AudioCodes Ltd (AUDC) 2008 Q3 法說會逐字稿

Greetings and welcome to the AudioCodes third quarter 2008 earnings conference call.

(Operator Instructions) It is now my pleasure to introduce your host, Erik Knettel with AudioCodes.

Thank you, Mr.

Knettel.

You may begin.

Thank you, Diego.

I would like to welcome everyone to AudioCodes' third quarter 2008 earnings conference call.

Let me begin the call today with a brief Safe Harbor statement concerning AudioCodes' business outlook for future economic performance, product introductions and plans and objectives related thereto and statements concerning assumptions made or expectations as to any future events, conditions, performance or other matters.

These are forward-looking statements as that term is defined under US Federal securities law.

Forward-looking statements are subject to various risks, uncertainties and other factors that could cause actual results to differ materially from those stated in such statements.

These risks, uncertainties and factors include, but are not limited to, the effect of global economic conditions in general and conditions in AudioCodes' industry and target markets in particular, shifts in supply and demand, market acceptance of new products and continuing product demand, the impact of competitive products and pricing on AudioCodes' and its customers' products and markets, timely product and technology development, upgrades and the ability to manage changes in the market conditions as needed, possible disruption from acquisitions, the ability of AudioCodes to successfully integrate the products and operations of acquired companies into AudioCodes' business and other factors detailed in AudioCodes' filings with the Securities and Exchange Commission.

AudioCodes assumes no obligation to update that information.

In addition, during the call we will refer to non-GAAP net income.

We have provided a reconciliation of non-GAAP net income to our net income, according to GAAP, in our press release and on our website.

Joining us today from AudioCodes we have Shabtai Adlersberg, Chairman, President and Chief Executive Officer, and Nachum Falek, Vice President, Finance and Chief Financial Officer.

I would now like to turn the call over to Shabtai Adlersberg.

Mr.

Adlersberg, please go ahead.

Thank you, Erik.

Good morning and good afternoon, everybody.

I would like to welcome all to our third quarter 2008 conference call.

With me this morning is Nachum Falek, Vice President of Finance and Chief Financial Officer.

Nachum will start off by presenting a financial overview of the quarter.

I will then review the business highlights for the third quarter.

Yesterday, we have made an announcement.

We have announced our strategy and initiative [for our] definition of voice over IP.

I will devote most of my presentation to providing more information and insight into the importance of this announcement.

We will then take it into the Q&A session.

Nachum?

Thank you, Shabtai, and good morning, everyone.

Before beginning the financial overview of the quarter, I would like to note that the following discussion will include GAAP numbers and pro forma numbers.

Our third quarter pro forma results reflect adjustment for the following two non-cash items -- stock-based compensation expenses, which totaled $800,000 in the third quarter of 2008, and amortization expenses relating to the acquisition of Nuera, Netrake and CTI, which totaled also $800,000 in the reported quarter.

Full reconciliation of the pro forma results discussed on this call to GAAP results is currently available for review on our website and in the press release issued yesterday.

Getting to our quarterly results.

In the third quarter, revenues were $46.6 million, which represent a 2% increase from the last quarter.

As a percentage of our revenues, sales in America accounted for 46%; Europe, 27%; Asia Pacific, 23%; and Israel, 4%.

We had one customer above 10%.

Our top 15 customers accounted for 54% of our revenues compared to 53% in the previous quarter.

In terms of revenues by business group, in the third quarter, our technology business group accounted for 31% of revenues and our networking business group accounted for 69% of revenues.

In the third quarter of 2008 pro forma gross margin was 57.2% compared to last quarter's pro forma gross margin of 57.6%.

On a GAAP basis, gross margin was 56%.

Our total pro forma operating expenses were $21.5 million, which is 5% less than the second quarter OpEx level.

On a GAAP basis, operating expenses for the third quarter were $22.5 million.

Headcount decreased this quarter by 52 employees, which brings us to a total of 611 employees.

Pro forma net income for the third quarter was $4.8 million or $0.11 per share.

GAAP net income for the second quarter was $3.2 million or $0.08 per share.

Short-term and long-term cash balances were $158 million compared to $147 million last quarter.

The increase in cash balances is attributed mainly to a positive cash flow from operations and financing, which were offset by negative cash flow related to investment activities.

During the quarter we did a buyback of our shares in the amount of $2.3 million and received a bank loan in the amount of $15 million for five years.

