10-Q/A 1 sc10-qa043002.txt FORM 10-Q/A SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q/A Amendment No. 1 Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For Quarterly Period Ended April 30, 2002 Commission File Number 1-13851 Sonus Corp. (Exact name of registrant as specified in its charter) Yukon Territory, Canada Not Applicable (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 111 S.W. Fifth Avenue, Suite 1620, Portland, Oregon 97204 (Address of principal executive offices) Registrant's telephone number, including area code: 503-225-9152 Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 6,127,228 Common Shares, without par or nominal value, outstanding as of June 10, 2002. FORWARD-LOOKING STATEMENTS Statements in this report, to the extent they are not based on historical events, constitute forward-looking statements. Forward-looking statements include, without limitation, statements containing the words "believes," "anticipates," "intends," "expects," and words of similar import. Investors are cautioned that forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance, or achievements of Sonus Corp. (the "Company") to be materially different from those described herein. Factors that may result in such variance, in addition to those accompanying the forward-looking statements, include economic trends in the Company's market areas, the ability of the Company to manage its growth and integrate new acquisitions into its network of hearing care centers, development of new or improved medical or surgical treatments for hearing loss or of technological advances in hearing instruments, changes in the application or interpretation of applicable government laws and regulations, the ability of the Company to complete additional acquisitions of hearing care centers on terms favorable to the Company, the degree of consolidation in the hearing care industry, the Company's success in attracting and retaining qualified audiologists and staff to operate its hearing care centers, the ability of the Company to attract audiology centers as licensees under The Sonus Network, product and professional liability claims brought against the Company that exceed its insurance coverage, the Company's ability to collect its accounts receivable in a timely manner, and the availability of and costs associated with potential sources of financing. The Company disclaims any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-looking statements contained herein to reflect future events or developments. PART I FINANCIAL INFORMATION ITEM 1. Financial Statements. -2- SONUS CORP. CONSOLIDATED BALANCE SHEETS (in thousands, except share data) April 30, July 31, 2002 2001 ---------- --------- (unaudited) ASSETS Current assets: Cash and cash equivalents $ 2,050 $ 1,317 Restricted cash and cash equivalents 661 3,870 Restricted securities available for sale --- 1,006 Accounts receivable, net of allowance for doubtful accounts of $1,546 and $1,501, respectively 3,420 4,797 Inventory, net 621 1,073 Prepaid expenses 707 665 Other receivables 2,237 2,419 --------- --------- Total current assets 9,696 15,147 Property and equipment, net 5,006 6,357 Goodwill, net 15,877 17,419 Covenants not to compete, net 947 1,142 Other assets 691 234 --------- --------- $ 32,217 $ 40,299 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 7,059 $ 8,382 Customer deposits 208 378 Bank loans 200 600 Accrued payroll 1,760 1,889 Other accrued liabilities 793 1,462 Deferred revenue 1,663 1,763 Note payable to related party 1,500 --- Capital lease obligations, current portion 286 261 Long-term debt, current portion 1,709 5,820 --------- --------- Total current liabilities 15,178 20,555 Deferred revenue 866 854 Capital lease obligations, less current portion 414 201 Long-term debt, less current portion 607 660 --------- --------- Total liabilities 17,065 22,270 --------- --------- Shareholders' equity: Series A convertible preferred stock, no par value per share, 2,666,666 shares authorized, issued, and outstanding (liquidation preference of $21,915) 15,701 15,701 Series B convertible preferred stock, no par value per share, 2,500,000 shares authorized, issued, and outstanding (liquidation preference of $12,161) 16,628 15,661 Common stock, no par value per share, unlimited number of shares authorized, 6,127,228 issued and outstanding (6,156,164 at July 31, 2001) 8,078 9,095 Notes receivable from shareholders --- (168) Accumulated deficit (25,002) (22,055) Accumulated other comprehensive loss (253) (205) --------- --------- Total shareholders' equity 15,152 18,029 --------- --------- $ 32,217 $ 40,299 ========= ========= See accompanying notes to consolidated financial statements. -3- SONUS CORP. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (Unaudited)

See accompanying notes to consolidated financial statements. -4- SONUS CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited)

-5- SONUS CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Interim Financial Statements The interim consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 2001. All adjustments, consisting only of normal recurring adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented have been made. 2. Comprehensive Loss

-6- 3. Segment Information The Company has a single operating segment: the sale and servicing of hearing instruments and the provision of audiology services primarily to individual consumers. No customer constituted more than 10% of total revenues. Revenues by country were as follows:

