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Sonus Networks, Inc. (NASDAQ:SONS)

Q2 2012 Earnings Call

August 7, 2012 04:45 p.m. ET

Executives

Patti Leahy – VP, IR

Ray Dolan – President & CEO

Moe Castonguay – CFO

Todd Abbott – SVP, Worldwide Sales & Marketing

Analysts

Paul Silverstein – Credit Suisse

Subu Subrahmanyan – TheJudaGroup

Catharine Trebnick – Northland Securities

Ryan Hutchinson – Lazard Capital Markets

James Kisner – Jefferies

Jonathan Kees – Capstone Investments

Steve Cohen – Provo Partners

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Sonus Networks Quarter Two 2012 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we’ll conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded, Tuesday August 7, 2012.

I’d now like to turn the conference over to Patti Leahy, Vice President of Investor Relations. Please go ahead, ma’am.

Patti Leahy

Thank you, Jamie. Good afternoon, everyone. Welcome to Sonus Networks Second Quarter 2012 Operating Results Conference Call. Thank you for joining us today. Before we get started, I would like remind you that a recording of this call will be available on our website at sonus.net.

Speakers on the call today are Ray Dolan, Chief Executive Officer; and Moe Castonguay, Chief Financial Officer. Todd Abbott, Senior Vice President of Worldwide Sales, Marketing and Business Development is also here to address your questions at the end of our prepared remarks. If you have questions following today’s call, please direct them to me at pleahy@sonusnet.com.

Please note for purposes of Safe Harbor provisions that during this call we will make projections and forward-looking statements regarding items such as future market opportunities and the company’s financial performance.

Actual events or financial results may differ materially from those projections or forward-looking statements and are subject to various risks and uncertainties including, without limitation, any statements relating to our acquisition of NET or their financial results and outlook, difficulties we may experience in expanding our customer base and in leveraging new market opportunities.

A discussion of factors that may affect future results is contained in our filings with the SEC, which are available on our website. While we may elect to update or revise forward-looking statements at some point, we specifically disclaim any obligation to do so unless required by law.

Finally, during our call, we will be referring to certain GAAP and non-GAAP financial measures. A reconciliation of the non-GAAP to comparable GAAP financial measures is included in our press release issued today, as well as in the Investor Relations section of our website at sonus.net.

It’s now my pleasure to introduce the Chief Executive Officer of Sonus, Ray Dolan. Please go ahead, Ray.

Ray Dolan

Thank you, Patti, and good afternoon, everyone. Sonus delivered a solid second quarter. The team again produced strong SBC results, which were 27% above the high end of our guidance and 77% above our second quarter last year. We are gaining increasing share and see no evidence of this market slowing down. So today, we are reiterating our SBC guidance for the year, which reflects growth almost three times the industry growth according to Infonetics.

We delivered total second quarter revenue in line with our expectations, despite a challenging macro environment. We also met our EPS outlook. So, overall, I’m pleased with our results for this quarter.

My prepared remarks this afternoon will focus on three areas: first, I’ll discuss our outlook in the context of the current environment; second, I’ll cover some of the key milestones we reached this quarter; and third, I’ll provide some proof points around the success we’re having in the SBC market and specifically with our 5200.

Turning to our outlook. As I said, despite a challenging environment, we have executed well and continue to grow our SBC business, as evidenced by our results and guidance. However, in the current environment, we believe it is prudent to take the more conservative view for the rest of our business.

Given this, we are now assuming approximately a 20% reduction in our Trunking product revenue this year versus the original assumption for a 10% reduction. To make this clear, this now translates to a potential decline in Trunking product revenue this year of approximately $20 million to $25 million, when compared to last year. The good news is that our expected SBC growth is sufficient to offset this decline.

In light of the current environment, we are taking proactive cost reduction measures, which we believe will ensure that Sonus has an appropriate cost structure that not only allows us to continue to grow our SBC business, but should also accelerate our path to long-term profitability and growth.

We have already begun to implement some of these actions and expect on an annualized basis to reduce our spend by approximately $12 million or 7%, when compared to the low end of our previous OpEx guidance of $168 million to $171 million. These savings will come from across-the-board initiatives to improve our efficiencies, the bulk of which will be realized as OpEx savings.

To put this in context, had we implemented these initiatives at the start of the year, we would reach breakeven profitability at around $260 million in revenue.

Now turning to our key operational milestones this quarter. In addition to exceeding our revenue expectations for SBC for the first half, we achieved a number of important accomplishments in the second quarter, which will fuel our growth. First, we launched our newest SBC product, the 5100, which is our flagship enterprise SBC.