DSO came in at 69 days compared to last quarter's DSO of 59 days.

Our guidance for the fourth quarter is as follows.

Based on our visibility at this time and due to the weakening global economy and delays in projects tied up to credit difficulties in the emerging market, we forecast revenues for the fourth quarter to be lower by 5% to 10% compared to the third quarter of 2008 revenues.

At this time, we do not provide any change to our annual non-GAAP earnings guidance of $0.34 to $0.38 as we expect additional reduction in OpEx due to reduction in [those] steps made during the third quarter.

I will now transfer the call to Shabtai.

Thank you, Nachum.

We are very pleased to report record total year revenues growing more than 15% year over year and more than 2% over the previous quarter.

More impressive is our performance on the earnings side.

So, we grew earnings to $4.8 million, which basically translates to a 70% improvement year over year and about 30% improvement over the second quarter of 2008.

Our focus continues to be on the networking business, which is currently 70% of our business and where we continue to grow for the sixth year in a row more than 20%, close to 25%.

We should reach sales of above $120 million in a business that was just started five years ago from scratch.

And with a growing portfolio and better infrastructure that we have in place and our global presence, we are (inaudible) all necessary ingredients for our continued future growth.

Operationally, we kept improving on several fronts.

Most important, we achieved this quarter the targets that we have set forth to grow operating margin to above 10%.

I'm glad to report that this quarter we grew to 11.1% compared to 8.3% in the second quarter of 2008.

Also important to note is the very substantial improvement in our operating income.

Non-GAAP operating income grew to $5.1 million compared to $3.8 million in the previous quarter.

That represents a jump in 34% in our operating income in the quarter.

Obviously, this related both to growing on the revenue side and also doing very good work in controlling and reducing expenses.

As Nachum reported, we decreased OpEx by 5% compared to the second quarter and should do better in Q4 of 2008.

Headcount, as Nachum mentioned before, decreased by more than 50 employees.

Key reduction in force was due to the following stats -- A) we have completed the integration of the acquired businesses of the old Nuera and Netrake.

We have done a reduction in force of about 25 persons in our Session Border Controller operations.

And I'll talk about why we did that.

Basically, the key motivation is moving more to an integrated approach on Session Border Controllers rather than focusing on (inaudible) [lamp] market.

We also did reduction in force in our CTI Squared application group, where we have released 10 employees.

All in all, we have -- we came down by 52 employees out of 688.

I think at this stage we are built lean and mean to tackle what's coming ahead.

Going to a brief review of business slides.

All in all, third quarter of 2008 performance was in line with our plan.

To give you some color on the individual lines, we had continued momentum and strength in our CPE business.

We are capturing more and more accounts there.

We have strengthened our position in that market in the enterprise business, mainly through partners, again, or work with leaders in that market segment, such as Microsoft, Avaya, and a few more partners, including Global System Integrators brings us a lot of benefit.

We had good core on selling mid- and high-density media gateways, and we seem to have a winning product on the mid-density side, which is currently performing very well and growing hundreds of percent a year.

We've seen more success in the government market.

Going back to the Session Border Controller and Security Gateway markets, the decision was taken to focus more on the Security Gateway product line where we have early lease and established customers and, therefore, we did not need any change in that line.

As I've mentioned before, we believe that, going forward, the market is going to change ways and instead of focusing on standalone Session Border Controllers, we believe that functionality will move more and more to be integrated with gateway functionality and security features, and that, we want to be able to provide a more competitive product.

The decision was basically to rely more on the integrated product that is being developed in our R&D facilities in Israel and invest less on the standalone Session Border Controller.

Although I should mention that we continue to sell and do well in that market as well.

Going to the sales side, as we have mentioned before, good quarter.

The area that's growing fastest for us is Asia Pacific, where we have seen a big, big jump in revenue.

This quarter alone, we grew almost 30% on Asia Pacific comparing to second quarter.

As Nachum mentioned before, 23% of our revenues are coming today from Asia Pacific.

If you compare that to a year ago, at that time we had only 11%.

So, we have more than doubled our revenues from that region.

EMEA, which represents mainly Western Europe and Eastern Europe, was kind of steady.

It's around 28%, with more activity in Eastern countries.

On the American side, the difference between the two different continents, sales in North America was lower than anticipated, and we hope to see some kickback this quarter.

Latin America has been quite reasonable.