At April 30, 2002 and July 31, 2001, the net assets of the Company located in Canada totaled $1,303,000 and $1,404,000, respectively. 4. Indebtedness At April 30, 2002, the Company owed $200,000 to a commercial bank, U.S. Bank National Association. The Company is making monthly interest payments on the loan, which is due and payable, and negotiating with the bank regarding the terms of repayment of the principal amount. At April 30, 2002, the Company was indebted to its major shareholder, Warburg Pincus Ventures, L.P., in the amount of $1,500,000 pursuant to an unsecured promissory note dated December 19, 2002. The note bears interest at 10% per annum and is due on June 19, 2002. The Company is currently negotiating to have $750,000 of the debt extended beyond June 19, 2002. The Company, through its subsidiary Sonus-USA, Inc., has entered into a credit agreement (the "Credit Agreement") with GN Great Nordic A/S, an affiliate of one of the Company's major hearing instrument suppliers. The Credit Agreement, which has a term of seven years, provides for borrowings up to $20,000,000 for the purpose of acquiring hearing care practices. Borrowings bear interest at 6% and may be made until May 31, 2006. No repayment of principal is required during the first two years of the Credit Agreement ending May 31, 2003, after which repayments of principal equal to 20% of the unpaid principal amount existing as of the immediately preceding May 31 are due during each year ending May 31, 2004, 2005, 2006, 2007, and 2008, when the remaining balance is due in full. As of April 30, 2002, the amount outstanding under the Credit Agreement was $1,000,000. Sonus-USA, Inc. has pledged as security for borrowings under the Credit Agreement all accounts, inventory, general intangibles, -7- chattel paper, and interests in subsidiaries formed to hold assets acquired with the proceeds of borrowings ("Acquisition Subsidiaries"). In addition, such Acquisition Subsidiaries have pledged as security all inventory, general intangibles, documents, instruments, equipment, investment property, collateral accounts, and books and records (including customer lists) acquired with the proceeds of borrowings. The line of credit requires the Company to comply with certain financial and non-financial covenants. At April 30, 2002, the Company was in violation of the fixed charge coverage ratio covenant under the Credit Agreement, giving the lender the right to terminate the Credit Agreement and declare the entire outstanding balance to be immediately due and payable. Therefore, the entire $1,000,000 balance outstanding at April 30, 2002, was classified as short-term. At April 30, 2002, the Company had restricted cash and cash equivalents of $361,000 as a result of borrowings under the Credit Agreement. 5. Income Taxes Due to net operating loss carryforwards for tax purposes, and a taxable loss, no income tax provision is recorded for the three and nine-month periods ended April 30, 2002 and 2001. 6. Restatement During the fourth quarter of the year ended July 31, 2001, the Company changed its method of accounting for revenue recognition retroactively to August 1, 2000. Based on guidance provided in Securities and Exchange Commission Staff Accounting Bulletin 101 ("SAB 101"), the Company concluded that when the sale of a hearing instrument is coupled with the performance of future services or obligations for free batteries, revenue related to the fair value of the obligations should be deferred and recognized as revenue as the obligations are discharged. The Company's previous revenue recognition policy was to recognize all revenue upon the sale of hearing instruments, including post-sales services, at the time the hearing instrument was delivered and to accrue the cost of estimated battery replacement. In accordance with SAB 101, the Company recorded a non-cash charge of $2,114,000 (or $0.35 per share, basic and diluted) to reflect the cumulative effect of the change as of August 1, 2000. Deferred revenue of $172,000 and $298,000 included in the cumulative effect was recognized as revenue in the three months ended April 30, 2002 and 2001, respectively, and deferred revenue of $612,000 and $1,056,000 included in the cumulative effect was recognized as revenue in the nine months ended April 30, 2002 and 2001, respectively. In addition to the change in its method of accounting described above, during the fourth quarter of the year ended July 31, 2001, the Company made other adjustments that were material to the results of the quarter ended April 30, 2001. These adjustments related to the recording of beneficial conversion and deemed dividends on convertible securities and an additional accrual for marketing expenses based on changes in management's estimates. Also, during the July 31, 2001 year-end closing process management determined that the Company's accounts receivable were misstated as a result of internal control deficiencies in accounts receivable and billing systems throughout fiscal year 2001. These deficiencies were primarily related to failure to: (1) Update contractual allowances for most current collection experience, -8- (2) Send reimbursement invoices to insurers in a timely manner resulting in an inability to maximize collections, (3) Write-off residual balances remaining in accounts receivable after payments from insurance carriers had been received, and (4) Adjust receivables recorded from one payor (State of California Medi-Cal program ) that could not be collected because certain of the Company's hearing care providers were not credentialed to bill Medi-Cal. Because of the nature of the above factors the Company concluded that the adjustment was a result of the correction of an error rather than a change in estimate, and therefore restatement of the first three quarters of 2001 was appropriate. The adjustments described above increased and (decreased) the net loss attributable to common shareholders for the three and nine-month periods ended April 30, 2001, as follows:

These adjustments increased the net loss per share attributable to common shareholders (basic and diluted) by $0.18 and $1.98 for the three and nine-month periods ended April 30, 2001, and increased the Company's accumulated deficit as of April 30, 2001, by $5,013,000. 7. Dispositions During the nine months ended April 30, 2002, the Company sold nine hearing care centers in six separate transactions. The consideration received by the Company consisted of cash payments of $37,000, promissory notes of $469,000 payable over three to five years, and the assumption of Company liabilities of $9,000. During this period, the Company also closed six centers. As a result of the sales and closures, the Company wrote-off of $133,000 in property and equipment, $38,000 in other assets, and $989,000 in goodwill, and recorded an aggregate loss of $645,000. 8. Litigation -9- Since June 2001, the Company has been engaged in a lawsuit against Siemens Hearing Instruments, Inc. ("Siemens") for breach of a hearing instrument supply agreement. The lawsuit seeks damages in excess of $2,190,000. Siemens has filed a counterclaim against the Company alleging that Siemens is owed $920,000 for hearing instruments purchased by the Company on account, $104,000 for failure to pay a promissory note assumed by the Company, $340,000 for consignment inventory, and $200,000 plus accrued interest for an alleged advance. As this litigation is in the early states of discovery, management, in consultation with outside legal counsel, has not finalized an opinion as to the ultimate outcome. 9. Separation Agreement On March 22, 2002, Brandon M. Dawson resigned as Chairman of the Board of Directors of the Company. In connection with his resignation, the Company entered into a Separation Agreement and Release of Claims (the "Separation Agreement") with Mr. Dawson that provides for severance pay in the amount of $540,000, payable in substantially equal installments so long as Mr. Dawson fulfills his commitment not to compete with the Company. Mr. Dawson may terminate the noncompetition agreement after March 22, 2003 or on the occurrence of certain events as described in the Separation Agreement. The Company is recognizing this severance expense ratably over the term of the Severance Agreement. Mr. Dawson was also granted an employee option to purchase 400,000 common shares of the Company at an exercise price of $0.38 per share. The Separation Agreement provides that Mr. Dawson, at any time on or prior to March 22, 2004 may, upon the occurrence of events as defined in the Separation Agreement including a change in control of the Company, require the Company to purchase up to 865,000 common shares of Sonus Corp. at a price of $1.50 per share plus the amount of any severance that remains to be paid to Mr. Dawson at the time the Company purchases his common shares (the "Put Option"). The Company may record a charge to operations if an event occurs which would allow Mr. Dawson to exercise the Put Option. 10. Computation of Loss Per Share Basic and diluted loss per share are computed using the weighted-average number of common shares outstanding during the period. Common stock equivalent shares are excluded from the computation of diluted loss per share because their effect is anti-dilutive due to the Company's net losses. 11. Subsequent Event Subsequent to April 30, 2002, the Company settled a professional negligence lawsuit against it and one of its former employees for the sum of $150,000, $25,000 of which was covered by insurance. Of the $125,000 payable by the Company, $62,500 is due currently and $62,500 is due on or before January 7, 2003. -10- ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Critical Accounting Policies and Estimates The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect amounts reported in the financial statements. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of the financial statements. Revenue Recognition. The Company recognizes revenue from the sale of products at the time of delivery of the product and acceptance by the customer. Amounts received from customers in advance of the delivery of the products are recorded as customer deposits. Revenue from diagnostic hearing care services is recognized at the date the service is performed. Revenue from the sale of hearing instrument products under contracts with managed care groups and corporate health care organizations is recognized at the time of delivery and acceptance by the patient at the contracted rates. The Company also acts as a third party administrator and submits claims on behalf of service providers under contracts with managed care groups and corporate health care organizations. Revenue from administering providers' claims is recognized when claims are processed and submitted to the insurance carrier and repaid to the providers. Under certain product sales, the customer receives the right to future hearing care and diagnostic services and free batteries. The Company defers revenue related to these obligations based on their fair value and recognizes such revenue over one to three years, the period during