SB on Sonus
? Sonus reported an 'OK' quarter with somewhat disappointing guidance.
? Sonus rev and EPS came in below consensus estimates of $48.7m and $0.01
EPS, reporting $45.7MM and ($0.01) EPS with a book-to-bill of about 1.0.
? Numbers were negatively impacted by $4.7MM in product rev that was pushed
into def services rev due to the accounting treatment of the renegotiation of
certain customer contracts. Adjusting for this yields an EPS in-line with
expectations, a top-line slightly ahead of expectations, and a B-B of ~0.91.
? Management spoke to a heightened degree of 'stickiness' to its revenue as more
of its customers have required more customization, particularly in its IMS
deals.We got the impression from our discussion with mgnt that a meaningful
portion of today's recognized revenue were as a result of pilot deployments,
which suggest to us much larger deal sizes coming down the pike.
? All in, while lowering numbers, we are still believers in SONS long-term story.
StillWaiting For That Top-Line Hockey Stick – Despite A So-So QtrWith
Disappointing GuidanceWe Encourage Long Term Focused Investors To Hang In.
Sonus reported $45.7 million in revenue and ($0.01) EPS and a book-to-bill of 1.0, falling
short of consensus estimates of $48.7 million and $0.01, respectively. Due to the accounting
for the renegotiations of certain customer contracts, regarding bundled maintenance and
support arrangements, the product top-line was negatively impacted in the quarter by $4.7
million, which was pushed into deferred service revenue. If one adjusts for this issue, Sonus
EPS would have come in-line with consensus with a top-line slightly ahead of consensus,
albeit with book-to-bill of 0.9. Management’s guidance for second half of 2005’s revenue to
be “slightly ahead” of first half’s is disappointing, leading us to lower our near-term
estimates. As a result of lowering our near term top-line numbers, our 2006 and 2007
estimates are lowered as well as we are maintaining our growth assumptions off the lowered
base.
Management’s Commentary and Tone Support Our Buy Rating. While the near-term
guidance may be somewhat disappointing, our conversation with management helped
reaffirm our belief in Sonus’ long-term story. Management spoke to a heightened degree of
'stickiness' to its revenue as more of its customers have required more customization in their
network deployments, particularly in its IMS deals. Additionally, we got the impression from
our discussion with management that a meaningful portion of today's recognized revenue
were as a result of pilot deployments, which suggest to us much larger deal sizes coming
down the pike, a dynamic that is not captured in deferred revenue or the book-to-bill number.
While this prolonged waiting period for Sonus’ revenue to ‘hockey stick’ can be distressing,
we firmly believe in the Sonus story and encourage long term focused investors to be buyers
of this stock at these levels.
Revenues Come In Below Expectations. Sonus reported 3Q revenues of $45.7
million, down 21% sequentially, and below our $47.6 million estimate and First Call at
$48.7 million. According to the company, the quarter’s product revenues were
negatively impacted by $4.7 million in product revenue as a consequence of the
accounting treatment required for the renegotiation of certain customers' bundled
maintenance and support arrangements in the quarter. The entire $4.7 million was added
to deferred revenues on the balance sheet and Sonus expects this revenue will be
recognized in subsequent periods as service revenue.
Sonus had only one 10% customer in the quarter, Cingular Communications. 61% of
the company’s September quarter revenues were derived from its top five customers
compared to 68% in June. In all, Sonus recognized revenue from 47 customers in the
quarter, up from 39 in the June quarter. Service revenues for the third quarter were $16.6
million, compared to $16.8 million in the second quarter. Revenue from international
customers represented 21% of the total for the third quarter, compared to 19% in the
second quarter.
Gross Margins And OPEX. Gross margins for the third quarter came in at 48.6%,
down from 2Q levels of 63.6%, and below the company's long-term model of 58% to
62%. According to the CFO, Sonus incurred costs but did not recognize revenues on the
$4.7 million of product related to the renegotiation of maintenance and support
arrangements with two customers, and this impacted overall GMs by 480 bps in the
quarter. In addition, this quarter's revenues had a higher percentage of third party
components, which have lower gross margin profiles. Despite these 3Q issues,
management reaffirmed full-year GMs guidance in the range of 58% to 62%.
Operating expenses for the quarter were $28.1 million, below the $29.1 million Sonus
reported in the second quarter. 3Q R&D expenses came in up about $700K Q-Q to
2
$11.8 million. We expect 4Q R&D expense to increase as an absolute value as Sonus
continues to focus on new product initiatives in wireless and access. Sales and marketing
expenses decreased to $10.8 million in 3Q, compared to $11.5 million in 2Q, with the
decrease primarily related to lower sales commissions on lower revenues. Sonus guided
to higher S&M expense in 4Q. 3Q G&A expense decreased to $5.5 million, compared
to the $6.5 million reported in 2Q. Overall, we expect G&A expenses to trend higher in
4Q due to year-end audit expenses.
Balance Sheet Remains Strong. Sonus finished the quarter with $325 million in cash
and short and long-term securities and only $10 million in debt and convertibles.
Sequentially, this represents about a $13 million improvement in net cash on the balance
sheet. Cash flow from operations was $15 million in the quarter and capex was $4
million. Accounts receivables were $42.7 million, of which unearned receivables were
$14.5 million. The unearned receivables balance reflects the portion of deferred revenue
for which Sonus has not yet received payment. The DSO's on the earned receivables
balance was 52 days versus 25 days in 2Q. Including unearned receivables, the DSO for
the second quarter was 103 days versus 70 days in 2Q.
Sonus ended the quarter with $30.3 million of inventory, down from the $30.5 million in
2Q. $17.5 million of this net inventory balance is associated with deferred revenue for
products that have shipped to customers. The total deferred revenue balance was $113.4
million, down slightly from the $114.9 million reported in 2Q. The long-term portion of
deferred revenue was $32.4 million, up from the $27.4 million reported in 2Q. The
increase in long-term deferred revenue balance reflects a portion of the product revenue
that was deferred for maintenance agreements beyond one year as of September 30th.
The current portion of deferred revenue was $81.0 million compared to $87.4 million in
2Q. To give some additional insight into the business, Sonus is now also providing a
balance for those items that have been shipped and billed but are not included in
deferred revenue due to extended payment terms or for which revenue is recognized as
cash is collected. In the third quarter, there were approximately $7.7 million that fit this
criteria as compared to $4.4 million in 2Q and $10.6 million in 3Q of 2004.
Changing Estimates. Management issued some disappointing 4Q guidance, particularly on
the OPEX lines. With G&A expected to increase significantly due to increased costs related
to the company’s year-end audit, Sox 404 testing and systems support costs, in addition to
Sales and Marketing increasing due to higher commissions, we are lowering our 4Q EPS
estimate to a penny from $0.04. Our top-line is also moderating from $54.6 million to $50.3
million, given management’s commentary. Our 2005 estimates now come down to $189
million in revenue and $0.03 EPS from $193 million in revenue and $0.08 EPS. Our 2006
and 2007 revenue estimates are now declining to $236 million and $294 million, down from
$256 million and $319 million, respectively, as we apply our original growth assumptions to
the lowered 2005 base. Our 2006 and 2007 EPS, subsequently, decline to $0.18 and $0.24
from $0.21 and $0.25, respectively. |
