerings. In consideration for the acquisition of Taqua, Sonus paid $19.9 million in cash to the sellers on the Taqua Acquisition Date, net of cash acquired. The Company also entered into an Earn-Out Agreement, dated as of September 26, 2016, with Taqua Holdings, LLC and Jeffrey L. Brawner, the seller representative in the transaction, under which there is the potential for additional cash payments of up to $65.0 million in the aggregate to the sellers if certain annual revenue thresholds are exceeded as measured annually through 2020. The Company had initially recorded $10.0 million of contingent consideration as of the Taqua Acquisition Date, with the estimate based on historical sales and probability weighted cash flows related to forecasted sales. During the fourth quarter of 2016, the Company reassessed the historical and updated forecasted sales and accordingly, reversed the previous estimated contingent consideration such that as of both September 30, 2017 and December 31, 2016, no incremental contingent consideration was recorded.

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

The Company finalized its valuation of the identifiable intangible assets in the second quarter of 2017. During both the first quarter of 2017 and the fourth quarter of 2016, the Company recorded changes to the initial preliminary purchase price allocation. The primary adjustments in the first quarter of 2017 were a $0.4 million increase to current liabilities and a $0.1 million increase to noncurrent liabilities. The primary adjustments recorded in the fourth quarter of 2016 were the reversal of the $10.0 million of previously recorded contingent consideration discussed above, a reduction of $12.1 million to the developed technology intangible asset and an increase of $5.5 million to the customer relationship intangible assets. These adjustments, as well as other immaterial adjustments to the balance sheet accounts, resulted in a net reduction to goodwill of $2.2 million since September 30, 2016. Based on this final purchase price allocation, the Company recorded $9.6 million of goodwill, which is primarily due to expected synergies between the combined companies and expanded market opportunities resulting from the expanded product offering portfolio. The goodwill is deductible for tax purposes.

A summary of the final allocation of the purchase consideration for Taqua is as follows (in thousands):

Fair value of consideration transferred:
 
  Cash, net of cash acquired
$
19,919

 
 
Fair value of assets acquired and liabilities assumed:
 
  Current assets
$
3,347

  Property and equipment
1,478

  Intangible assets:
 
    Developed technology
2,100

    Customer relationships
9,510

  Goodwill
9,581

  Other noncurrent assets
23

  Current liabilities
(5,435
)
  Long-term liabilities
(685
)
 
$
19,919



The valuation of the acquired intangible assets is inherently subjective and relies on significant unobservable inputs. The Company used an income approach to value the acquired developed technology and customer relationship intangible assets. The valuation for each of these intangible assets was based on estimated projections of expected cash flows to be generated by the assets, discounted to the present value at discount rates commensurate with perceived risk. The valuation assumptions take into consideration the Company's estimates of technology attrition and revenue growth projections. The Company 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 financial information, as the historical amount are not significant to the Company's consolidated financial statements.


12



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

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, services and other costs, such as legal, audit, consulting, paying agent and other related expenses. The expense recorded in the three months ended September 30, 2017 relates to the pending merger with GENBAND. The expense recorded in the nine months ended September 30, 2017 primarily relates to the pending merger with GENBAND, plus approximately $56,000 of costs related to the Taqua acquisition. The acquisition-related expense recorded in both the three and nine months ended September 30, 2016 relates to the acquisition of Taqua. The Company's acquisition-related expense for the three and nine months ended September 30, 2017 and 2016 are as follows (in thousands):
 
 
 
 
 
 
 
 
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Professional and services fees
$
1,543

 
$
951

 
$
6,278

 
$
951



(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 earnings 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 earnings (loss) per share are as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Weighted average shares outstanding—basic
49,753

 
49,402

 
49,472

 
49,436

Potential dilutive common shares
378

 

 

 

Weighted average shares outstanding—diluted
50,131

 
49,402

 
49,472

 
49,436



The Company has excluded 5.2 million weighted shares underlying options to purchase shares of the Company's common stock from the computation of diluted earnings per share for the three months ended September 30, 2017 because the options' exercise prices were greater than the average market price for the common stock and their effect would have been antidilutive. Options to purchase the Company's common stock and unvested shares of restricted and performance-based stock aggregating 7.4 million shares have not been included in the computation of diluted loss per share for the nine months ended September 30, 2017 because their effect would have been antidilutive. Options to purchase the Company's common stock, unvested shares of restricted and 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"), totaling 8.2 million shares for the three and nine months ended September 30, 2016 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 nine months ended September 30, 2016, the Company sold $3.8 million of its available-for-sale securities and recognized gross losses aggregating $18,000, which is included as a component of Other income, net, in the Company's condensed consolidated statement of operations for that period. The Company did not sell any of its available-for-sale securities in the nine months ended September 30, 2017. Investments with continuous unrealized losses for one year or greater

13



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

at September 30, 2017 were nominal. However, the Company currently intends to liquidate approximately $50 million of marketable securities in the fourth quarter of 2017 in connection with the cash payments due for the pending merger with GENBAND. As a result of this planned liquidation, the Company expects to recognize losses of approximately $60,000.

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 30, 2017.

The amortized cost, gross unrealized gains and losses and fair value of the Company's marketable debt securities and investments at September 30, 2017 and December 31, 2016 were comprised of the following (in thousands):

 
September 30, 2017
 
Amortized
cost
 
Unrealized
gains
 
Unrealized
losses
 
Fair
value
Cash equivalents
$
21,114

 
$

 
$

 
$
21,114

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
1,085

 
$

 
$

 
$
1,085

U.S. government agency notes
26,395

 

 
(43
)
 
26,352

Corporate debt securities
23,163

 

 
(28
)
 
23,135

Certificates of deposit
2,700

 

 

 
2,700

 
$
53,343

 
$

 
$
(71
)
 
$
53,272

Investments
 
 
 
 
 
 
 
U.S. government agency notes
$
11,036

 
$

 
$
(23
)
 
$
11,013

Corporate debt securities
12,157

 
2

 
(20
)
 
12,139

Certificates of deposit
3,866

 

 

 
3,866

 
$
27,059

 
$
2

 
$
(43
)
 
$
27,018



 
December 31, 2016
 
Amortized
cost
 
Unrealized
gains
 
Unrealized
losses
 
Fair
value
Cash equivalents
$
6,619

 
$

 
$

 
$
6,619

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
3,264

 
$

 
$
(3
)
 
$
3,261

U.S. government agency notes
16,477

 
3

 
(3
)
 
16,477

Corporate debt securities
41,893

 
4

 
(45
)
 
41,852

Certificates of deposit
246

 

 

 
246

 
$
61,880

 
$
7

 
$
(51
)
 
$
61,836

Investments
 
 
 
 
 
 
 
U.S. government agency notes
$
19,473

 
$
3

 
$
(39
)
 
$
19,437

Corporate debt securities
10,520

 

 
(44
)
 
10,476

Certificates of deposit
2,458

 

 

 
2,458

 
$
32,451

 
$
3

 
$
(83
)
 
$
32,371



The Company's available-for-sale debt securities classified as Investments in the condensed consolidated balance sheets at September 30, 2017 and December 31, 2016 had maturity dates after one year but within approximately two years or less from the balance sheet date.