which the obligations are discharged. Revenue related to revenue sharing arrangements with respect to supplier sales to members of The Sonus Network is recognized when the hearing instrument product is shipped to the member. Such revenue is also reduced by a provision for estimated returns as members may return hearing instrument products to the supplier and obtain a full refund. The provision for estimated returns is based upon historical product return rates. Revenue from the sale of extended warranties is deferred and recognized over the one-year term of the warranties. The Company does not receive any initial or continuing licensing fees from licensees who are members of The Sonus Network. Consequently, no revenue is recorded related to these activities. A portion of the Company's revenue is from third-party insurers and government agencies. Any restrictions imposed by these parties on the frequency with which hearing products may be replaced or upgraded or services may be obtained, or any decreases in the amounts reimbursed will have a negative impact on the Company's operating results. In addition, a portion of the Company's revenue comes from the Medicare and Medicaid programs. Laws and regulations governing these programs are complex and subject to interpretation. Any failure or alleged failure of the Company to comply with the applicable laws and regulations of these programs could result in sanction or penalties, including exclusion of the Company from participation in these and other government health care programs. -11- Allowance for Contractual Adjustments and Reserve for Sales Returns. In order to reduce gross product and service revenue to the estimated net realizable amounts due from customers, the Company estimates an allowance for contractual adjustments in the period products are sold and diagnostic hearing services are provided. Gross product revenue is also reduced by a provision for estimated sales returns at the time of sale. These estimates may change by a material amount in the future. The allowance for contractual adjustments and the reserve for sales returns are adjusted in future periods as final settlements with third parties are determined. Allowance for Doubtful Accounts. The Company maintains an allowance for doubtful accounts based on historical collections of accounts receivable. The primary risk of collection is with self-pay customer accounts where primary insurance has paid a portion of the bill but the customer is responsible for the remaining balance. The Company continually monitors its accounts receivable balances. If the financial condition of the self-pay customers deteriorates, additional allowances may be required. Goodwill and Intangible Asset Impairment. In assessing the recoverability of the Company's goodwill and other intangibles, the Company makes certain assumptions regarding estimated future cash flows and the determination of related estimated useful lives. Changes in the Company's strategy or market conditions may result in the Company recording an impairment charge for these assets. To date, the Company has recorded impairment charges of $106,000. The Company will adopt the provisions of Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangibles Assets" ("SFAS No. 142") and Statement of Financial Accounting Standard No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144") effective August 1, 2002. The adoption of SFAS No. 142 will be accounted for as a cumulative effect of change in accounting principle. Because any charge resulting from the adoption of SFAS No. 142 is highly dependent upon the market value of the Company's capital stock at the date of adoption, the Company is unable to determine the impact, if any, that such adoption will have on its results. Adoption of SFAS No. 142 will also cause the Company to cease the amortization of goodwill, which totaled $331,000 and $1,035,000 for the three and nine-month periods ended April 30, 2002, respectively. The Company is currently assessing the impact of SFAS No. 144. -12- Legal Contingencies. The Company is subject to various lawsuits and claims incidental to its business, including professional liability claims. To mitigate a portion of this risk the Company maintains insurance. In consultation with its legal counsel, the Company accrues an estimate of the probable costs to resolve these matters when it has been determined that an unfavorable outcome is likely and the amount can be reasonably estimated. This estimate may change in the future as additional information becomes available. Results of Operations Three Months Ended April 30, 2002 Compared to Three Months Ended April 30, 2001 Revenues. Total revenues for the three months ended April 30, 2002, were $14,842,000, representing a 23% increase over revenues of $12,070,000 for the comparable period in fiscal 2001. Same-store revenue for Company-owned hearing centers increased by 32% for the three months ended April 30, 2002, compared to the three months ended April 30, 2001. Product revenues were $10,324,000 for the three months ended April 30, 2002, up 31% from $7,879,000 for the same period in fiscal 2001. The increase in product revenue resulted from a 23% increase in the number of hearing instruments sold and a 6% increase in the average per unit selling price. Product revenues represented 70% and 65% of total revenues for the three-month periods ended April 30, 2002 and 2001, respectively. Audiological service revenues increased 12% to $1,227,000 for the three months ended April 30, 2002, from $1,095,000 