Veraz Networks, Inc. Q2 2008 Earnings Call Transcript

Veraz Networks, Inc. (VRAZ)

Q2 2008 Earnings Call

August 6, 2008 4:30 pm ET

Executives

Cynthia Hiponia – Investor Relations

Doug Sabella – President and Chief Executive Officer

Albert J. Wood – Chief Financial Officer

Analysts

Eric Kainer – ThinkPanmure LLC

[Adam Scroll] – Cantor Fitzgerald

Paul Silverstein – Credit Suisse

Catharine Trebnick – Americas Growth Capital

George Notter – Jefferies and Co.

Greg Mesniaeff – Needham and Co.

Presentation

Operator

Welcome to the Veraz Networks second quarter 2008 earnings results conference call. (Operator Instructions) I would now like to turn the conference over to Cynthia Hiponia, Veraz Networks Investor Relations.

Cynthia Hiponia

With me on today’s call are Doug Sabella, Veraz President and Chief Executive Officer and Al Wood, Veraz Chief Financial Officer. At 4:05 pm Eastern Time, Veraz issued a press release with the results for its second quarter ended June 30, 2008 on Business Wire. The text of this release is available on our website at www.veraznetworks.com.

We would like to remind you that during the course of this conference call, Veraz management may make forward-looking statements, including financial projections, statements as to the plans and objectives of management for future operations, and statements as to the company’s future economic performance, financial condition or results of operations. These forward-looking statements are not historical facts but rather are based on Veraz’s current expectations and beliefs and are based on information currently available to us.

Words such as “may, will, expect, intents, plans, beliefs, targets and estimates,” and variations of these words are intended to identify forward-looking statements. By discussing our current perception of the market and making these forward-looking statements, we are not undertaking obligation to provide updates in the future.

Veraz’s actual results may differ materially from those projected in these forward-looking statements and no one should assume at a later date that these comments from today are still valid. Please refer to Veraz’s recent SEC filings for a more detailed discussion of these and other risk factors.

Any future product feature or related specification that may be referenced in today’s call are for informational purposes only, and are not commitments to deliver any technology or enhancement. Veraz reserves the right to modify future product plans at any time.

I would now like to turn the call over to Veraz’s President and CEO, Doug Sabella.

Doug Sabella

And thank you for joining us on our second quarter 2008 earnings call. With me today on the call is our CFO, Al Wood. I’ll begin the call by providing an overview of our business in the second quarter of 2008 and then I’ll turn the call over to Al for a detailed description of our financial results and outlook.

Without a doubt the second quarter was a particularly difficult quarter for Veraz. Following a series of relatively stable quarters in terms of revenue and margins since going public in April, 2007, our second quarter fell short. Additionally, we received an informal SEC inquiry which caused a delay in filing our 10-Q for the first quarter which in turn prompted a letter of non-compliance and potential de-listing from the NASDAQ. In short, we faced challenges on many fronts in the second quarter.

We have made steady progress, however, in confronting these challenges. As we previously reported, the independent investigation resulting from the informal SEC inquiry has been closed, with no changes to previously reported financials. We believe that we are now in compliance with SEC reporting obligations, and just this morning were informed by the NASDAQ that the NASDAQ hearing panel has determined to continue the listing of the company shares on the NASDAQ stock market.

For second quarter 2008, revenues were down sharply from the first quarter, largely caused by three factors. First, a number of quarters that we expected to close in the second quarter were delayed or pushed out into the second half of this year, including a number of deals in Asia specific due to the informal inquiry.

Second, as we stated in previous quarters our DCME business continued to represent a shrinking part of our overall revenue mix. And finally, we did experience some slow down in capital spending in some regions that have placed orders in the past.

As we identified these challenges in our business, we took quick and decisive action. On July 15, we announced to the market that we expected our revenue to be in the range of $15 to $17 million. On July 31, we announced a number of initiatives designed to return Veraz to profitability, including reducing our workforce by 160 employees and contractors which Al will discuss in greater detail.

Veraz will become profitable in its stand alone IP business. Achieving profitability will give our prospective customers the confidence to select us and our shareholders the confidence to invest in us, thus giving us the ability to grow and prosper. Having people leave our company is clearly painful, but our current business volumes required us to re-size the business.

