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Sonus Networks, Inc. (NASDAQ:SONS)

Q3 2010 Earnings Call

November 02, 2010 4:45 pm ET

Executives

Fran Murphy - VP, Finance

Ray Dolan - CEO

Wayne Pastore - CFO

Guru Pai - COO

Analysts

Nicole Greenfield - Credit Suisse

George Notter - Jefferies

Catharine Trebnick - Avian Securities

Subu Subrahmanyan - Sanders Morris Harris

Todd Koffman - Raymond James

Ari Bensinger - Standard & Poor’s

Operator

Welcome to the Sonus Networks Third Quarter 2010 Financial Results Conference Call. I would like to remind everyone that today’s call is being recorded and all participants are currently in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions)

At this time, I would like to turn the conference over to Mr. Fran Murphy, Vice President of Finance at Sonus for opening remarks and introductions. Please go ahead, Mr. Murphy.

Fran Murphy

Welcome to Sonus Networks’ third quarter results conference call. Thank you for joining us today.

With me on the call this afternoon are Ray Dolan, who has joined as CEO; Wayne Pastore, our Chief Financial Officer and Guru Pai, our Chief Operating Officer.

Before we get started, I would like to remind you that during this call, we will make projections or forward-looking statements regarding items such as future market opportunities, and the company’s financial performance. These remarks about Sonus Networks’ future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. These projections or statements are neither promises nor guarantees, and instead are predications based on management’s current beliefs and involve various 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 risks that could cause actual events or financial results to vary from these forward-looking statements, please refer to the Risk Factors section of our Form 10-K for the year ended December 31, 2009 and our most recently filed quarterly report on Form 10-Q, which was filed today 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 a subsequent date. While we may elect to update or revise forward-looking statements at some point, we specifically disclaim any obligation to do so unless required by law.

Finally, please note that during our call, we will be referring to certain GAAP and non-GAAP financial measures within the meaning of SEC regulation. A reconciliation of the non-GAAP to comparable GAAP financial measures, along with our earnings press release is available in the Investor Relations section of our website www.sonusnet.com under the heading Financial Documents and subheading third quarter 2010 reconciliation of non-GAAP and GAAP financial information.

A recording of this telephone call will be available until November 16, 2010. The instructions for accessing this recording and a replay of the webcast will be available on the Sonus Networks’ Investor Relations website. Please visit www.sonusnet.com, About Us, Investor Relations for details.

I would now like to turn the call over to our CEO, Ray Dolan. Please go ahead, Ray.

Ray Dolan

Good afternoon everyone, and welcome to our third quarter 2010 earnings call. This is my first earnings call since joining Sonus three weeks ago. I will begin with brief overview of my experience and some initial observations; then Guru will review the highlights of the quarter before turning it over to Wayne for the detailed financial results.

As many of you know prior to coming onboard at Sonus I worked for nearly 25 years in the telecoms industry. This experience has given me an appreciation for the competitive environment, which our customers operate and how they select and purchase from their trusted suppliers.

I joined Sonus because I believe our company has significant untapped potential. With our valuable portfolio of innovative products and solutions, strong customer relationships and some of the best employees in the business, Sonus has a strong foundation in place.

For the past several years, the board and the senior management team have been working on a strategic plan to re-establish Sonus’s category leadership and improve our financial performance. We will build on that going forward.

I spent my first three in Sonus meeting with our customers and employees and becoming more familiar with our operations. I look forward over time to meeting with many of you as well. I believe we have a great story to tell and importantly a significant opportunity to build shareholder value.

Before I turn the call over to Guru, let me briefly touch upon our third quarter results. Revenue for Q3 was $42.7 million, down from $61.2 million in Q2 2010 and down from $56.2 million in Q3 ‘09. This decrease was due in large part to several orders being deferred beyond Q3. That said, I worked extensively with our team and the opportunities we have for the balance of 2010. We continue to have a positive outlook ahead and we will be reiterating our full year guidance on revenue.