14



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

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 30, 2017 and December 31, 2016. 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 30, 2017 using:
 
Total carrying
value at
September 30,
2017
 
Quoted prices
in active
markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash equivalents
$
21,114

 
$
21,114

 
$

 
$

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
1,085

 
$

 
$
1,085

 
$

U.S. government agency notes
26,352

 

 
26,352

 

Corporate debt securities
23,135

 

 
23,135

 

Certificates of deposit
2,700

 

 
2,700

 

 
$
53,272

 
$

 
$
53,272

 
$

Investments
 
 
 
 
 
 
 
U.S. government agency notes
$
11,013

 
$

 
$
11,013

 
$

Corporate debt securities
12,139

 

 
12,139

 

Certificates of deposit
3,866

 

 
3,866

 

 
$
27,018

 
$

 
$
27,018

 
$




15



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

 
 
 
Fair value measurements at
December 31, 2016 using:
 
Total carrying
value at
December 31,
2016
 
Quoted prices
in active
markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash equivalents
$
6,619

 
$
6,619

 
$

 
$

 
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Municipal obligations
$
3,261

 
$

 
$
3,261

 
$

U.S. government agency notes
16,477

 

 
16,477

 

Corporate debt securities
41,852

 

 
41,852

 

Certificates of deposit
246

 

 
246

 

 
$
61,836

 
$

 
$
61,836

 
$

Investments
 
 
 
 
 
 
 
U.S. government agency notes
$
19,437

 
$

 
$
19,437

 
$

Corporate debt securities
10,476

 

 
10,476

 

Certificates of deposit
2,458

 

 
2,458

 

 
$
32,371

 
$

 
$
32,371

 
$


The Company's marketable securities and 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 at September 30, 2017 and December 31, 2016 consists of the following (in thousands):
 
September 30,
2017
 
December 31,
2016
On-hand final assemblies and finished goods inventories
$
14,465

 
$
15,346

Deferred cost of goods sold
3,317

 
4,237

 
17,782

 
19,583

Less current portion
(16,282
)
 
(18,283
)
Noncurrent portion (included in Other assets)
$
1,500

 
$
1,300




16



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

(6) INTANGIBLE ASSETS AND GOODWILL

The Company's intangible assets at September 30, 2017 and December 31, 2016 consist of the following (dollars in thousands):
September 30, 2017
Weighted average amortization period
(years)
 
Cost
 
Accumulated
amortization
 
Net
carrying value
Developed technology
6.54
 
$
34,980

 
$
21,222

 
$
13,758

Customer relationships
5.78
 
19,540

 
9,946

 
9,594

Internal use software
3.00
 
730

 
730

 

 
6.23
 
$
55,250

 
$
31,898

 
$
23,352


December 31, 2016
Weighted average amortization period
(years)
 
Cost
 
Accumulated
amortization
 
Net
carrying value
Developed technology
6.54
 
$
34,980

 
$
16,453

 
$
18,527

Customer relationships
5.78
 
19,540

 
7,870

 
11,670

Internal use software
3.00
 
730

 
730

 

 
6.23
 
$
55,250

 
$
25,053

 
$
30,197



Amortization expense for intangible assets for the three and nine months ended September 30, 2017 and 2016 was as follows (in thousands):
 
Three months ended
 
Nine months ended
 
Statement of operations classification
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
 
Developed technology
$
1,602

 
$
1,455

 
$
4,769

 
$
4,537

 
Cost of revenue - product
Customer relationships
691

 
319

 
2,076

 
956

 
Sales and marketing
 
$
2,293

 
$
1,774

 
$
6,845

 
$
5,493

 
 


Estimated future amortization expense for the Company's intangible assets at September 30, 2017 is as follows (in thousands):

Years ending December 31,
 
Remainder of 2017
$
2,293

2018
6,615

2019
5,608

2020
4,166

2021
2,395

Thereafter
2,275

 
$
23,352




17



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

The changes in the carrying value of the Company's goodwill in the nine months ended September 30, 2017 were as follows (in thousands):
 
 
Balance at January 1, 2017
 
  Goodwill
$
52,499

  Accumulated impairment losses
(3,106
)
 
49,393

Purchase accounting adjustments - Taqua
498

Balance at September 30, 2017
$
49,891

 
 
Balance at September 30, 2017
 
  Goodwill
$
52,997

  Accumulated impairment losses
(3,106
)
 
$
49,891


The changes in the carrying value of the Company's goodwill in the nine months ended September 30, 2016 were as follows (in thousands):
 
 
Balance at January 1, 2016
 
  Goodwill
$
43,416

  Accumulated impairment losses
(3,106
)
 
40,310

Acquisition of Taqua
11,826

Balance at September 30, 2016
$
52,136

 
 
Balance at September 30, 2016
 
  Goodwill
$
55,242

  Accumulated impairment losses
(3,106
)
 
$
52,136



(7) ACCRUED EXPENSES
Accrued expenses at September 30, 2017 and December 31, 2016 consist of the following (in thousands):
 
September 30,
2017
 
December 31,
2016
Employee compensation and related costs
$
14,941

 
$
15,879

Other
8,830

 
10,007

 
$
23,771

 
$
25,886



(8) RESTRUCTURING ACCRUAL

2016 Restructuring Initiative

In July 2016, the Company announced a program to further accelerate its investment in new technologies as the communications industry migrates to a cloud-based architecture (the "2016 Restructuring Initiative"), and that it planned to utilize most of the savings from this initiative to shift headcount toward new strategic initiatives, such as new products and an expanded go-to-market footprint in selected geographies and discrete vertical markets. The Company recorded $2.0 million of restructuring expense in the aggregate in connection with this initiative, comprised of $1.9 million for severance and related costs and $0.1 million to abandon its facility in Rochester, New York (the "Rochester Facility"). The actions under the 2016 Restructuring Initiative have been implemented and accordingly, the Company does not expect to record additional expense in connection with this initiative. The amounts accrued for severance and related costs had been fully paid by the end of the third

18



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

quarter of 2017. The Company expects that the amounts accrued for facilities will be paid by the end of October 2019, when the lease on the Rochester Facility expires.