So, all in all, we are pleased with [targets] made on the sales.

A few words about the voice market as a whole, before I get to our announcement.

I'm basing my presentation based on a report that was released lately by Infonetics.

All in all, the VOIP industry exhibits healthy growth.

The five-year outlook looks good, and demand for voice over IP networking gear remains unabated.

The market should grow about 25% each year over the next five years, adding, on the average, 22 million users each year.

That's quite a room for expansion.

Most important, and that relates directly to our announcement of yesterday of the high def voice, is that voice over broadband continues to be the big driver across the board, and that is the most important development for us and this is where we focus next.

So, the gateway market has been quite healthy, grew in the second quarter to $380 million.

All in all, the gateway market should grow less in coming years.

But basically leading that market and being quite competitive, we believe that we remain in a very competitive position to take advantage of that market.

All in all, it's about 2 billion market segment and we believe that remaining one of the few very competitive players in that market, we should be able to grow our share in that market.

And now I'll get to our announcement about the high definition voice over IP.

High definition voice over IP significantly improves voice quality and the user experience.

It does that merely based on the fact that it's based on using wideband speech codecs, and those codecs simply double the audible voice spectrum.

And I'll get to that very technical details, but very simply.

Until today, almost all of the codecs used were utilizing only about 3.4 kilohertz of the voice spectrum.

If you use a wideband speech coder, all of a sudden you get double the voice spectrum and hence the improvement in quality.

So, doubling the spectrum, you can get higher clarity, you get better intelligibility and get a richer sound.

Now, wideband speech codecs are available for a long time now, and they have been used in WiLine applications.

I won't get into mentioning specific standards simply because I don't want to get people into different G standards, ICOG standards.

But there are wideband speech codecs available for WiLine for quite some time, since the late 80s.

We have wideband speech coders developing for mobile and wireless applications for almost 10 years now.

Internet application, you all know the Skype applications.

Lately, enterprise play by the introduction of Microsoft of a wideband codec, a conferencing codec, so many different codecs exist so far.

And now we think it's very [positive] to basically talk about the evolution and why now is really the perfect time to introduce high def voice over IP to the industry.

So, voice over IP basically was from the old switch network, which traditionally was limited to the use of 3.4 kilohertz.

As such, all of the codecs that were designed for use were basically designed for narrowband transmission.

Similar such logic the process existed for mobile network, where the objective of maximizing capacity in secured wireless links dictated the use of narrowband channels.

Now, when voice over IP appeared and when converged voice and data came to the world, the simplest logic or approach to developing voice over IP network was simply to take the legacy narrowband voice codecs which were available and take care of providing that quality of service, given to IP routes and new IP tracks.

Which is indeed what was achieved and this is why voice over IP today is a very successful, growing industry.

However, in terms of quality, the perception was and still is in certain areas that quality is still not comparable to that of the wireline quality.

However, one key phenomena has been overlooked, and that is the fact that these days, the dominant drive for voice over IP development is the growth of voice over broadband.

Meaning IP broadband network growth is very substantial.

And yet almost all have not taken advantage of the fact that you've got a broadband link to the end user to provide better quality.

And this is basically the logic behind our current initiatives.

Wideband speech codecs, which provide double the voice spectrum and thus provide better quality, exists for a long time now.

And yet there was no major effort by the industry to take advantage of that fact.

Take you to another amazing fact.

Amazingly enough, the quality of calls provided by phones, which exist for more than 100 years now, has never changed throughout the years.

Other things change, and if I'll just mention iPhone and Smartphone, so you all acknowledge that everything else was eventually improved -- a solution to mobility, data access, internet access, video streaming, camera in the phone and many other features.

However, one important thing did not change -- the voice quality.

AudioCodes has always been a synonym for voice quality, and today we make another big step to increase that leadership.

[HE voc] is already needed for the application.

You can find it over the internet, including codec user Skype.

In the enterprises, I've mentioned before, ascended from the old ISDNs, (inaudible) lately, Microsoft and IP phones in conferences.

The experience of people using this is such that most will never go back to use the old narrowband technology.

So, it's very promising technology.

Is it a 100-meter run?

No.

Rather it's a marathon.

It is a long, but enduring, process where finally in five to ten years from today most people will use high definition voice.

However -- so, the profits for us are tremendous and should last for a good three, five and ten years.

