Ribbon Communications Inc.
Q3 2008 Earnings Call Transcript

Published: 6 Nov 2008

[Operator:]

Welcome to the Sonus Networks third quarter fiscal 2008 financial results conference call. (Operator Instructions) This call is being recorded Thursday, November 6, 2008. I would now like to turn the conference over to Karen Cellupica from Investor Relations.

[Karen Cellupica:]

Thank you and good morning everyone. With me on the call this afternoon are Richard Nottenburg, President and Chief Executive Officer; Rick Gaynor, Chief Financial Officer; and Vikram Saksena, Chief Technology Officer. Earlier this morning we issued a press release announcing our results for the third quarter 2008. The text of this release, along with the accompanying income statement, balance sheet, and operating statistics, as well as a reconciliation of the most directly comparable GAAP financial measures to any non-GAAP financial measures used during this call and for certain prior periods, are available on the Investor Relations section of our website. Before Richard offers his opening remarks, I would like to remind you that during this call we are making projections or forward-looking statements regarding items such as future market opportunities and the company’s financial performance. These remarks about the company’s future expectations, plans, and prospects constitute forward-looking for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. These projections or statements are just predictions and involve risks and uncertainties such that actual events or financial results may differ materially from those we have forecasted. As a result, we can make no assurances that any projections of future events or financial performance will be achieved. For a discussion of important risk factors that could cause actual events or financial results to vary from these forward-looking statements, please refer to the risk factors section of our most recent quarterly report on Form 10-Q which is on file with the SEC. Any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. While we may elect to update forward-looking statements at some point, we specifically disclaim any obligation to do so unless required by law. During this call, we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with the generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available on the Investor Relations section of our website, www.sonusnet.com. I would now like to turn the call over to Richard Nottenburg.

[Richard N. Nottenburg:]

Thank you for joining us on the call today. We are here to review financial results for the third quarter 2008 and to provide insight into our business performance and the operating environment. We will also share with you our plan to manage Sonus through the current economic environment. Key take-aways from the third quarter include

[Richard J. Gaynor:]