for the comparable period in fiscal 2001. This increase resulted primarily from a shift in marketing emphasis on product price to the provision of professional audiological services. Other revenues increased 6% to $3,291,000 for the three months ended April 30, 2002, from $3,096,000 for the three months ended April 30, 2001. The increase in other revenues was attributable to an increase in the number of members in The Sonus Network from 568 as of April 30, 2001 to 874 as of April 30, 2002. Product Gross Profit. Product gross profit for the three months ended April 30, 2002, was $5,858,000 or 57% of product revenues, compared to $4,575,000 or 58% of product revenues for the comparable period in fiscal 2001. Clinical Expenses. Clinical expenses for the three months ended April 30, 2002, were $4,834,000, representing a 2% decrease over clinical expenses of $4,926,000 for the comparable period in fiscal 2001. The decrease resulted from a decrease in marketing and other expenses of $443,000 and $53,000, respectively, offset by an increase in personnel expenses of $406,000. As a percentage of combined product and service revenue, clinical expenses decreased to 42% for the three months ended April 30, 2002, compared to 55% for the three months ended April 30, 2001. The percentage decrease was primarily the result of higher revenue over which to absorb fixed costs. Clinical expenses include all personnel, marketing, occupancy, and other operating expenses at the center level. Provision for Doubtful Accounts. The provision for doubtful accounts decreased to $191,000 for the three months ended April 30, 2002, compared to $287,000 for the three months ended April 30, 2001. The decrease resulted from improved collection experience. -13- General and Administrative Expenses. As a percentage of net revenues, general and administrative expenses were 28% for the three-month period ended April 30, 2002, consistent with the same period in the prior fiscal year. General and administrative expenses increased 22% from $3,375,000 for the three months ended April 30, 2001, to $4,128,000 for the three months ended April 30, 2002. The increase in general and administrative expenses was primarily due to increases of $281,000 in personnel costs related to building the appropriate infrastructure to support the growth of the Company and $165,000 and $299,000 in additional personnel and marketing costs, respectively, related to The Sonus Network. Depreciation and Amortization Expense. As a percentage of revenues, depreciation and amortization expense decreased to 6% for the three months ended April 30, 2002, from 8% for the three months ended April 30, 2001. Depreciation and amortization expense for the three months ended April 30, 2002, was $921,000 compared to depreciation and amortization expense of $915,000 for the same period in the prior fiscal year. Other Income/Expense. Interest income for the three months ended April 30, 2002, increased to $14,000 from $6,000 for the same period in the prior fiscal year as a result of higher balances of short-term investments. Interest expense for the three months ended April 30, 2002, was $119,000 compared to $86,000 for the three months ended April 30, 2001, reflecting an increase in interest-bearing obligations. For the three months ended April 30, 2002, the Company had $645,000 in losses from the sale of hearing centers located in California, Illinois, Missouri, and Washington, and other expense of $167,000, compared to other income of $1,000 for the three months ended April 30, 2001. The increase in other expense for the three months ended April 30, 2002 resulted primarily from the settlement of a professional negligence lawsuit. Nine Months Ended April 30, 2002 Compared to Nine Months Ended April 30, 2001 Revenues. Total revenues for the nine months ended April 30, 2002, were $39,988,000, representing a 11% increase over revenues of $35,946,000 for the comparable period in fiscal 2001. Same-store revenue for Company-owned hearing centers increased 8% for the nine months ended April 30, 2002, compared to the nine months ended April 30, 2001. Product revenues were $27,167,000 for the nine months ended April 30, 2002, an increase of 6% from $25,663,000 for the same period in fiscal 2001. The increase in product revenue resulted from a 6% increase in the average per unit selling price. Product revenues represented 68% and 71% of total revenues for the nine-month periods ended April 30, 2002 and 2001, respectively. Audiological service revenues increased 14% to $3,744,000 for the nine months ended April 30, 2002, from $3,282,000 for the comparable period in fiscal 2001. This increase resulted primarily from a shift in marketing emphasis on product price to the provision of professional audiological services. Other revenues increased 30% to $9,077,000 for the nine months ended April 30, 2002, from $7,001,000 for the nine months ended April 30, 2001. The increase was due to increased revenues from The Sonus Network as a result of an increase in the number of Sonus Network members from 568 as of April 30, 2001 to 874 as of April 30, 2002. Product Gross Profit. Product gross profit for the nine months ended April 30, 2002, was $16,035,000 or 59% of product revenues, compared to $14,573,000 or 57% of product revenues -14- for the comparable period in fiscal 2001. The increase in product gross profit percentage was due to increased sales of higher margin hearing aids. Clinical Expenses. Clinical expenses for the nine months ended April 30, 2002, were $15,086,000, representing