Interconnecting the IP trunk, delivering announcements and conferences and new products, we are one of the companies that are best positioned to take advantage from this new development.

We're going to focus on standard codecs, but add to it our special stock when it comes to administer our capabilities, such as handling echoes, dealing with [static[ loss and a few more single processing functions.

As we target the CPE market, we plan to become a center-stage player for deploying high definition voice in the enterprise and service provider space, and it's only natural that we will be in position to terminate all of the calls coming from this endeavor, transcode them or apply conferencing to that.

We have prepared ourselves for this coming change for more than a year now and plan to come out with new design and equipment that will provide us the leading edge of competition when it comes to developing high definition voice over IP.

We plan to deploy high definition voice over IP across all of our business lines.

The fact that we are using a unified architecture will allow us to deploy it in gateways, the multi service business gateway, media service and more products.

We plan to work with market segment leaders in this space, be it wireless, be it cable, be it enterprise, be it internet, and promote, together with them, the use of high definition voice over IP.

We also plan to work with terminal and mobile [cell phone] companies [through] the use of HD voice and plan to announce shortly products in this area to make our offering more complete and be able to increase the use of the technology.

More specific information on our plans and products can be found in a special section on our website.

And thus, I will repeat it again.

I think that by going that, we are opening for us a tremendous opportunity for the coming three, five and ten years.

And with that, I've concluded my presentation and we will move to the Q&A.

Operator?

Thank you.

(Operator Instructions) Our first question comes from Ittai Kidron with Oppenheimer & Co.

Please state your question.

Thank.

Nachum, first of all, on the financial side, with regards to the headcount reductions, you've done a good job over the past 12 months in reducing your headcount quite extensively.

I guess the question is going into the December quarter, should we still see a step down in the OpEx, either because we still haven't seen the full impact of the cuts or there's more cuts to come?

So, Ittai, I mean, basically we did the majority of the reduction in force until the end of the third quarter, but you're absolutely correct -- the full impact of -- into the OpEx will be June, the fourth quarter.

And at this point, I do believe that the OpEx revenue in the fourth quarter will be lower than the third one.

And what is the exchange rate you're modeling for -- between the shekel and the dollar -- for the fourth quarter?

At this point, we are between 3.6 to 3.8, as we did some hedging for 2008 and for 2009 as well.

Okay.

And now with regard to the top-line guidance, your caution -- can you give us more color on whether this is just a general cautionary analysis or just true change in order patterns that you're seeing from clients?

I'm just trying to understand how much of it is real versus just being -- you look at the market, you don't know what's going to happen, and because of that you're being conservative.

Ittai, this is Shabtai.

Basically, it's a combination -- A) like everybody else, we are watching the developments in the global economy and see the trends, and we really cannot ignore other companies' experience and announcements that they see the environment weakening.

On our side, sales and PO stream has been quite well until kind of middle of October.

Since then we've seen some weakening and delays in projects.

Specifically tied up to specific economies where we -- that we know that have been hit more severely than others in this market due to credit issues and others.

So, we do see some slower intake rate of orders in the last two or three weeks, and combining that with the general assumption, and based on current backlog [SNs], we believe that we will -- that is the focus that we have provided, that we expect Q4 revenues to be lower compared to -- so, 4 or 5 -- about 5%.

And Shabtai, just to follow up on that, can you be a little bit more granule as far as where regionally have you seen more softness than not?

And also, what is sort of the -- I think, if revenues underperform by X to start reexamining again our headcount and perhaps being even more aggressive than we've been up until now.

What is that red line that you say, if we cross this line, we're going to have to, again, take another pass at our operating structure?

Okay.

So, specifically -- and I'm not saying that this is typical -- but we've seen more in East Europe, some of the countries in that region suffer substantially in the late crisis.

So, we know of big communication projects that have been delayed from the fourth quarter.

We have been told that they are delayed to Q1 and Q2, but that is what we hear today.

In terms of plans, at this stage, we have no plans for reduction in force.

I think we have done -- we have focused and done what we believe needs to be done.

We are -- and we haven't mentioned that -- but we are feeling that our competitive position is strengthening.

That means that we win more projects.

More projects means more headache.

We need to develop more features.

We need to develop more functionality.

So, we are kind of torn between the need to respond to the increased demand for our products, on one end, and then to be humble with how we plan and want to see [more] in developing.

So, before we will see a long-term trend that resides for more than two or three quarters, I don't think that we will go to any meaningful stats in that direction.