While we are disappointed with our results this quarter we are confident in our ability to respond appropriately to this challenging environment. Our fundamentals are strong. We are a market leader with a strong balance sheet, world-class engineering, and tier-1 customers. As Rich will discuss in more detail, we took a number of steps during the quarter to improve our cost structure, streamline our operations, and improve our responsiveness to future market opportunities. More work remains and we look forward to sharing those actions in our view for 2009 on our next earnings call. In April 2007 we acquired Zynetix to avail ourselves of certain wireless technologies which we incorporated into our product set, in particular, Sonus mobilEdge. In Q3, to improve our focus and reduce the opex drag associated with the residual Zynetix niche business we committed to a plan to sell the subsidiary and are currently negotiating the sale. Before we review our results I would like to point out that the Zynetix results of operations have been reclassified and are reported as discontinued operations for all periods presented. For the purpose of my remarks this morning I will refer to continuing operations unless otherwise stated. Please note that throughout my discussion I will reference both GAAP and non-GAAP financial information. There is a reconciliation of GAAP and non-GAAP information in the Investor Relations section of our website. As I do each quarter, I would like to remind investors that for a variety of reasons our business is inherently uneven and we suggest that you consider our performance over a longer time horizon as our results will fluctuate from quarter-to-quarter. Let me now recap our results. Revenue for the third quarter was $62.2 million, down 29.2% from $87.8 million in Q2 2008, and down 17.9% from $75.8 million in Q3 2007. While we were pleased to have had no unusual order cancellations or delivery push outs in quarter, our concerns, shared in the last call, regarding the slowdown in new orders did indeed materialize and this resulted in lower than anticipated revenue and a book-to-bill of less than 1. The slowdown in orders in Q3 was broad-based and in all geographies. Product revenue was $36.7 million, or 59% of total, down from $62.3 million in Q2, and down from $54.5 million in the same period last year. Service revenue was $25.5 million, or 41% of total revenue, flat with Q2, and up from $21.3 million in Q3 of last year. Now looking at revenue geographically, domestic revenue accounted for 81% of revenue versus 80% in Q2 and 85% in Q3 2007. AT&T contributed greater than 10% of total revenue in the third quarter. Our top five customers represented approximately 58% of revenue in Q3 versus 69% in Q2 and 61% in Q3 of last year. We reported revenue from 86 customers in the third quarter compared to 80 in the second quarter and 71 in Q3 2007. Before I begin discussing our gross margins and operating expenses, I would like to point out that these are non-GAAP numbers that exclude stock-based compensation and related expenses, amortization of intangible assets, legal settlements, the Zynetix earn-out in 2008, and a stock option review cost in 2007. Non-GAAP gross margins for the third quarter were 64.4% of revenue compared to 67.3% in Q2 and 62% in Q3 2007. Product gross margin for the third quarter was 69.5% compared to 71.3% in Q2 and 61.9% in the same period last year. Serviced gross margins were 56.9% compared to 57.6% in Q2 and 62.3% in Q3 of last year. Recently we have seen margins at or above the high end of our long-term target range due to very favorable customer and product mix and some of our larger customers continue their network expansion plans. However, we have a large multi-year project that has an unusually low margin profile, which we expect to recognize at some point in the next 12 months, that will have a negative effect on overall gross margins in that period. However, outside of this specific event, we believe that longer-term gross margins with our current product set and items currently in deferred revenue will be in our target range of 58% to 62%. As for non-GAAP operating expenses, Q3 R&D expenses were $16.9 million, flat with Q2 and up slightly from $16.7 million from Q3 2007. Our gross profit to R&D spend ratio for Q3, on a trailing 12-month basis, was 3.2 versus 3.3 in Q2. As we said before, we are committed to delivering and supporting our existing customer-based R&D projects. However, in the future we will be seeking funding participation from customers for development that does not provide broad market leverage for Sonus but which provides unique value to the customer. We will also continue to assign development work to lower-cost geographies and focus our engineering efforts on high-return opportunities. It is important to note that while we are executing on plans to reduce spend across all functions, we are also committed to making the thoughtful investments necessary to ensure we maintain our market leadership and position ourselves for success in high-growth market segments. We are prepared to use our balance sheet to fund initiatives which we believe, even in this trying economy, have attractive ROI and NPV profiles. Sales and marketing expenses were $16.5 million in Q3, down from $18.0 million in Q2 and up from $15.8 million in Q3 2007. The decrease in sales and marketing expense was primarily associated with lower commissions and lower people-related costs. Going forward, we will be taking additional steps to ensure we are getting the expected traction from the investments we previously