Wayne will review our guidance in further detail toward the end of the call. Now, I would like to turn the call over to Guru to discuss some of our recent accomplishments.

Guru Pai

Thank you, Ray. Good afternoon everyone. We continued to make good progress with the NBS-5200, our session border control solution build on our new ConnexIP platform. We have signed evaluation agreements with 14 customers to trial the NBS-5200 and we are excited about our healthy pipeline of customer engagements and the early market traction we are achieving. The platform’s value proposition is resonating with a broad set of our customers. The 5200 can maintain performance and throughput during strenuous network conditions such as a prolonged denial of service attack. In fact, independent lab testing has validated our product’s superiority and specifications especially around session density and scalability.

We also recently announced general availability of our network analytics products suite focused around the performance management of VoIP networks. These products are based on over 12 years of know-how acquired through deploying and supporting some of the world’s largest VoIP networks. These software products complement our market leading portfolio and create a more compelling total solution for our global customer base.

In addition to our new products we remain committed to the success of our GSX and NBS-9000 based hybrid trunking portfolio. During the third quarter, we recognized revenue from seven new hybrid trunking customers. We also booked new enterprise orders through both our direct channel and our recently established carrier channel and are excited about the efficacy of Sonus’s products for large enterprises.

In conclusion, we saw several positive developments for Sonus this past quarter including progress in the adoption cycle of NBS-5200 continued growth in our customer base for our hybrid trunking solutions and the launch of our network analytics suite. These developments will serve us well as we expand our market leadership and we remain optimistic and excited about our prospects.

With that, let me hand it over to Wayne who will go over our financials.

Wayne Pastore

Thank you, Guru. Good afternoon everyone. Before I review our financial results, please note that our results can vary significantly from quarter to quarter. So as always we encourage you to evaluate us on a longer term basis. Now, let me recap our results.

Revenue for the third quarter was $42.7 million, down from $61.2 million in Q2 2010 and down from $56.2 million Q3 2009. Our overall book to bill for the quarter was under one, however, our product book to bill was above one. Two customers contributed greater than 10% of total revenue in the third quarter, AT&T and CITIC 1616. Our top five customers represented approximately 52% of revenue during the quarter, up from 43% in Q2 and up from 49% in Q3 2009. We reported from 100 customers in the third quarter including 7 new customers. This compared to 93 customers in Q2 2010 and 89 customers in Q3 2009.

Looking at revenue geographically, domestic revenue accounted for 74% of revenue in Q3 versus 68% in Q2 and 66% in Q3 2009. Please note that the timing of deployment and the completion of longer term projects will affect the geographic mix quarter to quarter.

Before I go into further details on our financials, I would like to point out that the following are non-GAAP numbers that excludes stock-based compensation, amortization of intangible assets, and restructuring charges.

Gross margin for the third quarter was 56.9% of revenue, compared to 63.8% in Q2 and 63.8% in Q3 2009. Product gross margin for the third quarter was 63.4% compared to 70.9% in Q2, and 70% in the same period last year. The decrease in our product gross margins both sequentially and year-over-year was mainly attributed to the current quarter product and customer mix and not related to any single transaction. Service gross margins for the third quarter were 51.5% compared to 53.1% in Q2 and 54.6% in Q3 2009.

Total operating expenses for the third quarter were $38.9 million, up $3.3 million from Q2 2010 and up from $34.7 million in Q3 2009. Included in the current quarter expenses are approximately $2.6 million of accelerated cost associated with the departure of certain executives and depreciation expense related to the announced facility relocations.

Looking at our headcount, we ended the quarter with 962 employees, compared to 917 employees at the end of Q2 and 864 with comparable period a year ago.

Now looking at our balance sheet. We ended the third quarter with total cash, cash equivalents, marketable securities and long-term investments of $413.5 million. Cash investments decreased $6.3 million from the prior quarter but were essentially flat as compared to the beginning of the year. The decrease in our cash balances attributed to our investment of $4.9 million in capital expenditures mainly related to ongoing R&D initiatives combined with $1.4 million of cash using operating activities.