Okay.

Very good.

Good luck, guys.

Sure.

Thanks.

Our next question comes from Ted Jackson with Cantor Fitzgerald.

Please state your question.

Hey, Shabtai.

Hey, Nachum.

Congrats on the quarter.

Thanks, Ted.

Thanks, Ted.

A couple questions.

One is, Nachum, just on the balance sheet, you have this debt that you've taken out post quarter.

Could you just kind of walk through sort of where your current long-term debt levels will be at close in the fourth quarter?

Then I have a couple others.

So, looking at the fourth quarter, if I got your question correctly, we did a buyback of $51.5 million par value of our convert.

Originally, we had $125 million, so we've got a little bit less than $75 million, which is due at the end of '09, November '09.

Other than that, we've got a little bit less than $30 million of bank loans which is due in five years.

So, -- and if you take both of them from our cash position, we've got net cash of around $5 million at this point.

So, when you had -- with the end of the quarter, you have $48.8 million in current portion of long-term debt and $95.8 million in long-term debt, what would those numbers be in the fourth quarter?

In the end of the fourth quarter, it will be the same.

We just repaid the short-term debt in terms of -- that's exactly the $50 million of the convert.

Okay.

Next question is gross margin has been kind of tweaking down a little bit, consistently, as you've had success with the NBU business.

I was wondering if you could give a little outlook of where you see that line item trending as we look through this year and into '09.

Yes, so obviously, the gross margin has huge impact coming from the mix, so it's very hard for us to estimate what it will be at the end of '09.

I think if you look at the last couple of years, we are very close to $60 million, and it can change from quarter to quarter.

So, we can really end the fourth quarter with better margin than we did in the third one.

It's too early for me to even estimate this quarter.

It truly depends on the mix.

But would you expect, over the longer term, there to continue to be a modest reduction in gross margin, just given the mix of business?

So, we are doing cost reduction activities internally which improve the gross margin.

Obviously, we need to take into account the fixed costs that are spread on higher volume and therefore gross margin should be improved.

So, again, very hard to estimate, but it should be on those ranges, maybe a few basis points less than what we've got today.

Okay.

And then could you give me a sense in terms of the outlook for CapEx for the fourth quarter.

Similar to the average of the last, let's say, year or so, on a quarterly basis.

And then on the guidance, typically you've built your guidance, built up -- simplistically that you've had a 40% to 50% of the quarter in backlog.

Does that still hold with the fourth quarter guidance?

Right now, as we -- I think that's the trend that we have in the last couple of quarters.

We've got between 40% and 50% currently of the guidance for the fourth quarter.

Okay.

And then my last question, just jumping over to the HD voice announcement, do you -- do you have this capability in your products already?

Do you have customers on board for this?

Has this been -- is this a technology that you currently sold, that you have -- you've had customers come to you with an interest or with particular projects because of it?

Can you provide a little color sort of on the ground, relative to what's going on in your customer base relative to HD voice, where does it stand, what kind of activity level?

Thanks.

Okay.

So, there are a few areas in which we are already active.

If you take our chips business, we do have in our chips, and, as a result, also in our products, a long list of wideband speech codecs.

So, I think from the G.722, which is old, is -- I believe is being embedded in most of if not all of the IP phones sold currently.

However, there were no focus and no application for that if sales are dormant in the phone.

We have seen, as I've mentioned, Microsoft coming through the market with a new codec called RTA, and so that is already, in 2008, put to work.

The type of comments and reviews and feedback we're getting from our own people using it is tremendous.

So our sales operation told me that for them to maintain now conference calls with remote locations become substantially better.

Calls are longer.

People stay on the call and basically enjoy it.

So, on a chip, it exists already.

and it's being used by some of customers through the chip side.

On the enterprise, it is being use; Skype is using a wideband codec.

It's really more my belief that there was less focus on that.

Polycom, by the way, who is the leader by itself in the conferencing, has been promoting and preaching high definition voice for many months now.

So, my point is that, for us, it's something that represents a lot of opportunity because use of that is already embedded into the market, but on a very low scale.

So, all that needs to be done now is really turn more the application that will make [users] cooperate with leaders in different market segments that would push it towards their own benefit.

Okay.

Thanks a lot, Shabtai.

Sure.

Our next question comes from Jonathan Kreizman with Oscar Gruss & Son, Inc.