In connection with the 2016 Restructuring Initiative, the Company recorded $0.5 million of restructuring expense in the nine months ended September 30, 2017. The amount recorded in the nine months ended September 30, 2017 is comprised of $0.4 million for severance and related costs and $0.1 million related to the Company's Rochester Facility. The Company did not record restructuring expense in the three months ended September 30, 2017. A summary of the 2016 Restructuring Initiative accrual activity for the nine months ended September 30, 2017 is as follows (in thousands):

 
Balance at
January 1,
2017
 
Initiatives
charged to
expense
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at September 30, 2017
Severance
$
497

 
$
405

 
$
(26
)
 
$
(876
)
 
$

Facilities

 
126

 

 
(22
)
 
104

 
$
497

 
$
531

 
$
(26
)
 
$
(898
)
 
$
104



Taqua Restructuring Initiative

In connection with the acquisition of Taqua, the Company's management approved a restructuring plan in the third quarter of 2016 to eliminate certain redundant positions within the combined companies. On October 24, 2016, the Audit Committee of the Company's Board of Directors approved a broader Taqua restructuring plan related to headcount and redundant facilities (both restructuring plans, the "Taqua Restructuring Initiative"). The Company recorded $1.8 million of restructuring expense in the aggregate in connection with this initiative, comprised of $1.2 million for severance and related costs and $0.6 million related to the elimination of redundant facilities. The actions under the Taqua Restructuring Initiative have been implemented and accordingly, the Company does not expect to record additional expense in connection with this initiative. The amounts accrued for severance and related costs had been fully paid by the end of the third quarter of 2017. The Company expects that the amounts accrued for facilities will be paid by the end of 2018.

In connection with the Taqua Restructuring Initiative, the Company recorded $0.6 million of restructuring expense in the nine months ended September 30, 2017, comprised of $0.2 million for severance and related costs and $0.4 million related to redundant facilities. The Company did not record restructuring expense in the three months ended September 30, 2017. A summary of the Taqua Restructuring Initiative accrual activity for the nine months ended September 30, 2017 is as follows (in thousands):

 
Balance at
January 1,
2017
 
Initiatives
charged to
expense
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at September 30, 2017
Severance
$
384

 
$
245

 
$
(49
)
 
$
(580
)
 
$

Facilities
218

 
370

 

 
(275
)
 
313

 
$
602

 
$
615

 
$
(49
)
 
$
(855
)
 
$
313



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 and restructuring initiative (the "2015 Restructuring Initiative"). A summary of the 2015 Restructuring Initiative accrual activity for the nine months ended September 30, 2017 is as follows (in thousands):

19



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


 
Balance at
January 1,
2017
 
Initiatives
charged to
expense
 
Adjustments for changes in estimate
 
Cash
payments
 
Balance at September 30, 2017
Severance
$
168

 
$

 
$

 
$
(168
)
 
$



Balance Sheet Classification

At September 30, 2017, the Company's restructuring accruals aggregated $0.4 million, of which $0.2 million was included in Other long-term liabilities and represented future lease payments on restructured facilities. At December 31, 2016, the Company's restructuring accruals aggregated $1.3 million, of which approximately $62,000 was included in Other long-term liabilities and represented future lease payments on restructured facilities. The remainder of the restructuring accruals at both September 30, 2017 and December 31, 2016 are included in Accrued expenses in the condensed consolidated balance sheets.


(9) DEBT

The Company maintained 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 entered into on June 27, 2014 (the "Credit Agreement"), which agreement was amended by a First Amendment to Credit Agreement on June 26, 2015 and further amended by a Second Amendment to Credit Agreement on June 13, 2016 (the "Amended Credit Agreement"). The obligations of the Company under the Amended Credit Agreement were guaranteed by Sonus International, Inc., Sonus Federal, Inc., Network Equipment Technologies, Inc. and Taqua (collectively with the Company, the "Loan Parties") pursuant to a Master Continuing Guaranty and were secured by the assets of the Loan Parties pursuant to a Security and Pledge Agreement. The credit facility expired by its terms on June 30, 2017 and was not renewed. The Company did not have any amounts outstanding under the Amended Credit Agreement at December 31, 2016.


(10) COMMON STOCK REPURCHASES

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 funded with the Company's working capital. The Company did not repurchase any shares during the nine months ended September 30, 2017. During the nine months ended September 30, 2016, the Company spent $7.1 million, including transaction fees, to repurchase and retire 0.9 million shares of its common stock under the stock buyback program. At September 30, 2017, the Company had $5.4 million remaining under the stock buyback program for future repurchases.


(11) STOCK-BASED COMPENSATION PLANS

Amended and Restated Stock Incentive Plan

The Company's Amended and Restated Stock Incentive Plan, as amended (the "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.

20



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


At its 2017 annual meeting of stockholders held on June 9, 2017 (the "2017 Annual Meeting"), the Company's stockholders approved amendments to the Plan including, among other things, to:

Increase the aggregate number of shares of the Company's common stock authorized for issuance under the Plan by an additional 900,000 shares;

Make the Plan more explicit by providing that any dividends on unvested restricted stock or with respect to shares of common stock granted under restricted stock units and other stock unit awards will be paid to a participant only if and when such shares become free from the restrictions on transferability and forfeitability that apply to such shares and that any dividend equivalents with respect to restricted stock units and other stock unit awards will be subject to the same vesting conditions and restrictions on transfer and forfeitability applicable to the underlying award with respect to which it is paid. No interest will be paid on any such equivalents or dividend equivalents;

Explicitly require a participant who accepts an award under the Plan to be bound by any clawback policy that the Company has in effect or may adopt in the future; and

Eliminate the requirement that each share of stock subject to an award of restricted stock, restricted stock units, performance awards or other stock unit awards (collectively, "full value awards") be counted against the share reserve as 1.50 shares for every one share subject to such award. This change applies to all full value awards from and after June 9, 2017, the date of the Annual Meeting. Shares of common stock subject to awards that were granted under any prior ratio that applied at the time such awards were granted will continue to return to the Plan upon forfeiture of such awards at the previous applicable ratio.