made in our global sales operations. In cases where we are not, due to the economy or other reasons, we will be looking at what actions need to be taken in the interest of cost management. One initiative we are exploring is a greater reliance on partners. As expected, G&A expense at $17.6 million in Q3 2008 was higher than the $11.0 million in Q2 and $10.6 million for Q3 2007. The increase in G&A expenses in Q3 was primarily due to the expected increased legal fees associated with the resolution of two long-outstanding legal matters in the quarter, the C2 patent litigation and the 2002 shareholder suit. The legal fees associated with these two settlements amounted to $5.1 million in Q3 alone. We are happy to put these two matters behind us and believe our legal fee run rate will be lower going forward. In addition, during the quarter we recorded a $441,000 bad-debt charge as a result of the bankruptcy filing of one of our customers. Total non-GAAP operating expenses for the third quarter were $50.9 million, up from $45.9 million in Q2 and $43.0 million for Q3 of last year. Due primarily to the lower revenue and higher than expected legal expenses, we generated a non-GAAP operating loss in Q3 of $10.9 million compared to a non-GAAP operating income of $13.2 million in Q2 and a non-GAAP operating income of $4.0 million in Q3 2007. Our non-GAAP effective income tax rate was 76.3% for Q3. Our tax rate reflects nondeductible items, including new items in the third quarter, against earnings expectations by tax jurisdiction. Please note that we had a significant historical net operating loss position of $110.0 million at year end and our actual cash payments for taxes are much lower than the financial statement provisions. In summary, Q3 non-GAAP net loss was $1.9 million, or a loss of $0.01 per diluted share, compared to non-GAAP net income of $6.1 million, or $0.02 per diluted share, in Q2 and a non-GAAP net income of $5.3 million, or $0.02 per diluted share, in Q3 2007. Now let’s turn to the GAAP results. Our Q3 gross profit of $39.2 million included $578,000 of stock-based compensation and $263,000 of intangible amortization. We had operating expenses of $75.7 million in Q3, which included stock-based compensation of $3.9 million, intangible amortization of $55,000, legal settlements of $19.1 million, and a Zynetix earn-out of $1.7 million. Q3 GAAP operating loss was $36.5 million compared to an operating income of $7.9 million in Q2 and an operating loss of $49.1 million in the same period last year. Q3 interest income, net of interest expense, was $2.7 million compared to $3.2 million in Q2 and $4.4 million in Q3 2007. The interest income decline was primarily due to the lower interest rate environment. The GAAP effective tax rate was 43.7% for the third quarter and 31.1% for the first nine months of the year. As you know, we review our annual tax rate each quarter and make adjustments as required. Again, I remind you that we have a significant NOL position of $110.0 million at year end and our actual cash payments for taxes are much lower than the financial statement provisions. In Q3 our diluted share count was approximately 272.0 million shares. Now let’s turn to the balance sheet. Overall, Sonus ended the quarter with total cash, cash equivalents, marketable securities, and long-term investments of $404.7 million compared to $397.8 million in Q2. The increase in our cash balance was primarily driven by strong collections in the quarter. Please note that this balance reflects the payment of $9.5 million for the C2 patent litigation settlement. Our approach to how we invest and manage our cash remains conservative. We have a high-quality portfolio and have had no significant write-down against our investments. We continue to carefully monitor our portfolio with our main objective being the safeguarding of our capital. Accounts receivable were $42.8 million, down from $79.4 million in Q2 and down from $73.2 million in Q3 2007. The strong collections performance in the quarter brought DSO to 62 days, down from 81 days in Q2. Total deferred revenue was $88.5 million, a decrease from the $94.6 million reported in Q2 and a decrease from the $92.6 million in Q3 2007. Of total deferred revenue, $38.7 million was deferred product revenue and $49.8 million was deferred service revenue. The deferred service revenue relates primarily to maintenance contracts. We ended the third quarter with $53.7 million total inventory, up from the $48.4 million reported at the end of Q2 and up from the $51.8 million in Q3 of last year. $41.8 million of our inventory balances are on earned inventory, which reflects product shipped to customers but not yet reflected in our revenue results. Accounts payable days came in at 58 days versus 38 days in Q2. Capex during the quarter was $2.6 million compared to $2.7 million in Q2 and $1.8 million for Q3 2007. Depreciation was $2.9 million in the quarter, down from $3.1 million in Q2 2008 and $3.6 million in Q3 2007. Looking at our headcount, we ended the quarter with 1,042 employees compared to 1,039 employees at the end of Q2. As of October 31, 2008, our headcount was 1,026, or down 16 from September 30, 2008. Now turning to the fourth quarter. Given the current economic environment and the uncertainty in our customer spending patterns, we will be unable to forecast revenue for the fourth quarter or 2009 at this time. However, it is clear that the economic downturn that impacted us in Q3 continues and we expect Q4 revenue to be meaningfully less than the same period in 2007. In addition, I will offer the following