Please state your question.

Hi, Nachum and Shabtai.

Congratulations on a great quarter.

Nachum, maybe you can give us your outlook on the process you've made with your CPE business in the US.

If I recall, you previously pointed out you would take strong applications for that.

Now, are these (inaudible) different from what it was during the first half of the year?

Okay.

I'm sorry, Jonathan, it was very hard to hear you.

Did you mean the CPE business in North America?

Yes, yes.

Which you previously addressed as a growth driver for the first half of the year.

Okay.

So, again, our go-to-market strategy really relies substantially on partnering with some enterprise market leaders I've mentioned.

We are seeing growth activity on launching more and more trial and initially used by some of Microsoft customers for the OCF.

We have seen activity from the Avaya side.

We are -- we started and basically are on the verge of starting to work with a large distribution channel in the US.

The improvements are greater.

We have not seen a big jump in third quarter, but my belief is that putting an emphasis on that in the coming quarters, we will see improvement in that as well.

Okay.

And Nachum, on the OpEx side, actually, in terms of your [taking] cash, during the quarter, you generated [$2,000] -- $200,000 (inaudible) cash.

Cash inflow from the previous quarter is (inaudible) on the lower level of net income.

So, this -- in this instance, are you -- can you comment a little bit on some of the increase in receivables and on the opposite side decrease in payables we have seen this quarter?

Should we look at this as a [reflective] trend or are you expecting there to be this going forward?

Again, I'm not sure I'm getting the right question, but if I heard you correctly, you were asking about the cash flow on the operating activities?

Right.

Right.

Which was -- yes.

Yes.

Fine.

So, we did generate $8 million from the beginning of the year in terms of net cash provided by operating activities.

The last quarter by itself was weaker than the first six months.

And the only reason I can really point out is the [reality] within the quarters, and it was a little bit backhanded.

(Inaudible)if you estimate cash flow, but basically it should be very similar to our non-GAAP earnings.

Okay.

And just a brief follow-up on the OCS account and on the federal account, you know, through the recent quarters.

Is visibility -- what is visibility like going into next year on these two major accounts?

Yes, so we won't go into specific accounts, but all in all, as we mentioned before and as Shabtai mentioned earlier today, the Microsoft opportunity, we think very highly on it.

Obviously, that generates more meaningful revenues getting into '09, and it's obviously part of -- part of our strategy going into '09, together with the MSBG and the HD voice.

Okay.

That will be all for me.

Thank you very much and good luck.

Thank you.

Our next question comes from Eric Kainer with ThinkEquity Partners.

Please state your question.

Thank you very much and congratulations on a very fine quarter, gentlemen.

Let's see, first question is really about competition, especially competition coming from, obviously, the Chinese competitors.

What are you seeing there, especially in different geographies, and what might we expect moving forward?

Okay.

I cannot -- we have seen competing -- competition from Asia countries, mostly in emerging markets.

We have seen that more in Russia.

We have seen some of it also in Latin America.

I cannot give [you if you] ask me to rate strength of competition in decreasing order.

I wouldn't put them anywhere on the top five ones.

So, they play in the market.

They focus on specific markets, but it's nothing that represents to us, at this stage, substantial competition.

I think their focus is more on the core network.

We focus much more on the edge and the access, and I think we are faring quite well with that competition.

Okay.

Great.

That's good news, obviously.

I also missed what you may have said as far as the percentage of sales coming from Latin America and the percentage coming from North America.

Could you give us those numbers again?

Yes, it will take me a second.

I think, if I recall correctly, overall markets -- let me go back to one of the slides I have here and see if I can get that number for you.

Why don't we move to the next question and then I'll get -- be able to get back to your question?

Okay.

Next subject that I'd like to open up is high definition voice, which is, I think, a compelling product.

Obviously, I've read about that before.

How do you see operators going and potentially retrofitting this technology into their existing networks?

How does that wind up rolling out?

Okay.

So, basically there are a few ways in which we can think of HD voice getting to market.

One very simple one is mobile soft client getting into more and more use.

We have heard about Skype offering of the new Google phones.

There are a few more codecs -- wideband codecs which are being [opened] for Smartphones.

So, use of wideband speech on Smartphones will basically require a termination of those types of calls on the service provider side.

So, either using transcoding, either using conferencing gear, that would cease.

Then the other way around it is really to -- for any service provider that would like to differentiate itself from other service providers in each region -- I'll give you an example from our country.