a 6% increase over clinical expenses of $14,271,000 for the comparable period in fiscal 2001. As a percentage of combined product and service revenue, clinical expenses remained at 49% for each of the nine-month periods ended April 30, 2002 and 2001. The increase in clinical expenses was primarily the result of increased personnel, occupancy and other expenses of $859,000, $33,000, and $73,000, respectively, offset by a decrease in marketing expenses of $151,000. Clinical expenses include all personnel, marketing, occupancy, and other operating expenses at the center level. Provision for Doubtful Accounts. The provision for doubtful accounts increased to $719,000 for the nine months ended April 30, 2002, compared to $688,000 for the nine months ended April 30, 2001. The increase resulted from the write-off of receivables from two shareholders totaling $205,000, offset by improved collection experience. General and Administrative Expenses. As a percentage of revenues, general and administrative expenses increased to 30% for the nine-month period ended April 30, 2002, compared to 26% for the same period in the prior fiscal year. General and administrative expenses increased 29% from $9,351,000 for the nine months ended April 30, 2001, to $12,042,000 for the nine months ended April 30, 2002. The increase in general and administrative expenses was primarily due to increases of $916,000 in personnel costs related to building the appropriate infrastructure to support the growth of the Company and $461,000 and $1,086,000 in additional personnel and marketing costs, respectively, related to The Sonus Network. Depreciation and Amortization Expense. As a percentage of revenues, depreciation and amortization expense decreased to 7% for the nine months ended April 30, 2002, from 8% for the nine months ended April 30, 2001. Depreciation and amortization expense for the nine months ended April 30, 2002, was $2,741,000, a decrease of 6% over the depreciation and amortization expense of $2,916,000 for the same period in the prior fiscal year. The decrease was due to a decrease in depreciation expense as a result of certain equipment becoming fully depreciated. Other Income/Expense. Interest income for the nine months ended April 30, 2002, increased to $110,000 from $40,000 for the same period in the prior fiscal year as a result of higher balances of short-term investments. Interest expense for the nine months ended April 30, 2002, was $416,000 compared to $242,000 for the nine months ended April 30, 2001, reflecting borrowings by the Company under its line of credit and an increase in other interest-bearing obligations. For the nine months ended April 30, 2002, the Company had $645,000 in losses from the sale of hearing centers located in California, Illinois, Missouri, Washington, and New Mexico, and other expense of $216,000 which resulted primarily from the settlement of a professional negligence lawsuit, compared to other income of $532,000 for the nine months ended April 30, 2001, which resulted primarily from the settlement of a lawsuit brought by the Company against Starkey Laboratories, Inc. and other defendants for misappropriation of a customer list owned by the Company. -15- Cumulative Effect of Change in Accounting Principle. During the fourth quarter of the year ended July 31, 2001, the Company changed its method of accounting for revenue recognition retroactively to August 1, 2000. Based on guidance provided in SAB 101, the Company concluded that when a sale of a hearing instrument is coupled with the performance of future services or obligations for batteries, revenue related to the fair value of the obligations should be deferred and recognized as revenue as the obligations are discharged. The Company's previous revenue recognition policy was to recognize all revenue upon the sale of hearing instruments, including post-sales services, at the time the hearing instrument was delivered and to accrue the cost of estimated battery replacement. In accordance with SAB 101, the Company recorded a non-cash charge of $2,114,000 (or $0.35 per share, basic and diluted) to reflect the cumulative effect of the change as of August 1, 2000. Deferred revenue of $612,000 and $1,056,000 included in the cumulative effect was recognized as revenue in the nine months ended April 30, 2002 and 2001, respectively. Deemed Dividend to Preferred Shareholder. On issuance, the Company's 2,500,000 outstanding Series B Convertible Preferred Shares (the "Series B Shares") were convertible into common shares on a one for one basis. However, the terms of the of the Series B Shares provide that after October 31, 2000, the conversion rate is subject to upward adjustment each fiscal quarter until the Company attains specified quarterly earnings targets. The amount of such quarterly adjustment is based on a factor of 2% of the original purchase price plus the sum of all prior adjustments until November 1, 2004, increasing in steps thereafter to 4.5% beginning November 1, 2006. Once the Company has met the specified earnings targets for four consecutive quarters, no further adjustment to the conversion price will be made. Additionally, the conversion price was subject to further adjustment if the Company failed to collect certain receivables prior to July 31, 2000. Because the Company failed to collect certain of these receivables and has not met the quarterly earnings targets, the conversion rate has been adjusted such that the number of common shares issuable on conversion of all Series B Shares increased