We believe that these actions drive our breakeven point for profitability to approximately $25 million per quarter and will enable us to return to profitability in the fourth quarter of this year. On a positive note, we have built backlog in the second quarter and year-to-date. Further, we believe that some of the delayed orders in Q2 2008 will convert to revenue in Q3 of this year, which we will report in more detail during our third quarter earnings release.

I would now like to spend a few moments commenting on our products, our customers and our markets. On the product side, we are convinced that the shift to IP networks continues to advance because IP networks are the most cost effective way to move network traffic of all types around the corner or around the globe. We believe that we’ve had the right products – we have the right products at the right time for the global IP market place and our customers agree.

Our previous investments in R&D has yielded expansions to existing products and new products that enable us to leverage our existing channels and open up new markets and new customers in our bandwidth optimization and switching businesses. The actions we have taken will not affect our investment plans in our high growth segments. In fact, it has provided us with the opportunity to sharpen our focus.

Our bandwidth optimization business continues to lead the market in delivering the highest compression rates while maintaining total quality voice. We will continue to invest and lead the way for carriers to deliver cost effective solutions.

We most recently announced our I-Gate 4000 Session Band with Optimizer or SBO. Our SBO enables network operators to reduce trunking bandwidth by up to 67% while maintaining total quality voice service. This is important because many wireless operators lease bandwidth from other carriers and they can reduce bandwidth expenses significantly with our SBO.

This product is currently in trial with a Tier 1 wireless service provider, and we look forward to additional trials and conversions of these trials into orders over the remainder of 2008. Further, Veraz will be announcing additional product expansions in this area in the next several months, continuing our support of 3G network rollouts.

Our interconnects solutions, sometimes referred to as Class 4 Solution, continues to gain momentum. We are continuing to invest in product expansion, including our most recently announced capability, GMX or Global Multimedia Exchange, Veraz’s IPX solution. IPX is the GSMA initiative describing the commercial and technical principles for mobile operators to connect over an IP network.

This initiative creates a new business opportunity for wholesale carriers, as well as delivering a more cost effective transport model for mobile carriers. Veraz is actively participating in driving the IPX definition within the GSMA and recently announced jointly with Belgacom the completion of an IPX trial, and has completed another successful IPX trial with Telecom New Zealand.

Veraz expects commercial deployment of its GMX solution in 2008. We believe that this will be the next wave of IP peering deployments and that Veraz has the best solution in the industry.

Our end user services solution continues to gain traction in emerging markets. The focus is on classic, classified services and Veraz has developed as IMS infrastructive to cost effectively integrate applications focused on these classic services.

The market for true multimedia services has been slow to develop and going forward Veraz will leverage its existing solution set in the emerging markets. We also announced our Joint Interoperability Test Command, JITC, certification for I-Gate 4000 Edge and received both Interoperability Certification and Information Assurance Accreditation.

These certifications are required for all communication components connecting to the Defense Switch Network which serves the United States Department of Defense, all branches in the military as well as other approved federal departments, agencies, allies and contractors. This is important because they are among the most stringent interoperability test in the industry and also represent access to a substantial market.

All of these initiatives continue to build on previous investments which align the company with key industry trends and establish a platform for future growth. On the customer front, we added three new customers in Q2; two switching customers from North America and one in Russia, as well as a new bandwidth optimization customer in North America.

We now have 106 customers in over 60 countries. We announced our seaport deployments for Spice of India, which is now merging with Idea, a leading GSM mobile services operator with licenses to operate in all 22 service areas of India and a customer base of over 26 million.

North America had a strong quarter and we continue to see improved deal flow. We continue to see opportunity in [calar] and expect to grow our presence with the two large Tier 1 providers in Latin America. One is utilizing our bandwidth optimization solution. Another is deploying our Interconnect Class 4 switch in two of its networks.

Asia Pacific was disappointing, and we look forward to growth in the region now that the independent investigation has been completed and we have new sales leadership in place. We continue to strengthen our position in [Amea] with Colorcom Italia, OTE Globe of Greece, Deltacom, and with customers in Turkey and Africa.

We remain committed to the success of our 100 plus customers. We understand that when carriers make a decision to deploy our technology into their networks, it is a decision that begins a long term relationship with our company. Because our technology integrates into their network, and their operational support systems and back office support systems, we are essential parts of their ability to deliver services to their customers.

We believe that our geographically diverse customer base gives us access to some of the fastest growing regions for growth in communication services and provides us with a distinct advantage over our competitors. In addition, through our positive comments on backlog, we also see many reasons to be optimistic in terms of customers and products. We have collaborated with our customers in developing solutions to enhance their revenue and reduce their costs, demonstrated our commitment to R&D and leadership in international standard bodies like the GSMA IPX, and have obtained difficult to achieve interoperability certifications.

We believe that we understand our customers operating environment, and our new products and offerings like the I-Gate 4000 SBO and our GMS solution give them the tools to operate their businesses more efficiently. We are committed to return to profitability, delivering value to our shareholders and delivering solutions designed to enable our customers to maximize the value of their businesses. We are excited by the opportunities we see in front of us.

And now I’ll turn the call over to Al.

Albert J. Wood

We are pleased to be reporting second quarter results. I’m going to start with the financial highlights of the second quarter, and then I will provide an update on our outlook for the second half of 2008.

For Q2 FY’08, total revenues were $16.3 million, a 48% decrease from Q2 FY’07 and a 42% decline from Q1 FY’08. The decrease in total revenues year-over-year was due to a decrease in revenues from our IT products and IT services in addition to the expected decline in revenues from our DCME legacy product.

The revenue shortfall was attributable to a combination of factors, including the following. While we had respectable bookings in Q2, the bookings did not convert to Q2 revenues as we had seen in the past due to contracts being closed late in the quarter, undelivered items, etc. DCME product revenues, while expected to decline in Q2, were even softer than we had expected. Services revenues were somewhat lighter than expected as a result of the product revenues being lighter than expected.

Finally, the slowdown in capital spending has caused some of our customers to delay orders. We continue to steadily expand the already diverse customer base from which our revenues are generated. We had two customers that each accounted for 10% or more of our Q2 revenues, Deltacom International at 14% and Sky2Net at 10%. Our top ten customers accounted for 64% of our Q2 revenues and four customers each accounted for $1 million or more of Q2 ’08 revenues.

We believe that this lack of customer concentration has been and continues to be a significant advantage as we are not overly reliant on any particular customer, capital budget or geography. On a geographic basis, our 2Q FY’08 revenues were 21% from North America and 79% international, as compared to Q1 FY’08 revenues which were 16% from North America and 84% international. The geographic mix of revenues will vary significantly on a quarterly basis, depending on the timing of completion of projects and other factors.

Our Q2 IP product revenues consisting of our media Gateway and ControlSwitch family of products were $9.7 million, a decrease of 53% from the $20.7 million IP product revenues recognized in the preceding quarter, and a 55% decrease from Q2 FY’07. Our DCME legacy products revenues were $1.2 million for 2Q FY’08.

While this is a substantial decline for the same quarter on a year-over-year basis, as well as compared to the preceding quarter, as we’ve said previously at this late stage of the product life cycle of this legacy product the rate of decline of the DCME product revenues will vary from quarter to quarter. We still expect our DCME product sales to continue to decline over time, while there’ll be some periods where the DCME sales are different than our expectations.

Our services revenue of $5.3 million was essentially flat over the same quarter of last year, and a $4 decrease from the preceding quarter. As expected the mix of services revenues continues to shift towards the IP business, which offsets the expected decline in the services revenues attributable to our DCME business.

Total gross margin was 43.7%, a decrease from 61.9% in Q2 FY’07 and from 53.6% for Q1 FY’08. As we’ve stated previously, the percentage of total gross margin as well as the IP product margin will vary due to the mix of revenues as well as the characteristics of the specific deals recognized within the period. The lower gross margins were also attributable to increased competition and the allocation of the same fixed overhead costs to a smaller amount of revenues.

Additionally, service revenue margins will vary due to characteristics of the service engagements and the timing of the services expenses, which may not be in the same period as when the services revenues are recognized. While there will be some variability in any given quarter for our long term business model we expect to have total gross margins of 55 to 60% and we expect to gradually return to such gross margins in the coming quarters.

For Q2 operating expenses were $19.9 million, including $1.0 million to stock compensation expense and $2.1 million in expenses related to the informal SEC inquiry as compared to $17.2 million, including a $0.5 million stock compensation expense for Q2 FY’07 and $18.6 million, including $900,000 from stock compensation expense for Q1 FY’08.

Aside from the $2.1 million expenses related to the SEC informal inquiry, the increase in operating expenses for Q2 sequentially was also a result of an increase of our bad debt reserve of $700,000 and an additional $500,000 expense due to an unfavorable foreign exchange rate of the shekel versus the U.S. dollar. The operating loss was $12.8 million as compared to $2.1 million operating income for Q2 FY’07 and in Q1 FY’08 where we had a $3.7 million operating loss.

Other income and expenses and tax benefit netted out to $1.3 million positive for Q2, which is better than expected due to a tax benefit resulting from a loss incurred in Q2, as well as foreign exchange gains from some balance sheet items that were denominated in foreign currency. Net loss for the period was $11.6 million, or $0.28 loss per share and on a non-GAAP basis net loss was $8.3 million or $0.20 loss per share.

Turning to the balance sheet our cash in short term investments were $38.3 million as compared to $54.4 million as of Q1 FY’08. For Q2 FY’08 we have a negative cash flow from operations of $14.6 million and after taking into account the cash flows of investing and financing activities, our total cash flow was a net decrease of $18 million. This significant cash burn was the result of larger than expected $11.6 million loss incurred in Q2 combined with a $9 million reduction in accrued expenses and a $2.5 million growth in inventories, partly offset by a $7.6 million decrease in accounts receivable and a $2 million in deferred revenue.

In Q2 we did not factor any of our accounts receivable, but we did collect approximately $5.8 million of previously factored accounts receivables that were then remitted to the banks. In a press release issued last week, we announced that the special committee of the board of directors and the independent counsel retained by that committee to investigate matters raised by the SEC in a letter dated April 3, 2008, have now completed our independent investigation.

Following the investigation, there was no material affect on the financial statements of the 10-Q recently filed and there will be no amendments to other reports previously filed. And we are now current with all required SEC filings. During the course of the independent investigation, we were made aware of allegations of misconduct by a few non-management employees with whom we took quick and decisive action, relating to the company’s business practices in Asia Pacific. While the SEC must still complete its inquiry, we expect that going forward the expenses including possible fines, if any, to bring this matter to final closure will be minimal.

As stated in an earlier press release, we have already taken immediate measures to streamline our operations and reduce our expenses, including a reduction in force that we believe will gradually bring operating expenses back into line with our long term business model. Specifically, we recently reduced our headcount employees and contractors from 474 to 312, a reduction of 162 persons or 34%. The reductions were across the board in all departments, but were primarily focused in engineering, in particular our India engineering team and in services.

We expect that, due to the streamlining of operations and a reduction of force, we will have a one time expense in Q3 of $1.2 to $1.5 million and this additional expense is expected to be largely offset by the expense savings resulting from taking these streamlining measures early in Q3. Going forward, we believe that such streamlining measures will reduce our quarterly non-GAAP operating expenses by approximately $2 million to around $14 million per quarter, starting in Q4 FY’08. By quickly reducing our non-GAAP operating expenses to roughly $14 million per quarter, we believe we can lower our breakeven point for cash flow and non-GAAP operating income to around $25 million in revenues for quarter.

Let me close with a few forward-looking comments concerning an update to the outlook for FY’08. I remind you that the comments I’m about to make are based on current indications for our business, which may change at any time. We undertake no obligation to update these comments.

As outlined in our press release issued earlier today, we expect Q3 revenues to be in the range of $20 to $22 million and a loss of $7 to $6 million or $0.17 to $0.14 loss per share on a GAAP basis, and on a non-GAAP basis a net loss of $4 to $3 million or $0.09 to $0.07 loss per share, after exclusion of expenses related to stock compensation, restructuring and SEC inquiry costs. We expect Q3 net cash use from operations to be approximately $5 million. For Q4 we are targeting revenues of approximately $25 million and breakeven profitability on a non-GAAP basis, and approximately breakeven on a net cash from operations.

In summary, while we are disappointed with our financial performance for Q2, we have already taken measures to return us to profitability and positive cash flow as quickly as possible. We believe that although we are in a challenging environment, we are committed to taking steps necessary to meet those challenges and deliver value to our customers and our shareholders. We look forward to updating you with reports on our progress in future calls. We will now take your questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eric Kainer – ThinkPanmure LLC.

Eric Kainer – ThinkPanmure LLC

First question is I believe you had tipped us last quarter that even without the required Russian certifications that you were going to be aggressively marketing your switching products into Russia. And I guess we got some validation on that with one of your new switching customers being Russian. I wonder if you can tell us where you are in that certification process and if indeed you are on track for getting that this quarter?

Doug Sabella

First just so we’re clear, we are already certified on the Class 4 side so that’s not an issue, but for the certification process on the Class 5 side we’re in the middle of doing it right now. So we’ve initiated the process, we’ve obviously signed contracts – in Q1 we also signed by the way a contract in the Ukraine which has its own certification process for Class 5 also. So through both of those we’re going through our, you know, the process with the local authorities in addition with the local vendors to get certified, and it takes several months for that to get completed but the work is under way.

Eric Kainer – ThinkPanmure LLC

So you think you’ll have that by the quarter end or pretty close?

Doug Sabella

I would define it as by the end of the year we’ll have completed certification. But that generally does not – in fact it doesn’t stop the deployments from occurring. So the deployments occur with kind of a pending certification completion, and we’re doing all the work necessary to be certified.

Eric Kainer – ThinkPanmure LLC

Does it impact revenue recognition at all?

Doug Sabella

I think it generally will and that’s why we’re targeting by the end of the year.

Albert J. Wood

Yes. You know if the expectation is with the customer that this should be a certified operating system, Eric, then yes it definitely would affect revenue recognition.

Eric Kainer – ThinkPanmure LLC

I wonder if you could talk a little bit maybe more expansively about the IPX opportunity, because obviously, you know, we’re seeing a tremendous explosion in wireless and all of those operators globally, you know the GSM operators specifically, are seeing a tremendous uptake in data services and all kinds of interconnectivity issues. So I wonder if you can talk a little bit about the opportunity you see there?

Doug Sabella

We think it’s one of the most exciting opportunities we’re going to be working on over the next, you know, several years. Historically the settlement process between mobile operators and the long distance carrier community has been a very traditional one, using obviously TDM and all of the billing mechanisms, etc. With the new GSMA standards around IPX, fundamentally what they’re able to do is basically use IP communications, layer in all the security requirements, qualify of service requirements, etc., and provide a global capability to provide IP communications.

It will be a significant cost savings for the mobile community, the implementation of GSMA, so they’re very incented to embrace it. And in the same token it’ll be a great market opportunity for the next gen long distance providers, and even folks like Deltacom who we’ve already announced and talked about today, Telecom New Zealand.

From an architectural standpoint our distributed architecture plays very, very well into this opportunity. Because you really are dealing with global islands of properties for some of the largest wireless providers in the world, and their ability to actually provide, you know, all of the communications capabilities, etc., over IP on the long distance will save them a significant amount of money. And we’re able to fundamentally do it off of a single switching fabric.

So for instance, Telecom New Zealand we literally had mobile providers participating from Austria to Russia to Hong Kong to New Zealand, you know, all providing IP communications exchange with this new capability. So it will be generally available by the end of the year, and again we think it’s a great growth opportunity for Veraz and it’s going to be a big play inside the industry.

Eric Kainer – ThinkPanmure LLC

I wonder if you can talk to the opportunity, kind of take this viral if you will, that is, you know, once you get a TNZ deploying your IPX solution here, whether they’re interchange partners are also more likely to use your platform rather than somebody else’s, if indeed they’re not yet installed?

Doug Sabella

The answer is yes, we would expect them to. And for us we have two levels of opportunity. First of all, we obviously have the opportunity to market this to the 55 switch customers that we currently have today, but in addition there is a kind of a bit of a viral opportunity. Very similar to, oh, the first generation SBC’s that are out there today, this is in many ways the next generation of IP peering around the mobility market.