[Richard N. Nottenburg:]

A key consequence of the current economic environment is that network operators are reducing capital investments in response to a slowing economy and their higher cost of capital. While our value proposition to network operators remains unchanged, we expect the transition from carrier circuit voice to carrier IP voice to slow in the current economic environment for some of our customers and prospects. This is not a uniform trend across the customer landscape as each operator is at a different stage in the transition from legacy to next-generation all IP networks. Even in the current environment we remain competitive and we continue to see quality opportunities to expand our base of tier-1 and tier-2 customers and to increase the footprint of our solutions sold within our existing customers. This is due to our broad product offering, our core competence, and excellent reputation in delivering scalable carrier-grade IP-based voice solutions and in the investments we continue to make in our technology. In addition, the key part of our value proposition enables network operators to reduce operating expenses while allowing them to offer new services. During 2009 Sonus will focus on investing in technology and solutions to strengthen our product offering in three areas that have the best potential for growth and market share gains. We will build on our success in the network border session control space to extend our offering in the emerging wireless IP peering market where we have an opportunity to establish a leadership position. We will invest in delivering differentiated solutions in the access market that will allow operators to offer the enhanced and sticky services required to retain and grow their subscriber base. And we will continue to drive the transformation from legacy TDM to all IP core networks through innovations in number portability, ENUM, and other routing-based solutions. Turning now to our plans for managing Sonus through this economic environment. Right-sizing and realigning the business to address market opportunities means that we will be reducing expenses across the business while aligning our investments with those opportunities that generate the best financial returns and build category leadership. This process has already begun with several executive changes, functional reorganizations, and geographical moves designed to improve speed, agility, and efficiency, and increase our line of sight into key company functions while reducing costs. Product management, product marketing, and corporate marketing have been reorganized into one group to increase alignment between the broad market requirements for our solutions and specific customer needs and to unify our go-to-market approach. By investing in the right product front end process we will ensure that we generate best-in-class returns on our R&D investments while building long-term predictability into the business. This organization reports to me and is headed by Sheldon Segal. During Q3 we began our transformation of engineering by eliminating management layers and reinvigorating our world-class organization in Bangalore, which I visited in October. During 2009 we will continue to invest in our Bangalore design center to accelerate our engineering cost transformation and align the organization with opportunities in growth markets. Those of you who know me know the importance I place on quality and customer satisfaction. To drive better accountability throughout the company, we have centralized quality and [inaudible] quality assurance under Gail England. With these moves we have tightened the company focus and undertaken to significantly reduce opex in 2009 while improving efficiency. We recognize that more needs to be done. During Q3 I had the opportunity to visit some of our major customers in the U.S., Japan, India, U.K., and Europe. I am pleased with the relationships we have and confident that they will continue as the next generation of networks are deployed. As we parse the opportunity landscape we recognize that growth in emerging markets is an important driver for the future. There can be no doubt that carriers and service providers in some of the emerging markets are experiencing growth even in the current environment. To leverage these opportunities, within a reduced cost structure, we will rely on partnerships to a greater extent than we have in the past. This will be an important part of our go-to-market strategy as we move forward. As I mentioned earlier, we will be carefully managing our balance sheet and the opportunity that that affords. This will be achieved through a very disciplined approach to controlling expenditures across the business, improved management of working capital, and by maintaining our conservative approach to investment. Rick and I are working to improve discipline and execution in all internal operations to drive cost efficiencies within all functions. As Rick mentioned, one of our largest year-over-year expense increases in 2008 has been associated with legal fees. This quarter I am pleased that we have settled two outstanding lawsuits. In addition to improved return on our IT investments, we have hired a seasoned CIO to streamline IT infrastructure and drive business process improvement. Throughout this period I recognize that our employees remain our greatest assets and I am aware of the impact on those who will be affected by decisions we make over the coming year. We continue to evaluate and change the organization and will be assigning work to the most appropriate and cost effective of our global locations. The engineering and development talent of Sonus is very highly regarded within the industry and gives us a competitive advantage I will protect. The projects we support now and the investments we make will propel Sonus ahead with the effect of increasing our technology leadership and longer-term shareholder value. When the market begins to recover we will have the best technology and professional services to lead our customers through the evolution of next-generation networks. This is the goal behind which our winning culture will be defined. I want Sonus to be recognized as having the best technology, talent, and vision in the industry, coupled with high-quality operating earnings to match. Looking ahead, we cannot predict for how long the current economic environment will affect our customers’ spending patterns but our goal remains to grow this company profitably. With a lower break-even point and a strong balance sheet we believe we can maintain our solid position in our existing market and we have the capability to make opportunistic investments. The Sonus value proposition to customers has not changed. Our solutions deliver long-term cost savings through a combination of a differentiated IP architecture and distributed session control capabilities. Our solution can extend the investments our customers have made in their existing networks while migrating to next-generation technology. We are confident that as service providers and carriers evolve to meet the challenges from market disrupters, they will continue to choose Sonus as their trusted partner. Sonus has been in business for over a decade and learned to weather market volatility to emerge stronger. Sonus will use this period to become stronger and be better positioned for future growth.

[Karen Cellupica:]

Nick, could you please provide our callers with the instructions on how to ask a question.

[Operator:]

(Operator Instructions) Your first question comes from George Notter - Jefferies & Co.

[George Notter:]

Clarification on Zynetix, what is the top line and net income impact there? I guess if I look at your financials I can see the business lost $4.3 million on a net income basis, although I think that’s GAAP. What would be the non-GAAP net income impact and then how about on revenue?