Executive Equity Arrangements

On March 31, 2017, the Company granted an aggregate of 165,000 PSUs with both market and service conditions to five of its executives (the "2017 PSUs"). The terms of the 2017 PSUs are such that up to one-third of the shares subject to the 2017 PSUs will vest on each of the first, second and third anniversaries of the date of grant (collectively, the "2017 PSU 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 fiscal year, measured by the Compensation Committee after each of the 2017, 2018 and 2019 fiscal years, respectively (as used in this paragraph, 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 2017 PSUs that fail to be earned will be forfeited. The 2017 PSUs include a market condition that required 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 2017 PSUs. Because the 2017 PSUs have market conditions, the Company is required to record expense for the 2017 PSUs through the final 2017 PSU Vesting Date of March 31, 2020, regardless of the number of shares that are ultimately earned.

On April 1, 2016, the Company granted an aggregate of 131,250 PSUs with both market and service conditions to six of its executives (the "2016 PSUs"). The terms of the 2016 PSUs are such that up to one-third of the shares subject to the 2016 PSUs will vest on each of the first, second and third anniversaries of the date of grant (collectively, the "2016 PSU Vesting Dates") to the extent of achievement of the Company's TSR compared to the TSR of the companies included in the NASDAQ Telecommunications Index for the same fiscal year, measured by the Compensation Committee of the Company's Board of Directors (the "Compensation Committee") after each of the 2016, 2017 and 2018 fiscal years, respectively (as used in this paragraph, 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 2016 PSUs that fail to be earned will be forfeited. The 2016 PSUs include a market condition that required 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 2016 PSUs. Because the 2016 PSUs have market conditions, the Company is required to record expense for the 2016 PSUs through the final 2016 PSU Vesting Date of April 1, 2019, regardless of the number of shares that are ultimately earned. In February 2017, the Compensation Committee determined that the performance metrics for the 2016 PSUs for the 2016 Performance Period had been achieved at the 90.4% level, and

21



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

accordingly, 24,106 shares in the aggregate were released to the four executives holding such outstanding grants on March 16, 2017. The unearned shares relating to the 2016 Performance Period, aggregating 2,560 shares, were forfeited on March 16, 2017. These amounts are included in the performance-based units 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 "2015 PSUs"). In 2015, subsequent to the grant date, two executives separated from the Company and, in accordance with their respective employment agreements with the Company, the Company accelerated the vesting of certain unvested 2015 PSUs. The terms of the 2015 PSUs are such that up to one-third of the shares subject to the 2015 PSUs will vest on each of the first, second and third anniversaries of the date of grant (collectively, the "2015 PSU Vesting Dates") to the extent of achievement of the Company's 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 (as used in this paragraph, 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 2015 PSUs that fail to be earned will be forfeited. The 2015 PSUs include a market condition that required the use of a Monte Carlo simulation approach to calculate the grant date fair values of the 2015 PSUs. Because the 2015 PSUs have market conditions, the Company is required to record expense for the 2015 PSUs through the final 2015 PSU Vesting Date of March 16, 2018, regardless of the number of shares that are ultimately earned, if any. In February 2017, the Compensation Committee determined that the performance metrics for the 2015 PSUs for the 2016 Performance Period had been achieved at the 76.0% level, and accordingly, 23,750 shares in the aggregate were released to the four executives holding such outstanding grants on April 1, 2017. The unearned shares relating to the 2016 Performance Period, aggregating 7,500 shares, were forfeited on April 1, 2017. These amounts are included in the performance-based units table below.

Stock Options

The activity related to the Company's outstanding stock options for the nine months ended September 30, 2017 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, 2017
5,610,106

 
$
15.73

 
 
 
 
Granted
6,480

 
$
6.53

 
 
 
 
Exercised
(31,643
)
 
$
4.70

 
 
 
 
Forfeited
(35,107
)
 
$
13.79

 
 
 
 
Expired
(397,690
)
 
$
23.57

 
 
 
 
Outstanding at September 30, 2017
5,152,146

 
$
15.19

 
4.81
 
$
177

Vested or expected to vest at September 30, 2017
5,130,390

 
$
15.21

 
4.79
 
$
172

Exercisable at September 30, 2017
4,824,340

 
$
15.25

 
4.63
 
$
141



The grant date fair values of options to purchase common stock granted in the three and nine months ended September 30, 2017 were estimated using the Black-Scholes valuation model with the following assumptions:
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 30,
2017
Risk-free interest rate
1.81%
 
1.81% - 1.95%
Expected dividends
 
Weighted average volatility
50.7%
 
51.2%
Expected life (years)
5.0
 
5.0


Additional information regarding the Company's stock options for the three and nine months ended September 30, 2017 is

22



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

as follows:
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 30,
2017
Weighted average grant date fair value of stock options granted
$
3.11

 
$
3.00

Total intrinsic value of stock options exercised (in thousands)
$
17

 
$
80

Cash received from the exercise of stock options (in thousands)
$
59

 
$
149



Restricted Stock Awards and Units

The activity related to the Company's RSAs for the nine months ended September 30, 2017 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2017
2,030,028

 
$
9.69

Granted
735,912

 
$
6.86

Vested
(820,632
)
 
$
10.37

Forfeited
(25,426
)
 
$
13.02

Unvested balance at September 30, 2017
1,919,882

 
$
8.28



The activity related to the Company's RSUs for the nine months ended September 30, 2017 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2017
110,219

 
$
11.95

Granted

 
$

Vested
(36,694
)
 
$
7.04

Forfeited
(11,628
)
 
$
8.71

Unvested balance at September 30, 2017
61,897

 
$
7.05



The total fair value of shares of restricted stock granted under RSAs and RSUs that vested during the nine months ended September 30, 2017 was $8.8 million.

Performance-Based Stock Units
 
 
 
 
The activity related to the Company's PSUs for the nine months ended September 30, 2017 is as follows:
 
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested balance at January 1, 2017
147,085

 
$
12.11

Granted
165,000

 
$
8.41

Vested
(47,856
)
 
$
13.04

Forfeited
(10,060
)
 
$
11.87

Unvested balance at September 30, 2017
254,169

 
$
9.54



The total fair value of shares of restricted stock granted under PSUs that vested during the nine months ended September 30, 2017 was $0.6 million.

23



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


The Company did not have outstanding PSAs during the nine months ended September 30, 2017 or at December 31, 2016.

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.

In May 2017, the Compensation Committee determined to suspend all offering periods under the ESPP, effective September 1, 2017 until such time after the closing of the pending merger with GENBAND as the Compensation Committee determines is best in its sole discretion.