Total deferred revenue is $91.8 million, up from $88.8 million in Q2 and up from $83.4 million in Q3 of last year. Our higher deferred revenue during the quarter reflects our continued progress with certain long-term projects for which we can invoice, but are unable to recognize as revenue yet.

AT&T deferred revenue was $25.3 million in Q3, down from $26.3 million in Q4 and down from $33.9 million in Q3 ‘09.

Now looking forward to the remainder of 2010. Our full-year of 2010 will be as follows. We continue to expect total revenue for the full year 2010 to be between $225 million and $245 million. Our 2010 non-GAAP gross margin is expected to be within our longer term target range of 58% to 62%. We expect full year operating expenses to be in the range of $145 million to $148 million. The increase in our range of expected operating expenses takes into account of previously discussed accelerated expenses related to the departure of certain executives and the depreciation expense related fully relocations.

Turning now to our guidance for the fourth quarter. Total operating expenses for the fourth quarter are expected to be in the range of $34 million to $37 million. We expect to spend between $3 million and $5 million of CapEx in Q4 with a majority of these expenditures related to our research and development efforts.

We expect to end the year with cash and investments between $395 million and $400 million. Basic share count for Q4 should be approximately 276 million shares.

In conclusion, we expect our full year revenue results will remain within our previously guided expectations. We are pleased with the customer growth we achieved during the third quarter on our full portfolio products and service offerings. As we look ahead, we will continue to leverage all these offerings create value for our customers and our shareholders.

With that, let me turn it back to Fran.

Fran Murphy

Thank you, gentlemen. Edison, would you please provide our callers with the instructions on how to ask a question?

Question-and-Answer Session

Operator

(Operations Instructions) Our first question comes from the line of Paul Silverstein with Credit Suisse. Please proceed.

Nicole Greenfield - Credit Suisse

Hi, this is Nicole Greenfield on behalf of Paul Silverstein. Can you give us some color on SVC’s general and NBS-5200 platform more specifically? Either shown information you can give us on revenue contribution, service provider versus enterprise customer breakdown and also timeline from trails of revenue recognition would be appreciated?

Ray Dolan

Nicole, this is Ray Dolan. We had revenue for Q3 for our NBS product of little over $3 million about $3.1 million. (Inaudible) on a year-to-date basis to about $15.6 million.

Nicole Greenfield - Credit Suisse

Do you have a breakout for the 5200 versus the NBS-9000?

Wayne Pastore

No, we don’t have that. We’ve had a lot of trials. It’s early in the stage for the 5200 and we’re not breaking out revenue that way.

Nicole Greenfield - Credit Suisse

Okay and any more color on your service provider versus your enterprise customer trials?

Ray Dolan

Yes, all of them are going very, very well both in the service provider category and on the enterprise side. We’ll give you more color as they close, but the color was in Guru’s comments and in Wayne’s comments with regard to the number of trials we have and the breadth of those trials.

Add to that the fact that we got the third party research end is validated, our principle design parameters, which are the stability and scalability of the product under load and we are very, very pleased with the interaction we’ve had with customers and take up in those trials.

Catharine Trebnick - Avian Securities

You can’t breakout the number of service providers versus enterprise-focused customers that are in trial?

Ray Dolan

No, we’re not going to break that out at that level, Nicole.

Operator

Our next question comes from the line of George Notter with Jefferies.

George Notter - Jefferies

Just following up here on the discussion around the NBS-5200, I guess I’m trying to get a sense for, from a trial’s perspective from, seven trials last quarter to 14 this quarter. Is that in line with what you guys were expecting coming into Q3 and if I look at the space, I look at Acme Packet business for example they have got more than 1,100 customers.

Certainly, there is a significant opportunity out there. In that context, would it make sense to have more customer trials at this point and maybe there’s something I’m missing in this. Thanks.