[Richard J. Gaynor:]

I would say it’s relatively immaterial for the company overall. Zynetix, as you know, the object when we acquired Zynetix was to actually import over the intellectual property that we acquired, which we did into the mobilEdge product set primarily. And what was left in Zynetix was really a niche business that serviced things like cruise ship operators. And the revenue and cost implications are relatively immaterial to the company. So I would say you should just consider it immaterial.

[George Notter:]

And I wanted to ask about the long-term operating margin for Sonus. Historically the business has been fairly operating-expense-intensive, custom software development, lots of network inoperability work for customers. You talked a little about pushing that cost out on to the customers. How do you think that transition would work and where do you think the long-term operating margin structure of the company should go? Can this still be a 17% operating margin business longer term? What’s the thought now?

[Richard N. Nottenburg:]

I’m not going to really answer your question on long-term operating margins right now but what I can say, as far as pushing work onto customers, actually one of the things we are trying to do here is we are trying to transition to really being much more aligned with the market than just with specific customers. So if there are things that are really very, very customer specific, I just want to ensure that we get paid to do that work and that we want to maintain a very solid process for our product road map in bringing out products ahead of market demand. Really, it’s a balance. It’s a transition and I think we started that transition with Shaylan coming to my table with product marketing. I feel really comfortable with that. I think Rick wanted to comment on margins.

[Richard J. Gaynor:]

I would point out that Rich has made several executive management changes here and reorganized several business units and those new managers’ new responsibilities have been cast to go out and put operational efficiencies into their businesses and they’re working through that process right now. We do present our FY 2009 plan to our Board in the December time frame so we’re hoping that on the next earnings call we can give you much better clarity about our operating model on a go-forward basis. We’re just not in a position to do that as we continue to work through some of these cost initiatives we are currently pursuing.

[Operator:]

Your next question comes from Paul Silverstein - Credit Suisse.

[Paul Silverstein:]

Can you just remind us, the litigation settlement piece of the cash burn, how much is that expected to be this quarter? Both Q3 and Q4.

[Richard J. Gaynor:]

We had two broad elements to the litigation. We had one actually impacted us in Q3 to the tune of $9.6 million. We currently anticipate, the second has not been finalized, the terms are being finalized right now. We feel relatively confident the number is going to be $9.5 million. We are currently expecting that to happen in Q4 although there is the possibility that could roll out into Q1.

[Paul Silverstein:]

So your guidance of the $25.0 million to $35.0 million burn, roughly $10.0 million of that you expect to come from the litigation settlement, so the non-litigation piece is $15.0 million to $25.0 million?

[Richard J. Gaynor:]

That is correct.

[Paul Silverstein:]

And I know you’re only giving guidance for one quarter forward, but as you look beyond, any thoughts in terms of the cash burn going out into next year?

[Richard J. Gaynor:]

I don’t think we can give you a number on that yet. The next earnings call, hopefully we will be in a position to do that, but as I said earlier we’re working through the cost initiatives right now and we’re taking very seriously the need to pursue cost efficiency in the business and that will impact our operating cash position next year. So I would like to defer that until our Q4 call.

[Paul Silverstein:]

So I trust it would also be premature to talk about a cash flow break-even point at this particular juncture?

[Richard J. Gaynor:]

Yes, it would.

[Richard N. Nottenburg:]

It is premature to talk about a cash flow break-even point but I did say on my call that we would be reducing the break-even point. I wanted to be very clear.

[Paul Silverstein:]

Where was the break-even point?

[Richard N. Nottenburg:]

We didn’t give guidance on the break-even point but what I’m saying is that we will be reducing the break-even point.

[Paul Silverstein:]

I’m not asking you for where it’s going, I’m asking you to the extent you’re going to be reducing it, it begs the question where has it been.

[Richard N. Nottenburg:]

As you know, we are a very lumpy business. Revenues come in very unevenly for us. Deferred revenue and cash flow is quite different from revenue, but if you look at our cash balance over the last six quarters or so, we’ve been tracking in that 390’s, low 400 range, which would suggest if you average it out, we’ve been pretty much close to our cash break-even sort of run rate over the last year to two. But what we recognize is that if we do have revenue slowdown, our goal is to take our cost infrastructure down in such a way that we’re bringing down that cash break-even point on a revenue basis.

[Paul Silverstein:]

I appreciate the commentary about the slowdown but I’m trying to understand, for a long time now it seems like one of the problems for the company has been great customer base and unfortunately not enough of them buy enough. So I’m trying to understand what part of it is a slowdown as opposed to what piece of it is just the same old not enough of the DTs and soft banks and NTTs of the world stepping up and buying more. And we all know we’re in a global slowdown but any insight you can give in terms of just how much is due to slowdown and how much is people not stepping up.

[Richard N. Nottenburg:]

I think it’s a good question and I think there are a couple of components I want to address. One component is it’s pretty clear that we don’t address all of the top 20 operators in the world. That’s one thing for sure. At least the top-20 meaningful operators, many of whom have consolidated over the last couple of years. I think the other issue is, of course, is that carrier VoIP to some extent is a replacement business. And if you look at DSL traffic, for example, I could show you statistics where Internet traffic for data has grown 40% in the access network. If you’re a service provider, you don’t have a choice but to add more routers and switches to handle that traffic. Carrier VoIP is another situation. And basically in a slowdown the legacy will live longer and the next gen is something you can defer. Depending on which customers you have and where you are in the replacement cycle, you will have somewhat of a different outcome. I think that having a larger customer base of the top 20 would be more advantageous and that is what we are building towards.

[Operator:]

Your next question comes from Troy Jensen - Piper Jaffray.

[Troy Jensen:]

Could you talk about capacity utilization within your install base? I would be interest in class 5 versus class 4 and are these systems built with a lot of excess capacity or are they more success-based?

[Richard N. Nottenburg:]

Let me let Vikram answer that question.

[Vikram Sakensa:]

We continue to see traffic increases in our class 4 networks and month-over-month so clearly I think the capacity utilization on class 4 continues to drive up. The class 5 is still in very early stages. What we are seeing there is some of the larger customers focus on the enterprise market and enterprise-listed services and that is where we are focusing more on differentiated applications and services. But I would say class 5 is still in its early growth stages and it’s very hard to predict capacity utilization on those networks in this early stage of transition.

[Troy Jensen:]

The question was, are the networks built with excess capacity in them to begin with or is there just excess space to begin with?

[Vikram Sakensa:]

No, to begin with they always put in capacity that is a little ahead of demand and so they don’t over-stretch the network. But when it comes to an environment like this, the less the capacity stays and drives the utilization, which is basically what’s happening in these networks.

[Richard N. Nottenburg:]

I think the other comment here is really on class 5. Obviously you have the attackers, people who are challenging the incumbent legacy service providers. They were out of the gate relatively quickly. Look at the MSOs around basically voice. If you look at legacy PSTN replacement I think that’s in a very early stage right now and that’s a market which will extend well into the future as legacy providers figure out how they’re going to replace their existing PSTN infrastructure.

[Troy Jensen:]

Rick, you talked about using your balance sheet for a situation with an attractive ROI or NPVs. Are you talking about extended terms or vendor financing? Could you just give a little more color about what you’re thinking there?

[Richard J. Gaynor:]

We are really talking about investments into the engineering organization here. If we think that as we pursue some of the market opportunities where we think there are higher growth profiles, we would not hesitate to invest in delivering differentiated solutions in those spaces. So really what we’re saying is we do plan to defend our flanks and maintain our market leadership where we have it, and we’re also prepared to use the balance sheet to make selective investments where we think we can establish new market leaderships.

[Troy Jensen:]

Would you turn to vendor financing?

[Richard J. Gaynor:]

It’s not something we have considered.

[Richard N. Nottenburg:]

Let me just tell you from my experience here around vendor financing. Rick and I take a very conservative approach to business. This is not a place where we feel comfortable going.

[Operator:]

Your next question comes from Steven O'Brien - J.P. Morgan.

[Steven O'Brien:]

What are your customers telling you regarding longer-term projects? Are they saying they will be pushing them out or have you seen actually any cancellation of orders or parts of projects that impact you going forward? And then on the global RFP activity or lack thereof, is there anything going on terms of new potential projects that maybe are in the longer term, couple of quarters out time frame, that give you some optimism toward the long-term outlook?

[Richard J. Gaynor:]

I am going to answer the first part of it but I think Vikram and Rich will probably have some comments as well. Just in terms of did we see any delays, we didn’t see any significant project cancellations in the third quarter nor did we see any major orders that we had already received pushed out or delivery schedules pushed out. The phenomenon we seemed to have experienced is that anything that got through the approval cycle at our customer base in July and August had no issues. But when September ran around, we just could not get P.O.s approved by our customer base and things just seemed to slow down very dramatically and that really impacted us on the book/ship opportunities. Stuff that we could have received an order, shipped out and scored revenue on straight away, those are the types of orders that slowed down dramatically and impacted the quarter. In terms of RFP activity I will hand it over.

[Vikram Sakensa:]

I think on your long-term question, I think the long-term prognosis still holds true. We are not seeing any customers that their long-term plans have changed. Based on the activity we are seeing, both from wire line and wireless carriers, I think the session border control space continues to create RFPs and projects and we are responding to them and winning those deals as they are coming our way. We are seeing continued activity on the enterprise side as well as some of the fixed mobile convergence activities that are driving integrated operators to convert services. So there are areas in our space which are continuing to create RFP activities and customer projects and we do believe that the long-term prognosis for our projects is very healthy and good.

[Richard N. Nottenburg:]

There are two things. First of all, a significant part of our value proposition, as I mentioned, is that we really enable operators to reduce their opex. So to a large extent, when operators have to maintain three different silos, a voice silo, a data silo, and a video silo, that’s a very expensive proposition for an operator. I think that as time moves forward a lot of operators obviously have to homogenize that base and they have to basically share a common transport network and they want to have common sessions between the various silos. So clearly opex reductions are going to continue to require innovations to space. And the second thing that I think will drive growth really is, in terms of regulatory local bundling. That’s an activity which is still going on outside North America. And I think those are the kinds of forces here that are still in play. My earlier comment was if you look at legacy, for example, you look at the transition from 2G to 3G, or 3G to 4G, mobile voice, legacy tends to live longer. But in the end operators are going to be looking for ways to reduce their opex and I think the Sonus product platform basically is an enablement in doing that. And that’s where we are making our investments.

[Steven O'Brien:]

On the gross margin discussion, I have one clarification question. The large project that is coming through which will have a negative impact on gross margin, is that going to push the blended gross margin below the company’s 58% to 62% guidance or is it just that project in particular falls below the long-term range?

[Richard J. Gaynor:]

The answer is yes to both. This is a particularly low margin profile project for us. It is very heavily third-party pass through, which brought the margins down. We knew that when we initiated the project. But the project itself is fairly material in terms of its revenue and it does come from deferred into the P&L and will bring down below the 58% our blended rate.

[Operator:]

Your next question comes from Greg Mesniaeff - Needham & Co.

[Greg Mesniaeff:]

Question on the macro level. When you look at your customers are you seeing any divergence of order activity between your tier-1 one customers, particularly AT&T, and your smaller tier-2 customers?

[Richard N. Nottenburg:]

If you look at the slowdown in the quarter, you look at the last week or two of the quarter, basically it’s a pervasive across-the-board, uniform type of phenomenon. And I don’t think that that’s very different from what some of the other even larger providers of network infrastructure have found. So the answer is no. It’s very difficult to look at an inflection point in one quarter and make any kind of broad generalization about how tier-1’s and tier-2’s are going to behave. I really couldn’t draw any conclusion there.

[Richard J. Gaynor:]

The bulk of our orders come in month three of each quarter and obviously September was an extremely turbulent time in the capital markets and it seemed to have slowed down the release of any purchase orders in September. And it was broad-based. We see it in tier-1’s and tier-2’s and we see it domestically and we see it internationally. The fact is we don’t typically see that many orders in month one of a quarter so we see no recovery on that yet, so hence we’re moving forward with an assumption that this macroeconomic environment will continue for the foreseeable future.

[Greg Mesniaeff:]

And as you talk to your customers, realizing that there is clearly an overall slowdown across the board, are any of them telling you of any remaining pockets of strength or areas of resilience where spending continues to be, in relative terms at least, stronger than other areas?

[Richard N. Nottenburg:]

I think the business level, the whole area of interconnectivity between wire line and mobile networks, I think is something that carriers will have to address in the coming year. Because, again, I think there are certain opex and business efficiencies that they could afford. But there may be some opportunities in some of the emerging markets where there is some particular [inaudible] that needs to get built out. I think that we are going to know a lot more probably as when we see the budgets finalized by our customers for 2009. I know that they are all in that process right now and we will know a lot more once that process is really completed and they set their budgets and their priorities for the coming year.