Stock-Based Compensation

The condensed consolidated statements of operations include stock-based compensation for the three and nine months ended September 30, 2017 and 2016 as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Product cost of revenue
$
75

 
$
95

 
$
261

 
$
259

Service cost of revenue
199

 
331

 
777

 
985

Research and development
1,095

 
1,298

 
3,650

 
3,687

Sales and marketing
871

 
3,048

 
1,690

 
5,292

General and administrative
1,647

 
1,636

 
5,009

 
5,241

 
$
3,887

 
$
6,408

 
$
11,387

 
$
15,464


During the three months ended March 31, 2017, the Company reversed $1.0 million of incremental expense to correct an error in 2016 related to the acceleration of certain stock awards held by an executive who separated from the Company in 2016. Management had reviewed and considered the impact of the error and determined that it was not material to the Company's consolidated financial results for the third and fourth quarters of 2016, as well as the 2016 fiscal year. Management has also determined that the correction of this error is not material to the results of operations for the 2017 completed reporting periods.

There is no income tax benefit for employee stock-based compensation expense for the nine months ended September 30, 2017 or September 30, 2016 due to the valuation allowance recorded.

At September 30, 2017, there was $15.4 million, net of expected forfeitures, of unrecognized stock-based compensation expense related to unvested stock options, awards, units and ESPP shares. This expense is expected to be recognized over a weighted average period of approximately two years.

In connection with the pending merger with GENBAND, the Company accelerated the vesting of all outstanding stock options and certain outstanding RSAs, RSUs and PSUs. As a result, the Company expects to record incremental stock-based compensation expense in the fourth quarter of 2017 related to these accelerations. Upon consummation of the merger, the shares underlying the accelerated portion of the RSAs, RSUs and PSUs will be issued and the vesting schedules for the remaining unvested RSAs, RSUs and PSUs will be adjusted to reflect this acceleration. Option holders had an opportunity to exercise their stock options, including the accelerated stock options, from October 20, 2017 through October 24, 2017, after which date all remaining outstanding stock options, with certain exceptions, were canceled.



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 at least one of the three or nine month periods ended September 30, 2017 and 2016:
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Verizon Communications Inc.
16%
 
*
 
15%
 
*
AT&T Inc.
11%
 
12%
 
10%
 
13%
_______________________
* Represents less than 10% of revenue


At September 30, 2017, two customers accounted for 10% or more of the Company's accounts receivable balance, representing approximately 30% of the Company's accounts receivable balance in the aggregate. At December 31, 2016, 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 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
United States
75
%
 
70
%
 
71
%
 
69
%
Europe, Middle East and Africa
8

 
14

 
11

 
13

Japan
10

 
7

 
11

 
10

Other Asia Pacific
4

 
5

 
4

 
5

Other
3

 
4

 
3

 
3

 
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 30, 2017 and 2016 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 30, 2017 and 2016 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. Included in the Company's provision for the nine months ended September 30, 2016 is a discrete charge of $0.7 million related to an uncertain tax position of the Company's subsidiary in France.



25



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

(15) COMMITMENTS AND CONTINGENCIES

On July 19, 2017, Taqua Holdings, LLC ("Holdings") filed a lawsuit against the Company, GENBAND, Taqua and several of the Company's merger-related subsidiaries and GENBAND Holdings' merger-related holding companies (collectively, the "Holdings Lawsuit Defendants") in Texas state court, District of Dallas County (Case No. DC-17-08630) based on the parties' Earn-Out Agreement (the "Holdings Complaint") which expressly provides that the Company is to have "the absolute right and sole and absolute discretion to operate and otherwise make decisions with respect to the conduct of the Business." The lawsuit alleges that: (i) the Company purportedly breached the Earn-Out Agreement by implementing a restructuring plan, the Taqua Restructuring Initiative, that was allegedly intended to undermine Taqua's business and the Company's payment obligation; and (ii) the Company purportedly acquired Taqua for the purpose of eliminating Taqua as a competitor before the Company's pending merger with GENBAND (the "GENBAND Merger"), and that the Company never intended to promote Taqua products.

The Holdings Complaint purported to seek monetary damages for the Company's alleged breach of the Earn-Out Agreement (which is described in Note 2 of this Quarterly Report on Form 10-Q and a copy of which is filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 2016) and an injunction of both the Taqua Restructuring Initiative and the GENBAND Merger.

On August 17, 2017, Holdings filed a Motion for Expedited Discovery. On August 18, 2017, the Company filed its Answer and Motion to Compel Arbitration and Stay Proceedings, requesting the Texas state court stay the proceedings in favor of arbitration, as provided by the terms of the Earn-Out Agreement. On August 22, 2017, Holdings filed its Opposition to the Company's Motion to Compel Arbitration and Stay Proceedings. Also on August 22, 2017, the Company filed its Response to Holdings' Motion for Expedited Discovery. On August 24, 2017, the Company filed a Reply in Support of its Motion to Compel Arbitration and Stay Proceedings. On August 25, 2017, a hearing was held on: (i) Holdings' Motion for Expedited Discovery and (ii) the Company's Motion to Compel Arbitration and Stay Proceedings. On August 29, 2017, the Texas state court denied Holdings' Motion for Expedited Discovery and granted the Company's Motion to Compel Arbitration and Stay Proceedings. Therefore, as of August 29, 2017, this lawsuit is stayed until further order of the court. Pursuant to the Membership Interest Purchase Agreement between the parties, dated September 26, 2016, the Company and Holdings have initiated non-binding mediation in an attempt to resolve this dispute. The Company does not expect the results of this suit to have a material adverse effect on its business or consolidated financial statements.

The Company is fully cooperating with an SEC inquiry regarding the development and issuance of the Company's first quarter 2015 revenue and earnings guidance. Based on recent communications with the SEC's Division of Enforcement (the "Staff"), the Company currently expects the Staff to seek approval of the SEC commissioners to initiate proceedings alleging securities law violations, including violations of Section 10(b) and 17(a) of the Exchange Act with respect to the development and issuance of the Company's first quarter 2015 revenue and earnings guidance which the Staff believes, based on its assessment of the matter, would warrant a $3.1 million fine against the Company. The Company believes the allegations are without merit and intends to vigorously contest the matter and the Staff's view. The Company recorded $1.6 million in the three months ended September 30, 2017 for potential fines in connection with this investigation.

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.


(16) SUBSEQUENT EVENTS

On October 26, 2017, the Company held the Special Stockholders' Meeting, at which the Company's stockholders voted to, among other things, adopt the Merger Agreement. The Company expects that the Mergers will be consummated on Friday, October 27, 2017.