Two weeks later, we followed up with the launch of our channel program, Sonus Partner Assure. These are significant milestones in our strategy to strengthen our competitive positioning for the enterprise SBC market, a market which grew 60% in 2011 and continues to grow rapidly as SIP Trunking increases in adoption, unlocking the true potential of Hosted UC in the cloud. So while it is early days for these new initiatives, we expect the 5100 and our channel program to be important drivers of our growth in the enterprise market.

Another important milestone in our move to compete more aggressively in the enterprise market was our announcement in June of our intent to acquire Network Equipment Technologies or NET, which is a leader in enterprise class networking solutions. NET has scheduled a shareholder meeting for August 23, at which time we expect to close the transaction.

The strategic rationale for this transaction is clear. NET expands our enterprise market opportunity for SBCs, with solutions optimized for SIP Trunking and cloud-based UC deployments, targeting the small office and branch office environment. NET also brings an established set of channels, which will be able to sell the complete Sonus SBC product portfolio, and they bring deep relationships with the U.S. Federal Government.

In their most recent quarterly results, which they provided on August 1, NET reported 77% of their product revenue from enterprise customers, which is up from 66% last quarter and up from 34% last year. NET also continues to see strong traction with their Lync-certified UC program, which they call the UX series.

While NET has struggled to gain scale on its own, it has clearly made the successful pivot from a legacy business to an enterprise-centric growth business. In short, this acquisition significantly accelerates the enterprise strategy we laid out last year. Combined with strong SBC results that Sonus is delivering, we believe we can help accelerate the positive trends underway NET and drive greater scale for both businesses.

Now I’d like to share a few more data points on the SBC progress that Sonus is making. To start, 42% of our total product revenue this quarter was driven by SBC. This is the highest percentage on record in our transition to becoming an SBC company. We won six new customers this quarter, all of which purchased SBC products and services from us. With the addition of our 5100 and NET’s UX capabilities, we more than double our exposure to the enterprise SBC markets.

Both our 5200 and 5100 are now certified for Microsoft Lync and can provide the secure connection between a Lync UC environment and a SIP Trunking service. Our SBC portfolio is becoming increasingly competitive and robust.

Today, I’d like to provide some additional color around our SBC 5200 revenue. You may remember last quarter that we disclosed that approximately 75% of our SBC 9000 revenue over the prior 13 quarters was from competitive wins in the marketplace, meaning, new chassis sales.

Over the past four quarters, our SBC product revenue has averaged 26% from our SBC 5200 and 74% from our 9000. In this last quarter, two-thirds of our SBC customer wins was for the 5200.

While I do not intend to continue providing our revenue breakdown from various products, I do believe this clearly demonstrates the momentum we have with our SBC product portfolio and with the 5200 in particular. The bottom line is that the SBC market is growing at a healthy pace. Sonus is taking share and we will continue to use the full arsenal of products within our competitive portfolio to win in the marketplace.

I now ask Moe to take us through our second quarter results and outlook in more detail. Moe.

Moe Castonguay

Thank you, Ray, and good afternoon, everyone. Total revenue for the quarter was $57.6 million, compared to $64.3 million in the first quarter of 2012 and $51.8 million in the second quarter of 2011. Our SBC revenue was stronger than expected in our second quarter. Total second quarter SBC revenue was $19.1 million, compared to $17 million in the first quarter and $10.8 million in the second quarter of 2011.

One customer contributed greater than 10% of our total revenue in the quarter and that was AT&T. Our top five revenue customers represented 53.6% of revenue in the second quarter, down from 65.6% in the first quarter and up from 46.4% in the second quarter of 2011. We reported revenue from 123 customers in the second quarter. This compares to 117 customers in the first quarter and 98 customers in the second quarter of 2011. Looking at total revenue geographically, domestic revenue accounted for 73% versus 75% in the first quarter and 78% in Q2 of 2011.

Before I go into further details on our financial results and outlook, I’d like to point out that the numbers I’m about to discuss are on a non-GAAP basis and exclude stock-based compensation expense, amortization of intangible assets, acquisition-related costs and restructuring.

Total gross margin for the second quarter was 57.4%, compared to 65.3% in the first quarter and 58.8% in Q2 of 2011. Second quarter gross margins were slightly lower than forecast, due to a less favorable product mix than previously forecasted. Product gross margins for the second quarter were 66.3%, compared to 77.9% in Q1 and 67.7% in Q2 of 2011.

Service gross margins for the second quarter were 45.7%, compared to 42.4% in Q1 and 47% in Q2 of 2011. Total operating expenses were $41.7 million, compared to $46 million in the first quarter and $34.9 million in Q2 of 2011.