by 82,196 shares and 75,936 shares during the three months ended April 30, 2002 and 2001, respectively. At April 30, 2002, Series B Shares were convertible into 4,191,998 common shares. The Emerging Issues Task Force consensus 98-5 "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios" provides that contingent beneficial conversion features are to be recognized when the contingencies are resolved. Accordingly, the Company recorded a deemed dividend to the holder of Series B Shares in the amount of $329,000 and $304,000 during the three months ended April 30, 2002 and 2001, respectively. For the nine-month periods ended April 30, 2002 and 2001, the deemed dividend was $967,000 and $5,491,000 respectively. In fiscal 2001, the Company adopted the Emerging Issues Task Force consensus 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments" (EITF 00-27). Upon the adoption of EITF 00-27, management concluded that the Series B Shares contained an additional beneficial conversion feature requiring the allocation of the proceeds from the sale of the Series B Shares in October 1999 between the relative fair value of the Series B Shares and a related -16- modification of warrants to purchase common shares held by the holder of the Series B Shares. Accordingly, commensurate with the adoption of EITF 00-27, the Company recorded an additional deemed dividend to the holder of the Series B Shares in the amount of $1,554,000 that is reflected in the nine-month period ended April 30, 2001. Income Taxes Due to net operating loss carryforwards for tax purposes, and a taxable loss, no income tax provision is recorded for the three and nine-month periods ended April 30, 2002 and 2001. Liquidity and Cash Reserves Nine months Ended April 30, 2002 Compared to Nine months Ended April 30, 2001 For the nine months ended April 30, 2002, net cash provided by operating activities was $221,000 compared to net cash provided from operating activities of $1,218,000 for the nine months ended April 30, 2001. Net cash provided by operating activities for the nine months ended April 30, 2002, resulted primarily from a net loss of $2,947,000 and an increase in prepaid expenses of $58,000, and decreases in accounts payable, other accrued liabilities, customer deposits, and accrued payroll of $1,309,000, $677,000, $158,000, and $128,000, respectively. These uses of cash were offset by decreases in accounts receivable, other receivables, and inventory of $816,000, $138,000, and $419,000, respectively, along with non-cash depreciation and amortization, provision for doubtful accounts and the loss on sales of centers of $2,741,000, $719,000 and $645,000, respectively. Net cash provided by operating activities for the nine months ended April 30, 2001, was primarily attributable to an increase in accounts payable and other accrued liabilities of $2,243,000 and $321,000, respectively, and non-cash depreciation and amortization, provision for doubtful accounts, and the cumulative effect of a change in accounting principle of $2,916,000, $688,000, and $2,114,000, respectively, which was offset by a net loss of $4,154,000 and increases in accounts receivable, other receivables, inventory, and prepaid expenses of $920,000, $1,478,000, $294,000 and $195,000, respectively. Net cash provided by investing activities in the nine months ended April 30, 2002, was $3,719,000, consisting primarily of the sale of investment in restricted acquisition funds of $4,463,000 and the proceeds from sales of centers of $37,000, offset by the purchase of a restricted time deposit of $250,000, the purchase of property and equipment of $82,000 and net cash paid on business acquisitions of $375,000. In the nine months ended April 30, 2001, net cash used in investing activities was $685,000, consisting primarily of the purchase of property and equipment of $645,000 and net cash paid on business acquisitions of $47,000. Net cash used in financing activities was $3,198,000 in the nine months ended April 30, 2002, consisting of repayments of long-term debt and capital lease obligations of $4,804,000, repayments of bank loans and short-term notes payable of $462,000, and the repurchase of common stock of $50,000, offset by advances of bank loans and short-term notes payable, an advance of a short-term note payable from Warburg Pincus Ventures, L.P., and advances of long-term debt and capital lease obligations of $100,000, $1,500,000 and $518,000, respectively. Net -17- cash used in financing activities was $1,248,000 in the nine months ended April 30, 2001, consisting of repayments of long-term debt and capital lease obligations of $2,019,000 and the repurchase of common stock of $50,000, offset by advances of bank loans and short-term notes payable of $600,000 and advances of long-term debt and capital lease obligations of $228,000. Historically, the Company has generated losses and negative cash flows from operations and as a result has been required to periodically obtain additional cash through debt and equity financings. Significant additional revenues, which will result in additional receivables and inventory, will be required to achieve profitability. Accordingly, the Company must carefully monitor these assets to minimize the resources invested in them. To date, certain management information system limitations have limited the effectiveness of the Company's efforts in this area. In addition, an advance from Warburg Pincus Ventures, L.P. of $1,575,000, including accrued interest, is due on June 19, 2002. The Company is currently negotiating