On October 23, 2017, in connection with the pending merger with GENBAND, the Company committed to a restructuring initiative to reduce its post-transaction workforce by approximately 350 people, or approximately 15%, of combined Sonus and GENBAND employees worldwide. Cash expenditures of approximately $10 million to $12 million are anticipated to be

26



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

incurred for severance and related costs. The actions are expected to be substantially completed by the end of 2018. Annual cash savings of approximately $45 million are anticipated as a result of this restructuring initiative.


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, 2016, which was filed with the U.S. Securities and Exchange Commission on February 27, 2017.

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 secure and unify their real-time communications infrastructures. We help 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 Internet Protocol ("VoIP"), Voice over WiFi ("VoWiFi"), video and Unified Communications ("UC") by securing and enabling reliable and scalable Internet Protocol ("IP") networks. Our products include session border controllers ("SBCs"), diameter signaling controllers ("DSCs") and VoWiFi solutions, which are supported by a global services team with experience in design, deployment and maintenance of some of the world's largest IP networks.

Our solutions provide a secure way for our customers to 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 realize the intended value and benefits of UC platforms by enabling disparate communications environments, commonplace in most enterprises today, to work seamlessly together. Likewise, our solutions secure the evolution to cloud-based delivery of UC solutions - both for service providers transforming to a cloud-based network and for enterprises using cloud-based UC.

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

We have traditionally sold our products through a global direct sales force, with additional sales support from regional channel partners throughout the world. Our channel partner program, Sonus Partner Assure, expands our coverage of the service provider and enterprise markets.

Business Acquisition

On September 26, 2016 (the "Taqua Acquisition Date"), we acquired Taqua, LLC ("Taqua"), a leading supplier of IP communications systems, applications and services to mobile and fixed operators. Taqua enables the transformation of software-based service provider networks to deliver next-generation voice, video and messaging services, including VoIP, VoWiFi and Voice over Long-Term Evolution ("VoLTE"). The acquisition of Taqua has, among other things, accelerated our mobile strategy by adding a Virtualized Mobile Core ("VMC") Platform and an IP Multimedia Subsystem ("IMS") Service Core and expanded our fixed portfolio by adding a Class 5 Softswitch (the T7000) for Network Transformation projects and a Multimedia Controller used in IP Peering applications (the T7100), both of which are complementary to our current product offerings. In consideration for the acquisition of Taqua, we paid $19.9 million in cash to the sellers on the Taqua Acquisition Date, net of cash acquired. We also entered into an Earn-Out Agreement, dated as of September 26, 2016, with Taqua

27



Holdings, LLC and Jeffrey L. Brawner, the seller representative in the transaction, under which there is the potential for additional cash payments to the sellers if certain annual revenue thresholds are exceeded as measured annually through 2020. Based on historical and forecasted sales, no incremental contingent consideration was recorded as of either September 30, 2017 or December 31, 2016. The financial results of Taqua are included in our condensed consolidated financial statements starting on the Taqua Acquisition Date.

Pending Merger

On May 23, 2017, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with (i)_Solstice Sapphire Investments, Inc. ("NewCo") and its wholly-owned subsidiaries and (ii) GENBAND Holdings Company ("GENBAND") and two related holding companies such that, following a series of merger transactions (collectively, the "Mergers"), both the Company and GENBAND will each become a wholly-owned subsidiary of NewCo. Our former stockholders will own approximately 50%, and former shareholders of GENBAND will own approximately 50%, of the shares of NewCo common stock issued and outstanding immediately following the consummation of the Mergers.

GENBAND is a Cayman Islands exempted company limited by shares that was formed on April 7, 2010.  Through its wholly owned operating subsidiaries, GENBAND creates rapid communications and applications for service providers, enterprises, independent software vendors, system integrators and developers globally. A majority of GENBAND's shares are held by funds affiliated with One Equity Partners. GENBAND shares are not listed on an exchange or quoted on any automated services, and there is no established trading market for GENBAND shares.

We believe that Sonus' and GENBAND's complementary products, solutions and strategies position the combined company to deliver comprehensive solutions to service providers and enterprises migrating to a virtualized all-IP environment in an expanded customer and global footprint.

Pursuant to the Merger Agreement, NewCo will issue shares to the GENBAND equity holders, with the number of shares issued in the aggregate to the GENBAND equity holders equal to the number of shares of the Company’s common stock outstanding immediately prior to the closing date of the Mergers. In addition, NewCo will repay GENBAND’s long-term debt, including both principal and unpaid interest, to a related party totaling approximately $48 million and repay GENBAND’s management fees due to a representative of a majority shareholder totaling $10.3 million. NewCo will also pay an estimated $9.0 million of NewCo's transaction fees incurred in connection with the Mergers and issue a promissory note for $22.5 million to certain GENBAND equity holders.

NewCo will assume the liability under GENBAND's revolving credit facility with Silicon Valley Bank (the "GENBAND facility"), which had outstanding borrowings and letters of credit totaling $18.0 million and $2.9 million, respectively, at October 26, 2017. At October 26, 2017, the outstanding borrowings had an average interest rate of 4.67%.

Our Board of Directors unanimously approved the Merger Agreement and the transactions contemplated thereby. A special meeting of the Company's stockholders was held on Thursday, October 26, 2017, at which our stockholders voted to, among other things, approve the Merger Agreement. The Company expects that the Mergers will be consummated on Friday, October 27, 2017.

Corporate Strategy

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

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

28



pursuing strategic transactions and alliances;
successfully implementing our cost reduction initiatives; and
delivering sustainable profitability by continuing to improve our overall performance.

Financial Overview

Restructuring and Cost Reduction Initiatives

We are, and have been, committed to streamlining our operations and reducing our operating costs.

To better align our cost structure to our then-current revenue expectations, in April 2015, we announced a cost reduction review and consequently, initiated a restructuring plan to reduce our workforce (the "2015 Restructuring Initiative"). At December 31, 2016, we had $168,000 accrued in connection with this initiative, which was paid in the first quarter of 2017.

2016 Restructuring Initiative

In July 2016, we announced a program to further accelerate our investment in new technologies as the communications industry migrates to a cloud-based architecture (the "2016 Restructuring Initiative"), and that we planned to utilize most of the savings from this initiative to shift headcount toward new strategic initiatives, such as new products and an expanded go-to-market footprint in selected geographies and discrete vertical markets. We recorded $2.0 million of restructuring expense in the aggregate in connection with this initiative, comprised of $1.9 million for severance and related costs and $0.1 million to abandon our facility in Rochester, New York (the "Rochester Facility"). The actions under the 2016 Restructuring Initiative have been implemented and accordingly, we do not expect to record additional expense in connection with this initiative. The amounts accrued for severance and related costs had been fully paid by the end of the third quarter of 2017. We expect that the remaining amount accrued for facilities will be paid by the end of October 2019, when the lease on the Rochester Facility expires.