Head count decreased slightly to 1,114 employees. Our net loss for the quarter was $8.6 million, compared to a net loss of $4.2 million in the first quarter and a net loss of $3.6 million in Q2 of 2011. We ended the quarter with total cash and investments of $363.8 million. Our DSO for the quarter was 65 days, compared to 46 days in the first quarter and 62 days in Q2 of 2011.

Now I’d like to provide our outlook, excluding NET’s financial impact. After I’ve completed providing the outlook for Sonus, I will provide a brief outlook for NET, under the assumption that proposed acquisition will close in late August. We are providing our outlook for Sonus’ third quarter ending Friday, September 28 and for our fourth quarter and fiscal year ending December 31, 2012.

Our total revenue outlook for the third quarter is between $51 million and $53 million. Our total revenue outlook for the fourth quarter is between $84 million and $86 million. Fiscal year 2012 revenue outlook has been reduced to the range of $257 million to $261 million. The revised outlook reflects anticipated reduced spending for media gateway product by service providers in the second half of this year.

Our total SBC revenue outlook for the third quarter is $17 million to $19 million. For the fourth quarter, it is $22 million to $25 million, and for the full year, we continue to expect total SBC revenue of $75 million to $80 million. Our SBC product revenue expectations for these same periods are included in today’s press release and, again, our outlook for the full year is consistent with our prior expectations.

For the third and fourth quarters, we expect total non-GAAP gross margins to range between 58% and 59%. For the full year, we expect non-GAAP gross margins of approximately 60%. This month the company initiated a plan to streamline operations and reduce operating costs, including a corporate-wide restructuring plan. In our third quarter, we expect to take a restructuring charge of approximately $2.3 million for severance and related expenses. These initiatives are expected to reduce our Q3 and Q4 non-GAAP operating expenses by $2 million and $3 million, respectively, compared to Q2 non-GAAP operating expenses of $41.7 million.

For the third quarter, we expect non-GAAP operating expenses to drop to between $39 million and $40 million. For the fourth quarter, we expect non-GAAP operating expenses to further drop to between $38 million and $39 million.

Total non-GAAP operating expenses for the full year 2012 are expected to be $165 million to $166 million. This compares to a previous expense outlook up of $168 million to $171 million, provided on our last call. For the third quarter, we expect non-GAAP loss per share of $0.03 and for the fourth quarter we expect non-GAAP net income of $0.04 per diluted share.

For the full year, we expect a non-GAAP loss per share of $0.04. Basic and diluted share count for the third quarter should approximate 280 million and for the fourth quarter diluted shares should approximate 282 million. For the full year basic and diluted shares should approximate 280 million.

We look forward to closing on our pending acquisition of NET in late August. If the acquisition closes, we expect NET revenues post close to result in incremental revenues of approximately $5 million in our third quarter and an additional $10 million to $12 million in our fourth quarter. The projected incremental NET revenues of $15 million to $17 million for fiscal 2012 are slightly lower than previous range, reflecting the later-than-previously-anticipated closing date.

On a combined basis, assuming the deal closes, we expect combined revenue to be $272 million to $278 million. We expect the acquisition to have a $0.01 dilutive to breakeven impact on non-GAAP EPS for the balance of the year. We will provide an update on our acquisition-related costs and restructuring charges related to the proposed NET acquisition at our Investor Day.

Sonus expects to incur acquisition-related costs of approximately $1.5 million in the third quarter, which we will exclude from our non-GAAP operating results. We expect our Q3 closing cash and investment balance, assuming acquisition closes, to approximate $300 million. We expect Q4 closing cash and investments to be in the range of $290 million to $300 million.

I’ll now turn the call back over to Ray.

Ray Dolan

Thanks, Moe. In closing, I believe the proof points of our transformation are becoming clearer each quarter. As we described during our year-end call, which we held in February, you can hold us accountable to four things this year.

First, SBC growth; we are now halfway through the year and I believe we can check this box, given the performance we have delivered so far and our outlook for the remainder of the year. Second, channel momentum. As committed, we launched our comprehensive channel program this past quarter, along with our SBC 5100, as a key part of our strategy to drive growth in the enterprise. It’s early days since the launch of these initiatives, but we believe our new channel and SBC product. Combined with the enterprise focus that NET brings, position us very well to deliver on the commitment to drive the third key metric that we laid out for this year, which is customer growth.

We reported revenue from 123 customers this quarter, which is up 26% from the second quarter of last year and 97% of our new customers over the past four quarters have purchased SBC products and services from us. That’s excellent progress, particularly for our SBC growth engine, but we expect to see the customer needle really move as our enterprise strategy takes root.