to have $750,000 of the advance extended beyond June 19, 2002. Management expects the Company's available cash to be severely limited in the near future as a result of repaying all or a portion of the advance. To alleviate the above conditions, the Company has continued to work with its Company-owned clinics to improve profitability and cash flow through changes in product mix and personnel, as well as through cost controls. The Company also continues to expand the number of members of The Sonus Network and has commenced a significant effort to reduce its receivables and improve its management information system. The Company believes that these actions, together with cash on-hand and the expected working capital commitment of its major investor, will provide sufficient cash for the Company. However, the Company is exploring its strategic alternatives, as factors outside the Company's control may have a negative impact on its ability to generate sales, collect receivables, obtain the expected working capital from its major investor, or otherwise execute its business plan, any of which may in turn have a material adverse effect on its operations. -18- ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. As of April 30, 2002 and July 31, 2001, the Company had cash and cash equivalents and short-term investments (including restricted amounts) totaling $2,711,000 and $6,193,000, respectively. The Company has assessed its vulnerability to certain market risks, including interest risk associated with financial instruments included in cash, cash equivalents, and short-term investments. Declines in interest rates over time will reduce interest income from these financial instruments, but the Company believes that its exposure to interest rate changes has and will be immaterial due to the short-term nature of these financial instruments. At April 30, 2002 and July 31, 2001, the Company had debt and capital lease obligations that totaled $4,716,000 and $7,542,000, respectively. Except for its $200,000 bank loan, interest rates on the Company's debt and capital lease obligations are fixed at the beginning of the repayment; therefore, exposure to changes in interest rates is limited to new financings. The interest rate of the Company's bank loan fluctuates based on the prime rate of the lender, plus a set incremental interest percentage above the prime rate. Due to the insignificant amount of the Company's remaining obligations subject to variable interest rates and the absence of significant adverse fluctuations in the prime rate, the Company believes that the exposure to interest rate changes is immaterial. The Company's earnings and cash flow are subject to fluctuations due to changes in currency rates in Canada. Since inception however, the impact of these fluctuations has been immaterial to the Company's earnings and cash flows. PART II OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-K. (a) The exhibits filed as part of this report are listed in the accompanying exhibit index. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the fiscal quarter ended April 30, 2002. -19- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SONUS CORP. By: /s/ Mark Richards -------------------------------- Mark Richards Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Authorized Signatory) DATED: September 10, 2002 -20- CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Daniel J. Kohl, certify that: 1. I have reviewed this quarterly report on Form 10-Q/A of Sonus Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; and 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. (1) Date: September 10, 2002 /s/ Daniel J. Kohl ------------------------------ Name: Daniel J. Kohl Title: Chief Executive Officer ------------------------ (1) Portions of the certifications required by Section 302 are omitted herein pursuant to the transition rule adopted by the Securities and Exchange Commission in Release No. 34-46427. CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Mark Richards, certify that: 1. I have reviewed this quarterly report on Form 10-Q/A of Sonus Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; and 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. (1) Date: September 10, 2002 /s/ Mark Richards ------------------------------- Name: Mark Richards Title: Chief Financial Officer ------------------------ (1) Portions of the certifications required by Section 302 are omitted herein pursuant to the transition rule adopted by the Securities and Exchange Commission in Release No. 34-46427. CERTIFICATIONS PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with Amendment No. 1 to the Quarterly Report of Sonus Corp. (the "Company") on Form 10-Q/A for the period ended April 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Daniel J. Kohl, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: September 10, 2002 /s/ Daniel J. Kohl ------------------------------- Name: Daniel J. Kohl Title: Chief Executive Officer In connection with Amendment No. 1 to the Quarterly Report of Sonus Corp. (the "Company") on Form 10-Q/A for the period ended April 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Mark Richards, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: September 10, 2002 /s/ Mark Richards ------------------------------- Name: Mark Richards Title: Chief Financial Officer EXHIBIT INDEX Exhibit Number Description of Exhibit 10.1 Separation Agreement and Release of Claims dated March 22, 2002, between the Company and Brandon M. Dawson. * * Previously filed.

SONUS CORP 10-Q/A