In connection with the 2016 Restructuring Initiative, we recorded $0.5 million of restructuring expense in the nine months ended September 30, 2017. We did not record restructuring expense in the three months ended September 30, 2017. The expense recorded in the nine months ended September 30, 2017 is comprised of $0.4 million for severance and related costs and $0.1 million related to the Rochester Facility.

Taqua Restructuring Initiative

In connection with the acquisition of Taqua, our management approved a restructuring plan in the third quarter of 2016 to eliminate certain redundant positions within the combined companies. On October 24, 2016, the Audit Committee of our Board of Directors approved a broader Taqua restructuring plan related to headcount and redundant facilities (both restructuring plans, the "Taqua Restructuring Initiative"). We recorded $1.8 million of restructuring expense in the aggregate in connection with this initiative, comprised of $1.2 million for severance and related costs and $0.6 million related to the elimination of redundant facilities. The actions under the Taqua Restructuring Initiative have been implemented and accordingly, we do not expect to record additional expense in connection with this initiative. The amounts accrued for severance and related costs had been fully paid by the end of the third quarter of 2017. We expect that the remaining amount accrued for facilities will be paid by the end of 2018.

In connection with the Taqua Restructuring Initiative, we recorded $0.6 million of restructuring expense in the nine months ended September 30, 2017, comprised of $0.2 million for severance and related costs and $0.4 million related to redundant facilities. We did not record restructuring expense in the three months ended September 30, 2017.

Financial Results

Our revenue was $74.6 million in the three months ended September 30, 2017 and $65.0 million in the three months ended September 30, 2016. Our revenue was $183.7 million in the nine months ended September 30, 2017 and $185.0 million in the nine months ended September 30, 2016.

Our gross profit was $54.5 million in the three months ended September 30, 2017 and $43.6 million in the three months ended September 30, 2016. Our gross profit was $124.7 million in the nine months ended September 30, 2017 and $122.2 million in the nine months ended September 30, 2016. Our gross profit as a percentage of revenue ("total gross margin") was 73.1% in the three months ended September 30, 2017 and 67.0% in the three months ended September 30, 2016. Our total

29



gross margin was 67.9% in the nine months ended September 30, 2017 and 66.1% in the nine months ended September 30, 2016.

Our operating expenses were $50.6 million in the three months ended September 30, 2017 and $47.9 million in the three months ended September 30, 2016. Our operating expenses were $144.3 million in the nine months ended September 30, 2017 and $133.1 million in the nine months ended September 30, 2016. Operating expenses for the three months ended September 30, 2017 included $1.5 million of acquisition-related expense and $0.2 million of merger integration expense, both in connection with the pending merger with GENBAND. Operating expenses for the nine months ended September 30, 2017 included $1.1 million of restructuring expense as described above, $6.3 million of acquisition-related expense and $0.2 million of merger integration expense. The acquisition-related expense for the nine months ended September 30, 2017 is comprised of $6.2 million in connection with the pending merger with GENBAND and $0.1 million in connection with our acquisition of Taqua. The merger integration expense relates to the pending merger with GENBAND. The merger integration expense in both the three and nine months ended September 30, 2017 is included as a component of General and Administrative expense. We recorded $1.6 million of restructuring expense in both the three and nine months ended September 30, 2016, comprised of $1.2 million related to our 2016 Restructuring Initiative and $0.4 million related our Taqua Restructuring Initiative. We recorded $1.0 million of acquisition-related expense in both the three and nine months ended September 30, 2016 for professional fees, primarily legal fees, in connection with the acquisition of Taqua.

We recorded stock-based compensation expense of $3.9 million in the three months ended September 30, 2017 and $6.4 million in the three months ended September 30, 2016. We recorded stock-based compensation expense of $11.4 million in the nine months ended September 30, 2017 and $15.5 million in the nine months ended September 30, 2016. These amounts are included as components of both Cost of revenue and Operating expenses in our condensed consolidated statements of operations. In connection with the pending merger with GENBAND, we accelerated the vesting of all outstanding stock options and certain outstanding RSAs, RSUs and PSUs. As a result, we expect to record incremental stock-based compensation expense in the fourth quarter of 2017 related to these accelerations. Upon consummation of the merger, the shares underlying the accelerated portion of the RSAs, RSUs and PSUs will be issued and the vesting schedules for the remaining unvested RSAs, RSUs and PSUs will be adjusted to reflect this acceleration. Option holders had an opportunity to exercise their stock options, including the accelerated options, from October 20, 2017 through October 24, 2017, after which date all remaining outstanding stock options, with certain exceptions, were canceled.

The Compensation Committee of our Board of Directors (the "Compensation Committee") elected to reallocate the payment schedule in connection with our company-wide cash bonus program. For the year ended December 31, 2016, payment of 30% of the target bonus was allocable to achievement for the first half of the year, with 70% of the target bonus allocable to achievement for the second half of the year. For the year ended December 31, 2017, the Compensation Committee changed this allocation to 20% of the target bonus for the first half of the year and 80% of the target bonus for the second half of the year. As a result, we recorded less bonus expense in the first half of 2017 compared to the first half of 2016, with higher expense anticipated to be recorded in the second half of 2017 compared to the second half of 2016.

We reported income from operations of $3.9 million for the three months ended September 30, 2017 and a loss from operations of $4.3 million for the three months ended September 30, 2016. We reported losses from operations of $19.6 million for the nine months ended September 30, 2017 and $10.9 million for the nine months ended September 30, 2016.

We reported net income of $3.5 million for the three months ended September 30, 2017 and a net loss of $3.7 million for the three months ended September 30, 2016. We reported net losses of $19.5 million for the nine months ended September 30, 2017 and $11.3 million for the nine months ended September 30, 2016.

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

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

30



consolidated financial statements. The significant accounting policies that we believe are the most critical include the following:

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

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, 2016. There were no significant changes to our critical accounting policies from December 31, 2016 through September 30, 2017.


Results of Operations

Three and nine months ended September 30, 2017 and 2016

Any forward-looking statements regarding revenue, costs, gross margins and expenses in this "Results of Operations" discussion do not include the potential impact of the pending merger with GENBAND.