Finally, we laid out the metric of consistent execution and delivering on our commitments. Part of this commitment is to provide greater transparency and predictability into our business. Clearly, predictability can be more challenging in this difficult environment.

We are taking proactive cost reduction measures, while also protecting the growth areas of our business, with the ultimate goal to drive long-term growth and profitability. To that point, while it is too early to provide guidance for next year, you should know that our team is laser-focused on reaching three key goals for next year: first, that more than 50% of our product revenue will be derived from SBC; second, that we will be profitable for the full year; and third, that we will generate positive operating cash flow for 2013.

Before we open up for questions, I have two other topics to share with you: one, about our potential uses of cash; and the other about my personal compensation. First, on uses of cash, given our strong cash position, we periodically receive questions about the possible uses of our cash, including whether we’ll consider a stock buyback.

Of course, our Board of Directors routinely considers this issue in the context of what would generate the highest total shareholder return. Our direction at this time is to concentrate on profitably expanding our business, which we believe is what will drive shareholder value. This view about the buyback could change as our business evolves, but we believe maintaining the flexibility of a strong balance sheet and focusing on profitable growth is the right approach at this time.

Now turning to my personal commitment. At my request the Compensation Committee of the Board has agreed to permit me to exchange my entire cash compensation, including salary and bonus, for restricted stock going forward. I requested this in order to demonstrate my unwavering conviction in Sonus and to make it perfectly clear that my interests are aligned with our shareholders. I firmly believe we are taking the right actions today that will allow us to drive to consistent profitability faster, while also growing our business. In short, Sonus is on the right path and I am thrilled to be part of the journey.

Thank you for your continued support. I’d also like to thank our more than 1,000 employees, who are working very hard here and in Westford, and around the globe, and that share my commitment to helping Sonus succeed.

Operator, would you please transition to the Q&A portion of the call?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Paul Silverstein with Credit Suisse. Please go ahead.

Paul Silverstein – Credit Suisse

Ray, first off, thank you for giving that breakout on the 5200; I appreciate that. Secondly, can you give two things; one, I’m trying – a little issue but I see on the services revenue on the SBC piece, if I have the numbers right it looks like you all did $5.6 million in the second quarter, up from $3.8 million in the first quarter. In giving the guidance on the product, I’m just trying to make sense of the guidance on the SBC business. Maybe I’m overanalyzing it but your product revenue for the third quarter in SBC, you’re projecting $19 million to $22 million for the fourth quarter and I’m sorry – was it $14 million to $16 million for the third quarter?

And if I continued the ramp in your SBC services revenue, it would suggest you’re either being appropriately conservative on the numbers or that there’s some onetime aspect to the services piece. I’m just trying to reconcile that. Can you help me out?

Ray Dolan

Paul, I’ll try to get that, there’s a lot of numbers you just put out there. I believe we are being appropriately conservative on our SBC revenue. I think given where we have visibility, we’ve tried to guide to that visibility. Our services component varies a little bit from time to time, customer to customer, whether it’s new or whether it’s follow-on work. So that’s where some of those issues may be moving around.

Paul Silverstein – Credit Suisse

Let me give you the numbers. You guys did $3.8 million services, SBC services in March, $5.6 million in June. If I take your product SBC revenue guidance as 14% to 16%, so if I took the midpoint of 15%, is there any reason, Moe, Ray, why the $5.6 million goes down – shouldn’t continue to go up as you get greater attach rates? Is there any reason why that goes down? And if it doesn’t go down, that would translate to $21 million, $22 million of total SBC revenue versus the $17 million to $19 million guidance. Same thing with the fourth quarter, similar analysis, what am I missing?

Moe Castonguay

Well, the answer is that the service revenue was slightly higher in Q2 than the norm, and we would expect it to get back to the norm. Obviously, there’s a continuing element of maintenance that will continue. We expect a smaller amount of professional services in our third and fourth quarter and that’s the reason why the numbers don’t have as big a spread.

Paul Silverstein – Credit Suisse

Okay, all right, let me move on. One other question if I may. On, again, focusing on the SBC portion of your business, Ray, can you go into where – can you update us on where the bulk of the applications, the deployments, what’s driving the customer acquisition and the growth in dollars?

Ray Dolan

Sure, I will do that and also Todd’s on the call and he can offer some commentary as well on that, Paul, thanks for your question. So we continue to succeed very well in the peering side, and we’re beginning to move more and more as we’ve launched the 5100 and launched the 5200 as well into the enterprise and opened the channel and expanding into the SIP Trunking side. So I’d say the results continue to be weighted in that direction but we’re starting to see some more diversification in our revenue. Does that answer your question?

Paul Silverstein – