Brean Murray on SONS
1Q06 Beats Forecasts Handily; Raising 2006 Estimates
Investment Summary
Sonus reported 1Q06 results that handily beat expectations on both the
top and bottom line. With record quarterly revenues of $60 million and pro
forma EPS of $0.03, Sonus is clearly executing in line with the factors that
drive our Accumulate rating. Specifically, the company is exploiting its
leadership position in the high-growth packet voice market. Sonus is making
operational improvements to allow it to more quickly (and hopefully steadily)
recognize revenues and is leveraging its expenses.
Discussion
?? Revenues for the quarter hit $60 million, well ahead of the
consensus expectation of the low $50s. This represents a record
quarterly level increasing 5% from 4Q05 and 79% over 1Q05. Some may
be inclined to quibble with the $20 million drop in deferred revenues,
which included $3 million from a change in revenue-recognition practices
with OEM customer Motorola. However, products shipped and billed
but not yet recognized as either sales or deferred revenues were up $10
million. More importantly, the reduction in deferred revenues represents
the company’s successful efforts to reduce the time between shipment
and revenue recognition. We believe these efforts will lead to more
predictable and less volatile quarters over time.
?? 10% customer rotation continued. Sonus reported three 10%
customers in 1Q06, none of which were a 10% customer in 4Q05. These
included Qwest and Level 3, and new time 10%’er, Motorola.
?? The company demonstrated strong leverage off the higher
revenues. The gross margin for 1Q06 at 61.7% was down modestly
from 63.5% in 4Q05 but comfortably within the company’s targeted
range of 58-62%. Operating expenses grew substantially slower than
sales, allowing the operating margin to increase from -15.9% in 1Q05 to
8.6% in 1Q06. We expect that leverage to continue, allowing the
company to reach a 20%+ operating margin by 4Q07.
?? Europe beginning to gain traction. For some time, Sonus has been
experiencing strong success in the Japanese market in both core and
access applications. Two major new initiatives there with KDDI and
Softbank are building nicely but not yet contributing to revenues. The
company hinted that in Europe, in addition to its announced win with TSystems,
several additional projects had been secured and would be
announced when the customers were ready to launch service.
Raising estimates but shares may weaken on lack of guidance. All trends appear to be on track for continued
improvement. The market is growing at a rapid pace, Sonus is maintaining its product innovation and market share leadership,
and the company is making the internal improvements to shorten the lead times between product shipment and the
recognition of revenues. We are maintaining our 2Q06 revenue estimate of $57 million and ticking up our pro forma EPS
estimate a penny to $0.03 on slightly lower expenses. We are raising our full-year revenue estimate to $266.2 million from
$250.8 million and our 2006 EPS estimate to $0.17 from $0.13, reflecting the stronger 1Q06 results.
Although the company, on the surface, significantly exceeded expectations, the market may be skittish due to the sharp drawdown
in deferred revenue and lack of revenue guidance for 2Q06. The latter is particularly consternating since the company
did provide guidance for 1Q06. Management indicated that the lack of guidance was not due to worsening visibility but rather
to the 1Q06 earnings report being made earlier in the period than the 4Q05 report. Sonus remains committed to grow at least
as fast as the market, which it believes is expanding at least 20-25% a year. We would use any weakness to further accumulate
the shares.
Valuation. Our valuation of SONS is based on the discounted expected future value of the equity adjusted for current cash
and debt. Using our five-year earnings model, we project net income of $119.6 million in 2010. Assuming the market multiple
stays constant at its current 16x, we believe the shares deserve to trade at 20% premium to the market given our expectation
that Sonus will still be growing at a rate superior to the overall market. On that basis, we expect Sonus’s enterprise value to be
$2.3 billion. To that we add $409.2 million of cumulative earnings over the five year period (a good proxy for cash flow in this
case) to reflect additional accumulated cash. We then discount the combined market capitalization and cash at a 15% rate, and
adjust for current cash and debt. In 1Q06, the company grew cash by $26 million to $340 million. About $10 million came
from net income and non-cash expenses with the remainder primarily from lower accounts receivable. The higher cash raises
our current value estimate by about $0.08 to $6.64 per share. Our calculations are summarized in the table below. |