Revenue. Revenue for the three and nine months ended September 30, 2017 and 2016 was as follows (in thousands, except percentages):
 
Three months ended
 
Increase
from prior year
 
September 30,
2017
 
September 30,
2016
 
$
 
%
Product
$
44,120

 
$
38,601

 
$
5,519

 
14.3
%
Service
30,509

 
26,410

 
4,099

 
15.5
%
Total revenue
$
74,629

 
$
65,011

 
$
9,618

 
14.8
%


 
Nine months ended
 
Increase (decrease)
from prior year
 
September 30,
2017
 
September 30,
2016
 
$
 
%
Product
$
98,305

 
$
108,719

 
$
(10,414
)
 
(9.6
)%
Service
85,425

 
76,300

 
9,125

 
12.0
 %
Total revenue
$
183,730

 
$
185,019

 
$
(1,289
)
 
(0.7
)%


Product revenue is comprised of sales of our communication infrastructure products.

The increase in product revenue in the three months ended September 30, 2017 compared to the three months ended September 30, 2016 was primarily the result of higher sales of certain of our newer product offerings aggregating $11.4 million, including approximately $7 million of product revenue from a major customer, and $1.6 million related to products from our acquisition of Taqua. These increases were partially offset by $7.5 million of net decreases in sales of our older product offerings.

The decrease in product revenue in the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016 was primarily the result of lower sales of certain of our older products aggregating $22.6 million, partially offset by higher sales of certain of our newer product offerings aggregating $9.0 million and a $3.1 million increase related to products from our acquisition of Taqua.

Approximately 24% of our total product revenue in the three months ended September 30, 2017 was from indirect sales through our channel partner program, compared to approximately 32% in the three months ended September 30, 2016.

31



Approximately 29% of our total product revenue was from indirect sales through our channel partner program in the nine months ended September 30, 2017, compared to approximately 26% in the nine months ended September 30, 2016.

Our product revenue from sales to enterprise customers was approximately 22% of our total product revenue in the three months ended September 30, 2017, compared to approximately 21% in the three months ended September 30, 2016. Our product revenue from sales to enterprise customers was approximately 24% of our total product revenue in the nine months ended September 30, 2017, compared to approximately 20% in the nine months ended September 30, 2016. These sales were made both through our direct sales team and indirect sales channel partners.

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. These complex arrangements are generally completed through our direct sales force.

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 30, 2017 and 2016 was comprised of the following (in thousands, except percentages):
 
Three months ended
 
Increase
from prior year
 
September 30,
2017
 
September 30,
2016
 
$
 
%
Maintenance
$
24,256

 
$
22,263

 
$
1,993

 
9.0
%
Professional services
6,253

 
4,147

 
2,106

 
50.8
%
 
$
30,509

 
$
26,410

 
$
4,099

 
15.5
%


 
Nine months ended
 
Increase
from prior year
 
September 30,
2017
 
September 30,
2016
 
$
 
%
Maintenance
$
69,198

 
$
64,290

 
$
4,908

 
7.6
%
Professional services
16,227

 
12,010

 
4,217

 
35.1
%
 
$
85,425

 
$
76,300

 
$
9,125

 
12.0
%


Our maintenance revenue increased in both the three and nine months ended September 30, 2017 compared to the three and nine months ended September 30, 2016, respectively, primarily due to the inclusion of maintenance revenue from our Taqua acquisition. Maintenance revenue attributable to our Taqua acquisition accounted for increases in maintenance revenue of $1.7 million in the three months ended September 30, 2017 and $4.7 million in the nine months ended September 30, 2017 compared to the same prior year periods.

The increase in our professional services revenue in the three months ended September 30, 2017 compared to the three months ended September 30, 2016 was primarily due to the higher number of projects completed in the current year quarter compared to the same prior year quarter, including a large project with a major customer. The increase in our professional services revenue in the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016 was primarily due to higher-than-usual revenue resulting from the completion of several large projects in the first and third quarters of 2017, including the aforementioned major customer project, which more than offset the decline in professional services revenue in the second quarter of 2017 compared to the second quarter of 2016.

The timing of the completion of projects for revenue recognition, customer payments and maintenance contracts may cause our service revenue to fluctuate from one period to the next.

The following customers contributed 10% or more of our revenue in at least one of the three or nine month periods ended September 30, 2017 and September 30, 2016:

32



 
Three months ended
 
Nine months ended
Customer
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Verizon Communications Inc.
16%
 
*
 
15%
 
*
AT&T Inc.
11%
 
12%
 
10%
 
13%
_______________________
* Represents less than 10% of revenue

Our 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 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
United States
75
%
 
70
%
 
71
%
 
69
%
Europe, Middle East and Africa
8

 
14

 
11

 
13

Japan
10

 
7

 
11

 
10

Other Asia Pacific
4

 
5

 
4

 
5

Other
3

 
4

 
3

 
3

 
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.

Our deferred product revenue was $11.2 million at September 30, 2017 and $6.9 million at December 31, 2016. Our deferred service revenue was $43.8 million at September 30, 2017 and $43.8 million at December 31, 2016. 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.

We expect that our product revenue in 2017 will decrease compared to 2016 levels, primarily due to continued consolidation among our customers and their suppliers. We will continue to focus on expanding our product offerings to address the emerging UC and IP-based markets in both the enterprise and service provider markets, which we believe are aligned with the technology strategies of our customers.

We expect that our service revenue in 2017 will increase from 2016 levels as a result of the continued growth of our installed customer base, coupled with the full year impact of maintenance revenue from our acquisition of Taqua.

Overall, we expect that total revenue in 2017 will be flat compared to 2016 total revenue.

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 30, 2017 and 2016 were as follows (in thousands, except percentages):
 
Three months ended
 
Increase (decrease)
from prior year
 
September 30,
2017
 
September 30,
2016
 
$
 
%
Cost of revenue
 
 
 
 
 
 
 
Product
$
9,708

 
$
12,285

 
$
(2,577
)
 
(21.0
)%
Service
10,374

 
9,140

 
1,234

 
13.5
 %
Total cost of revenue
$
20,082

 
$
21,425

 
$
(1,343
)
 
(6.3
)%
Gross margin
 
 
 
 
 
 
 
Product
78.0
%
 
68.2
%
 
 
 
 
Service
66.0
%
 
65.4
%
 
 
 
 
Total gross margin
73.1
%
 
67.0
%
 
 
 
 



33



 
Nine months ended
 
Increase (decrease)
from prior year
 
September 30,
2017
 
September 30,
2016
 
$
 
%
Cost of revenue
 
 
 
 
 
 
 
Product
$
28,748

 
$
35,230

 
$
(6,482
)
 
(18.4
)%
Service
30,285

 
27,572

 
2,713

 
9.8
 %
Total cost of revenue
$
59,033

 
$
62,802