Ray Dolan

Sure, George. This is Ray. Obviously, we love to have more, but I don’t think our current results that are aligned with our prior expectations have been relatively New Year. They are not outlined with five years. I just think we need to execute better over time and more broadly over time and we will do that.

There is a ramp up here, I think, a normal ramp up here and we are on that ramp and we are executing well. We’re in very good discussions with key prospects and I’m convinced that over time. We’ll win our fair share of the business there.

George Notter - Jefferies

One of the questions I had was just relating to the enterprise space. How big do you think the addressable market opportunity is there? One of the questions we’ve heard from some folks in the marketplace, was just the scaling of the 5200 product line for enterprise customers.

I got the sense that it was really designed for very, very larger enterprise customers and I’m wondering how big the market opportunity is there, and is it possible that you could come in behind the 5200 with smaller scale down product that’s more applicable for maybe medium size enterprises?

Ray Dolan

First, the latter question first, it’s always possible that we’ll evolve our products. We don’t have anything to talk about now, but that opportunity is there for us all the time, we will look at it, but I don’t think that there is a niche that we can provide with this 5200. The product is very, very scaleable.

The fact that it is very well-designed for large enterprise, it gives us unique opportunity at Sonus relative to some of our competitors, because as I said, not only it is stable, but it’s very scalable and it remains ratable through large deployments and customers are starting to get that and they take up as a result amongst the large enterprise, who will be very, very strong.

As to how big that addressable market is at this point in time? It’s hard to say, but we’re going to go after as aggressively if possibly we can.

Operator

Our next question comes from the line of Catharine Trebnick with Avian Securities.

Catharine Trebnick - Avian Securities

Good afternoon. Welcome Ray what a first earnings call you get to.

Ray Dolan

Well, Catharine for that welcome. Good talking to you.

Catharine Trebnick - Avian Securities

Yes, so my question is, we’re on the line of 100 customers. You said there were seven new ones, any color as to domestic, international enterprise carrier

Ray Dolan

We don’t have any color to add beyond that, Catharine. I’m not sure it has lot of value other than to satisfy the curiosity, but I can assure you that we’re going to go after every opportunity vigorously large and small in every geography.

Catharine Trebnick - Avian Securities

My other question is what is the R&D pipeline look like? Some of the (inaudible) done there is actually a lot of (inaudible) right, the activity globally you obviously are working on the streets than I do. So how are you really working at the pipeline in current zone, hybrid versus just IPied IT for the NBS-5200, because your core business is a solid business?

Ray Dolan

Our core business as you say is the solid business and we find ourselves in customer discussions of all those kinds. We really don’t have a pipeline to disclose to you in detail, but we are finding the customers who wanted to do hybrid deployment and if there are other customers either at this thing or not yet current customers that wanted to do more SVC deployments. We’ll meet all of those markets head on. That’s what is exciting about this 5200 as it complements to 9000 and our prior products as well.

Catharine Trebnick - Avian Securities

Since you’ve been in here three weeks, is there any anomaly or any thing that you right to change that you seen so far? Have you hired a replacement for the former sales VP?

Ray Dolan

The latter when first. We have not yet announced a replacement for our worldwide sales leader. When we have that individual to join, we will certainly introduce him/her to you and now focus on that as squarely as I can go forward. Meanwhile, in the absence of that sales leadership it’s been a excellent opportunity for me to get more intimately involved with our customers and our processes and how our value proportion is being understood and explained by our team. That’s been for me in three weeks a good opportunity. I’ll let you know as we look forward to that sales VP.

There are no other anomalies that I’d be prepared to address at this time, Catharine, other than as things come up we will continue to execute better. If there are opportunities to organize better we will do it.

Operator

Our next question comes from the line of Subu Subrahmanyan with Sanders Morris. Please proceed.

Subu Subrahmanyan - Sanders Morris Harris

I have two questions. First on the session border overall numbers. Your $15 million approximately for the year so far and in the past you have talked about 30% growth over last year’s numbers. Would you [explain] why although the $30 million numbers I wanted to see if you still feel comfortable with that kind of target? Also, in the past you guys have talked a lot of 5200 orders kind of in the second half of the year, maybe some revenue contribution in the fourth quarter. I was wondering if you still on track with that?

Ray Dolan

Specifically with regard to NBS and 5200 numbers, we’ve disclosed those this quarter and we’ll disclose them again next quarter. Going forward our plan is to disclose our overall revenue focus and to give you some view into our pipeline through potentially either a backlog number or some other sense for a momentum. Our plan is to focus our product sales across our entire portfolio and not to be singling out individual numbers.

I don’t know exactly what the logic was that talked 15 beyond some of your conclusions on our NBS numbers. We’ve got some choppiness in revenue recognition and some early market development numbers which may make those numbers challengeable and they may not. It’s too early for me to tell them my tenure here.

I can assure you I focus now on hitting our overall revenue numbers, our overall cash flow numbers. As we do that with customers, when NBS is the right product to sell we’ll sell that, when it’s not we’ll sell the remainder of our product line. We’ll report that out again and then going forward we will report out on our broader revenue number, Subu. Thanks for your question.

Subu Subrahmanyan - Sanders Morris Harris

Just a follow up. Also, can you specifically covered why things were pushed out this quarter. Was there any kind of timing of orders, was it the complexity of the deal, what caused the push out this quarter versus your (inaudible) or your expectations?

Ray Dolan

I’ll let Guru talk about that and I’ll be happy to follow up.

Guru Pai

Yeah, hi, Subu. There is nothing specific. I think some projects has got elongated, I think in terms of scope, they, in terms of delivery as you know, around (inaudible) revenue recognition, the inherent lumpiness especially for expand project midstream, and some of that occurred for us. Just given the size of some of these transactions, we couldn’t score revenue this quarter.

Ray Dolan

Do you want to add anything or?

Operator

Our next question comes from the lines of Todd Koffman with Raymond James. Please proceed.

Todd Koffman - Raymond James

Thank you. Can I just get a clarification, in your opening comments you said that you signed an agreement or agreements for the evaluation for the 14 customers, was that what you said?

Ray Dolan

Yeah, that’s correct.

Todd Koffman - Raymond James

With regard to those 14 evaluation trials that you entered into agreement, how long do you think you would like typically take for the customer to evaluate the product before they might decide to go forward with the deployment?

Ray Dolan

Like I said, it’s important in the context of what we are talking about here, for you to understand that in any product deployment, in any similarly situated product our expectations are that between six to nine months of an adoption cycle. Some of it went, they’re evaluating the efficacy of the product and testing the product specification and the second piece of how it fits into their network itself. Typically, in our experience that six to nine month adoption cycle.

Todd Koffman - Raymond James

Just one follow-up on that. With regard to the ongoing trials or future trials like these signs that you are calling out, do those customers currently have Session Border Controller solutions deployed or have they not yet made a commitment with regard to Session Border Control?

Ray Dolan

It’s both. Okay, think some of them have got solutions from Sonus, some of them have got solution from other vendors and some of them are just making their SBC decisions now.

Operator

(Operator instructions) We do have a follow-up question from the line of George Notter of Jefferies. Please proceed.

George Notter - Jefferies

I was trying to figure out how much was left here then from Q3 to Q4 and can you tell us how many projects were involved and then just confirm that revenue will all fall in Q4?

Ray Dolan

Yeah, this is Ray. We don’t break that out by projects. What I can say to you that I’ve had a chance to review with the team what our pipeline looks like into Q4 as a result for the balance of this year and I’m comfortable with the statement that we made in our earnings release and earlier on the call that we will come in within our previously guided range.

George Notter - Jefferies

The deferred revenue line up about 3 million sequentially, how should I think about that deferred revenue line in the context of these slipouts in revenue? I assume they stayed in the deferred revenue line in - give me a flavor for, what moving parts are in the deferred revenue line that would be helpful?

Wayne Pastore

George, this is Wayne, how are you doing? All of that $3.5 million increase in deferred revenue really came on the product side. Our short term deferred revenues is pretty much flat from this time last quarter.

George Notter - Jefferies

Is it fair to say then looking forward into Q4 -- I mean I guess the sense that the order book was particularly weak than this quarter given, you didn’t get any bump in deferred revenue certainly not revenue going to flow to deferred revenue, but I urged to say book-to-bill is below one, I’m just trying to get a sense for how bad that order book could have looked here in Q3 and again get a sense for your confidence in the Q4 expectation?

Wayne Pastore

George, this is Wayne again. You’re right. The total book-to-bill for the quarter was below one. Our product book-to-bill was above one. There is in a dollar-per -dollar code exchange with deferred revenue because some of the change in deferred revenue is related to the evaluation of it under rev rec.

The good news is we are continuing long-term projects. We are continuing to invoice (inaudible) projects and I like just say for the quarter the book-to-bill on the product side was above one.

Fran Murphy

George, thank you for the question. Edison, do we have anyone else queued up for question?

Operator

We do have Ari Bensinger from Standard & Poor’s.

Ari Bensinger - Standard & Poor’s

Just a general question on strategy. There has been noticeable uptick in M&A activity over the past couple of quarters. How does the company feel strategically about making moves to be a partnership or what not, to maybe improve scale or distribution reach?

Ray Dolan

Ari, this is Ray Dolan. I really don’t have anything to say on that, other than we’ll look at all of the opportunities that we report. My principal focus talking with all of you today is that we can execute better and we will focus on that in Q4 and as we do that is upon the foundation for our growth and if they are our M&A opportunities that present themselves will due those, but that’s not our principal area focus right now.

Operator

Our next question comes from the line of [Aj Nuan] with [Seligman Investment].

Unidentified Analyst

I was just wondering on base business, what is the break-even level of revenue now and I’m just wondering just like you seem to be doing about $50 million to $60 million in revenue for I don’t know a long period of time. If there is a lot obviously quarterly, but can you be profitable and made money on the base business that run rate or what’s the breakeven there?

Wayne Pastore

Hi, this is Wayne. We don’t break that up by product line, what we do say in our total revenue, we said this on prior calls. Our break-even numbers for this year is roughly 235 to 238, obviously that depends in the gross margin mix, but we are pretty consistent with what we said on prior calls regarding our breakeven.

Unidentified Analyst

Got and then so, anything above that what’s the operating model above that is there a lot of leverage on the margin above that break-even level or you have to scale sales and marketing as you introduce NDS.

Wayne Pastore

No, our operating structure is pretty much stable for this year so any revenue above the break-even point would most likely the majority of the float of the bottom-line obviously the variable cost related commission stuff, but majority of those that revenue before right to the bottom-line.

Unidentified Analyst

Got it and then how do you sell to these enterprise customers? You have like dedicated enterprise sales people or do they go through a carrier that the enterprise is dealing with. How do you get to the enterprise itself to make the sale?

Guru Pai

This is Guru. Great question again. We have a limited set of direct sales people, who are involved in very selected focused enterprises, but our channel to market to the enterprise is primarily through as we said as far of a strategy is to work it through our carrier customers and actually sell through them as well as value-added resellers.

Fran Murphy

Edison, do you have anyone else queued up for question?

Operator

It appears there are no more questions.

Fran Murphy

Thank you. I appreciate that update. That does conclude this evening’s financial results conference call. We’d like to thank you all again for joining us. We appreciate your interest in Sonus Networks. Edison, would you please provide our callers with the replay instructions once again please.

Operator

Ladies and gentlemen, that does conclude today’s conference call. You may access the recording of today’s call by dialing 1-800-633-8284 and entering reservation number 21484463. Once again, that’s 1-800-633-8284, entering reservation number 21484463. We thank you for your participation and ask that you please disconnect your line.

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