[Operator:]

Your next question comes from Analyst for Kenneth Muth - Robert W. Baird & Co.

[Analyst for Kenneth Muth:]

Can you provide a little more discussion on the nature of the partnerships that you mentioned you are looking at? Just Intel kind of strengthening the existing Motorola relationship, are you looking at similar types of OEM-type relationships or is it different types of relationships entirely that you are pursuing?

[Richard N. Nottenburg:]

We have got a very nice portfolio of products, technology solutions and frankly we’ve got a great sales force. But they can’t reach everywhere on the globe. And certainly in an opex constrained environment. We want to look at ways we can reward our shareholders and grow the top line without incurring costs that are not commensurate with those opportunities. And therefore, I think we’re looking to partner with large, global infrastructure providers who have significant system integration service organizations. And you can imagine who those players are and you can image there are lots of discussions going on. I think Motorola, we continue to work with them on WiMax. Obviously if there are other opportunities we will certainly talk to them. But I mean, clearly, this is a strategy we are going to use on a go-forward basis. And I think this is an important part of the strategy irrespective of the downturn. I think that companies with great technology have got to find ways to get to market with a smaller SG&A foot print.

[Greg Mesniaeff:]

Just to clarify, you think this is more appropriate for the emerging markets or do you think is viable for penetrating the developed markets, also?

[Richard N. Nottenburg:]

I think in the developed markets, I think we will look at it on a one-off basis. I have traveled extensively in my former role in the emerging markets and I think those are the kinds of places which are remote, which are hard to get to sometimes and we don’t have a service organization on the ground and that’s where we’re really looking to place those partnerships that work.

[Operator:]

Your last question comes from Natarajan Subrahmanyan - Smh Capital.

[Natarajan Subrahmanyan:]

On opex, you talked about some plans to reduce opex and I wanted to clarify that is over and above the elimination of the legal fees and if you could talk about broad time frames in which we should see a meaningful impact on opex. Also I know you are not providing specific guidance for the fourth quarter, given the environment, but the year-over-year declines you’re planning in the business, are they from a magnitude perspective similar to what we saw in the September quarter?

[Richard N. Nottenburg:]

Let me give you the broad principles. The basic principles, we are going to right-size and realign the business to match the market opportunity. That’s the guiding principle. I think with respect to engineering, clearly we live in a universe where engineering is done globally and what we have to do is we have to make sure that we leverage all of our assets in the most appropriate way. So I think as we roll out our plan, as we go to our Board, and as we come onto the next conference call, we will be much more articulate in terms of giving you the specificity about the plan for 2009 and beyond.

[Richard J. Gaynor:]

I would say two parts to that. You asked how big a define we see going forward. We really aren’t in a position to give guidance for Q4 because the range of outcomes has been so wide on the top line. But what we said it would meaningfully less than it was in Q4 of last year, which was around $97.0 million. So we don’t see any kind of strength like that in the quarter. And on opex, I would say that legal fees we hope are a pretty much resolved issue at this stage. But we’re focused right across the business. We’re focused across all the functions and we’re not going to hesitate to do the things that we need to do to respond to the economy.

[Natarajan Subrahmanyan:]

On a sequential basis do you think there is any kind of seasonality factor at all which would, given that Septembers results were impacted by similar factors, that you would be up sequentially or is it just at this point it’s really hard to call?

[Richard J. Gaynor:]

It’s too hard for us to call at this stage and then you also have the normal factor of when do certain items in deferred revenue come out of deferred revenue and hit the P&L. And when you combine those factors, we’re just not in a position to give you guidance. We would like to think that the market would stabilize in the fourth quarter and as we go into our Q4 earnings call we’re in a better position to give you outlook for 2009 and maybe more precise guidance, like we used to do on some of the opex lines, but we’re not in a position to do that right now.

[Natarajan Subrahmanyan:]

That G&A legal fee expense of $5.0 million, since some of these are settled does it drop off sharply?

[Richard J. Gaynor:]

It will drop off fairly significantly from that level.

[Karen Cellupica:]

That does complete this morning’s financial results conference call. We would like to thank you again for joining us and we appreciate your interest in Sonus Networks.

[Operator:]

This concludes today’s conference call. For a replay of today’s conference call please dial in 1-800-633-8284. For international callers, please dial 1-402-977-9140. The playback reservation number is 21397294.