Operator

Your next question comes from [Adam Scroll] – Cantor Fitzgerald.

[Adam Scroll] – Cantor Fitzgerald

I’m on for Ted Jackson. I was just curious if you could start out here first with operating cash flow depreciation in CapEx?

Albert J. Wood

Adam, we anticipated your question so with respect to depreciation, that was about $900,000 for the quarter. And then with respect to CapEx it was about $500,000 for the quarter.

[Adam Scroll] – Cantor Fitzgerald

And then operating cash flow?

Albert J. Wood

As I said in my call there, the operating cash flow from operations was a negative $14.6.

[Adam Scroll] – Cantor Fitzgerald

The shekel dollar exchange rate, was there much of an impact with that?

Albert J. Wood

On operating expenses it had a negative impact increased our expense by roughly $500,000.

Operator

Your next question comes from Paul Silverstein – Credit Suisse.

Paul Silverstein – Credit Suisse

Now concerns the classified opportunity where I believe [inaudible]. Can you give us some thought - are you just shelving for now until you get back on your feet with respect to Class 4, the IPX, etc.? Or are you still pursuing classified opportunities albeit with a [scaled] down workforce? Can you give us some input?

Doug Sabella

The answer is we’re going to continue to pursue classified, but we’re going to do it in a very focused way. One of the challenges that we’ve had over the course of this year on the classified opportunities is every service provider wanting to add features, tweak features, etc. And so we have a very strong – a good working product. It’s been deployed and it’s actually deployed in one Tier 1 vendor in a small deployment in Europe.

And our focus is going to be about selling what we have and as often as we can. And then if the customer wants to do additional work or things like that, it is going to be very much handled by customization basis versus, you know, on a more speculative basis which we had been doing. And in terms of, you know, the impact on our R&D this is probably the most fundamental impact on the R&D expense that we have.

Paul Silverstein – Credit Suisse

In your breakeven assumptions for Q4, the $25 million proforma breakeven number, is that assuming return to your goal – what is it, 55 to – I apologize, the gross margin 55 to 60% gross margin range or can you get there with lower gross margin?

Albert J. Wood

You know obviously as gross margin gets lower, it gets more and more difficult. But we think that, first of all, we will return to the 55 to 60% range so yes, it does include that. And then getting [non-gassed] operating expenses down to about $14 million, which again we think that’s achievable. That gets us to about breakeven.

Paul Silverstein – Credit Suisse

I take it in Q3 we should assume some rebound in gross margin, albeit not fully back to the 55 to 60%?

Albert J. Wood

That’s what we’re expecting. Again it’s – we’re seeing that, you know, the deals, you know, they continue to have reasonably good margins. But in Q2, particularly, when you’re spreading the same fixed overhead costs over a smaller amount of revenues that always has a negative impact on your margins. So as we get more revenues in Q3, we expect to have a margin improvement on that alone.

Doug Sabella

So just to add to what Al said if you think about services, which is kind of the fixed costs, one of the actions we did take was to reduce our services costs so we were more in the, you know, low fours, upper threes the last several quarters and we’re actually now going to be in the low threes so if you think about a, you know, $5 to $6 million services revenue stream, your margin does have incrementally improved performance which then ultimately leads to overall consolidated margin EBITDA.

Operator

Your next question comes from Catharine Trebnick – Americas Growth Capital.

Catharine Trebnick – Americas Growth Capital

Could you go back and give your international versus North America breakout again?

Albert J. Wood

On a geographic basis for Q2 it was 21% from North America and 79% international. And I’m anticipating your next question which was “what was it in the prior quarter?”

Catharine Trebnick – Americas Growth Capital

Yes.

Albert J. Wood

And that was 16% North America, 84% international.

Catharine Trebnick – Americas Growth Capital

Can you actually get a little more into, you know, your backlog and how booked you feel for this quarter?

Doug Sabella

We obviously don’t give full backlog, but we had a substantial difference between what our order flow was and our actual revenue was in Q2. So it was, you know, it was above one-point-five. It kind of gave us a good visibility into Q3.

Operator

Your next question comes from George Notter – Jefferies and Co.

George Notter – Jefferies and Co.

I guess I was just trying to come back to an earlier question. I mean you’re taking the operating expense rate of the company down to $14 million or so and then talking about a $25 million breakeven revenue run rate. I guess I’m trying to figure out if that intuitively makes sense. I mean you’re operating in a lot of different businesses here, your Class 4 and Class 5 on the switching side; you know, certainly static trunking applications; you’ve got some DCME revenue around still; you’re operating in many different countries internationally.

I guess I’m just wondering if it makes sense that, you know, we can still run this business across this different – this many different, you know, fronts with that kind of investment from an OpEx perspective. Or are there other areas of the business that you need to kind of, you know, further focus onto?

Doug Sabella

It was obviously a tough set of decisions we had to make. At the highest level, I would actually say that we feel actually pretty good about what we’ve done; for instance, around R&D and services that are going to allow us to continue to make the right developments. If you look at R&D the two things that we did that give us confidence that our gateway business and our Class 4 business most importantly will be able to continue to be an engine for innovation for us.

We shut down our [Punay] facility in India which, you know, it has always efficiency issues having multiple locations. So by closing that down it actually is going to save us a significant amount of money and improve, you know, kind of optimize the business in terms of what we were doing on the development side.

And the product plans that we have in place for the second half of the year around which, you know, around IPX and transcoding, etc., for our switching capability are all on schedule to be delivered. And we are now working through our 2009 deliverables on our switching side.

On the gateway side, the actions that we took were actually things that were more aligned with gateway supporting classifieds deployments than gateway’s supporting gateway. So all the 3G work that we are doing around our bandwidth optimization and other capabilities to support 3G deployments continues unabated.

The place that we took the larges reduction in terms of our engineering side was really in the classified. It was a substantial reduction for the reasons I talked about earlier. It was just – it was consuming a lot of resources, a lot of attention and every customer wanted it a different flavor. And so we’re kind of refocusing that business significantly. We’re not exiting it but we’re going to, you know, we’re kind of going down the path of Henry Ford, “It can be any color you want as long as it’s black.” And that’s how we’re going to be selling our platform.

And we do have customers that want to buy it as such. And that’s what we’re focused on. On the services side, you know, fundamentally we were able to kind of eliminate a layer of management to reduce our costs without it affecting the field personnel, etc. And so that’s how we focused that piece.

So it’s a longwinded answer, but we actually think we took some pretty tough decisions, and actually it’s going to enable us to focus the business in the places where we really have been growing. And we’re going to continue to invest in those segments. And in terms of just, you know, our presence around the world, yes it is expensive but you know every one of the regions is actually growing if you look at it from an overflow standpoint. And it’s contributing to the overall performance of the company.

George Notter – Jefferies and Co.

And then just as a follow up, any [smell] on employee morale? I mean, you know, obviously this is pretty tough.

Doug Sabella

It is – it was very tough. And, you know, obviously we were all kind of – it was a bit gut-wrenching for all of us. On the same token, I’m quite proud of the folks at Veraz because they knew what was necessary. And I’ve gotten quite a few notes from people saying that “we know this was tough, but we fully support it”. So I think actually there’s a bit of, I think, optimism kind of really happening around the building in San Jose’ and around the world. So we know what we have to do.

This is a company that in 2001 during the bust, you had people that worked for many months without pay before they got refinanced as private company. So they’re used to the challenge and I actually think they’re ready to step up and take this to the next level.

Operator

Your next question comes from Greg Mesniaeff – Needham and Co.

Greg Mesniaeff – Needham and Co.

You guys mentioned two new North American customers. I was wondering if you could maybe give us a little bit more, you know, color on that?

Doug Sabella

I would just actually they’re both Class 4 customers and that will – the one Class 4 customer is a U.S. based customer that actually is going to be providing international communications into India. So it is actually a global network they’re effectively going to be deploying but actually providing interconnects with Indian carriers.

And the second one actually is a media gateway customer that’s going to do [inaudible] bandwidth optimization and then ultimately switching support between North America and the African continent.

Greg Mesniaeff – Needham and Co.

And then looking at the geographic mix of customers in the quarter, you mentioned Asia being weak and some other pockets of strength throughout the world. Could you give us a little more sort of general what you’re seeing as far as, you know, CapEx trends if you were to, you know, segment them by world regions?

Albert J. Wood

In Asia Pacific it was obviously the inquiry we really kind of, you know, blunted anything we could do. And generally we would generate $2 to $3 million of business out of that region and we virtually got nothing out of it, because we couldn’t do anything. So that, you know, I can’t sit there and say the economy is slow in Asia Pacific. I can just tell you that we – we had significant pain in that region.

India actually, because we consider it outside of the Asia Pacific region, India is, you know, trucking along on our gateway business. And you know we announced Spice. We have several deals that we’re working on the switching side of it that we continue to pursue. But it is a slow decision process in India.

In the [Amia] theater, Africa continues to do well for us. It continues to be strong. We will continue to make investments in it. And the same with the southern Europe’s countries, Greece, Italy, Turkey and then Spain connected to Latin America. We continue to do very well in those countries. And then in northern Europe being Goldcom, they continue to buy.

In North America we started to see a turnaround, and I’m kind of optimistic. Part of it was from the Department of Defense with getting our JITC certification, which is important, and we think that will provide dividends in the coming quarters. And in [Kala] again between the two large operators we are in the beginning, I think, of some really good deployments, solid deployments.

But of the two markets that I had to say were the weakest of the markets and the most disappointing of the markets, it would have been Asia Pacific and it would be Russia, where we saw a lot of softness in Russia.

Greg Mesniaeff – Needham and Co.

Looking at your cost to goods sold, what areas if any have you identified as opportunities for potential, you know, gross margin improvement based on, you know, product redesign, you know, re-engineering using, you know, next generation silicon or what not?

Doug Sabella

On the hardware side we actually have, you know, so if you think about our gateway side, we have a significantly strong position in terms of our design and our cost structure. Because unlike many of the other vendors, our gateways we actually own the intellectual property around the DSPs that we put in there, you know, the free scale DSPs. And so we have a very competitive cost model on that. So the gateway side just continues to hump.

On the switching side where we expect to see improvements in the coming quarters is Sun, for instance, just announced the [G2000]. We are now adopting the G2000. The G2000 is a significantly more, you know, powerful machine than the previous metras for our switches so we will get the economic benefit out of that significantly. In fact we were able to actually roll out a low end switch using the same code because of the power that now is being placed into the G2000s.

So that’s the second piece of cost improvements that we expect to see in the coming quarters that’s really just starting to happen. And the last piece on the switching side is actually, which we’ve already announced, which is around signaling where we’re evolving as quickly as possible to M3UA which is our own software and our own capabilities versus using third party signaling technology.

Operator

Your next question comes from [Adam Schroll] – Cantor Fitzgerald.

[Adam Schroll] – Cantor Fitzgerald

You mentioned in the first quarter call that you were bidding on a number of larger switching deals with the global integrator. Have you had any success with these efforts?

Doug Sabella

These were in India and we had two different integrators we were working with. We want - so far there are two deals pending and we won one deal with one of the integrators. And it’s a decent – it’s a multi-million dollar deal. And we lost the very large deal. And it was kind of an interesting loss because we, you know, it was a large deal that we priced very hard – priced very aggressively but the Chinese came in and priced significantly more aggressively than not only us but more than Ericcson and Siemens, etc. So that’s kind of where we were on that deal. So won one, lost one and two to go.

[Adam Schroll] – Cantor Fitzgerald

And then it’s also been suggested that Verizon’s an installed base upgrade opportunity with 240 and 360 DCME products. I was just curious of where do we sit on the curve of this opportunity?

Doug Sabella

There’s not going to be an instantaneous conversion. It’s a slow process of converting these folks. In fact, what they generally do is they deal with expansions initially and eventually are beginning to look at retiring the DCME, both the 240’s, 360’s and even 600’s. But it still is really – I would just say it’s out there into the future. No different, by the way, than the fact that the retirement of circuit switches are still out there in the future in a lot of cases for these big players.

Operator

There are no further questions in the queue and that does conclude our Veraz Networks second quarter 2008 earnings results conference call. Ladies and gentlemen thank you for your participation.

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