Today, the new alternative voice service provider basically sell residential gateways, one-line, two-line gateways whenever people connect their old phone to the new voice network.

Now that way, they are using the same old 3.4 kilohertz telephone connected to an IP.

Imagine that service provider offering side by side with that a new option, which is A) why won't you get the new HD VOIP phone I have here and you'll be able to conduct your call within my group of subscribers in much better quality.

And I think that is type of -- an approach that people will prefer.

If you take just two Skype users, when they connect over a good connection, the quality of the call is substantially better than any other call on a regular network.

So, by offering service providers the option, [total direct hardware], the ability to talk on a higher quality, higher clarity call, I think that way we can push that technology to market.

Okay.

Do you have existing design wins with Smartphone manufacturers today?

We have not put that for ourself as a target.

We do not focus on clients.

We focus much more on the CPE side where we provide multi-channel processing.

On the other end, we do have cooperation with model [top client] manufacturers who sell that type of technology.

So, for us there are [enablers] and partners and simply enable the growth of our business through the spread of their technology.

But we are not involved directly in development of clients.

Okay.

Then the focus of your design activity in the HD voice market, is that really on kind of the over-the-top service providers for voice over broadband?

What are you doing on the mobile front where, obviously, we're getting a lot of mobile broadband rolled out and there's a clear need for voice products over the top there?

How can we look at that?

Okay.

So, our primary focus, I think, in the short term is going to be on the enterprise side.

We do focus on CPE.

We, by the way, do plan to announce shortly a very important addition to our line in that market segment.

So, we will focus on small, medium enterprises through our partners, adding the HD capability.

Then I believe we need to start exploring the service provider state by using the same exactly like I basically used before.

So, that's how we plan to go about it.

Okay.

Great.

Well, I will look forward to hearing more about that as we go forward.

Good luck.

Thank you.

Thank you.

Thank you.

(Operator Instructions) Our next question comes from Irit Jakoby with Susquehanna Investment Group.

Please state your question.

Hi.

Thank you.

So, going back to your guidance for the fourth quarter, you mentioned credit issues, and I wanted to go back and ask about that.

Is it something that you're seeing with specific customers in the pipeline specifically for Q4 or is it a sense that you get from your overall customer base that could spill also into 2009?

Yes, this is -- Irit, this is Shabtai.

Right now it's connected with a certain very specific list of customers.

It's not a phenomena that's spread in other regions.

It's specifically -- you can see economies that were hit substantially and due to credit difficulties and credit crunch simply -- I would assume that management in those communication business decided to hold off of certain the infrastructure investments.

But that's very specifically; it's not an overall phenomena.

And so, in that case, is that something that you also expect will carry over into 2009, and that this will be a potential decrease of the available market and available pipeline that you see?

We have been told that it's a delay of a quarter or two.

Frankly, we'll have to wait and see how this quarter develops and how Q1 trends.

It's something that I believe everybody will have to live through to understand exactly what happening.

And then as you look through your pipeline in -- maybe in broader terms, what other macro effects are you seeing already coming into play, both from carriers and from enterprise?

Do you expect lower deployments, lower CapEx, maybe less buildouts of infrastructure, especially with your enterprise (inaudible)?

Okay.

So, it's a rule, I would think -- and as the CEO, I am always looking into my budget and looking to see where I can save some costs.

Definitely, communication is one of them.

I think the way we refer and other refer to it is that, at this time, I believe that a lot of the investments in the infrastructure are not being made.

On the other end, there's definitely investments in expanding linked routes and terminal use.

So, we believe that we -- and I'll tell you that when I look into my budget in North America and look to see how I can basically cut out some of the expenses in the communication area, I came immediately to the conclusion that use of VoIP within my organization will allow me to lower expenses.

So, I believe that VoIP, as an industry and market segment, will probably suffer less compared to some of the other areas, such as if you take [outing] or you take [detail wireless].

I think communication is probably ranked number three or four among what people would consume going forward, and VoIP contributes a lot by lowering the cost and providing good connection.

And I think we'll enjoy from that.

Why do you think -- what do you perceive as contributing more risk at this point?

Would it be enterprise or carrier?

I'm sorry, in terms of risk?

Right.

Yes, my belief is that enterprises that are well established will keep investing in lowering communication costs.

It's really tied up more to the specific economy and the economical pressure on the consumer in those economies, and therefore could be that we'll see more weakness on the service provider side.

But we're not to that intimate level with these guys, so it's hard for me to predict on a level about that.

Okay.

Thank you and good luck.

Thanks, Irit.

Thanks, Irit.

Our next question comes from Vivek Arya with Merrill Lynch & Co.

Please state your question.

Thank you.

Hello, Shabtai.

Hello, Nachum.

Shabtai, if you ignore these recent macro issues, have you seen a general slowdown in the voice over IP market this year?

I think the promise has always been for 25% [at] growth levels, but the growth that we have actually seen has been closer to 10% to 15%.

Is that a fair comment and what would be the catalyst to make the market grow towards the 25% type level that you've been expecting?

Okay.

I think you've got some small mistakes in your assumptions.

In this we do grow on the networking side, as I've mentioned before, between 20% and 25%.

That's the networking business.

If you recall, we still have [30%] of our business side up to the old Blades operation.

That is not growing.

So -- and in fact, in certain areas, it's being diminished, if you look on performance of companies such as Natural Microsystems and others.

So, all in all, 2008, from a pure market point of view, has been a great year.

We are on track, hopefully, to complete the year on 15% growth on the revenue side.

And without that crisis, our competitive position is becoming better and better with the year.

Again, due to the fact that the small companies are (inaudible) than larger companies we've got, they're focusing other places.

So, all in all, very satisfied, very glad.

This is the market segment we hear and we believe that we will continue to prosper there.

And next thing, Shabtai, if you look at next year, I know it's somewhat early to talk about next year, but generally the expectation is for about 14% type top-line growth.

Does that seem like a reasonable assumption?

What could be sort of the upside and downside to that?

Well, at this time, I would not count on that type of growth.

Simply assuming we will be able to finish this year with 15% where the economy is being very [smartly] in the -- I would say the last quarter of the year.

I think that assuming more than 10% growth for next year is risky at this stage.

And again, I think we all need to update our focus as we move on into 2009.

All right.

And then, Nachum, two questions for you.

You have been doing quite well on the OpEx side.

On the balance sheet, what measures can you take to improve on the cash position?

I know you've bought [Converged] recently, so I think that was a good opportunistic buy.

What other things are you considering to improve your balance sheet?

Because I think the net cash level is on the lower side.

Yes, so in terms of net cash, we've got, probably right now, around $5 million.

But take into account the loans that we took, it's for -- these were five-year loans.

So taking into account that at the end of '09 we will need to repay the remainder of the convert.

We've still got the loans for five years.

And as I said, if you look at our cash flow position from the beginning of the year, we already generate this year $8 million from operating activities.

And [otherwise] we've been comfortable generating cash and taking our net cash and (inaudible) with it within the last six months, obviously, it was our call where exactly to put the money.

So far we feel kind of safe with the loans that we took and the cash positions that we've got.

And Nachum, just one last question.

How should we model the share count, interest income, interest expense and any other financial income items for Q4?

It should be very similar to the third quarter, almost the same.

Obviously, it depends on the share price, but all in all, it should be very similar to the third quarter.

Okay.

Even though you bought back the convert?

I guess that doesn't --.

Yes, so again, it depends really on exactly when.

So it will be less, but at the end of the day what you need -- the EPS calculation, you need to add the shares that will come up from the convert (inaudible).

On the other end you need to reduce the interest payment that we did.

So again, the fourth quarter, it will be very similar, take or give 1 million shares, probably.

And any indication for '09?

What is the best way to do it once you get to the normalized levels, the share count for '09?

Yes, so again, we will probably need to take out around 2 million from the dilutive EPS due to the buyback of the convert that we did during the third quarter.

But I think it's early.

I promise to bring the exact number or the best estimate that I can get you on the next conference call.

Okay.

Thanks a lot and good luck.

Thank you, Vivek.

Thank you.

Ladies and gentlemen, there are no further questions at this time.

I will turn the floor back over to Shabtai Adlersberg for closing comments.

Thank you, operator.

I'd like to thank everybody for attending our conference call today.

I believe that with the (inaudible) announced initiative for high def voice, we have created a very sound basis for steady future success and growth in our business in coming years.

And we look forward to have you all on our next conference call.

Thank you very much.

Thank you.

This concludes today's teleconference.

You may disconnect your lines at this time.

Thank you all for your participation.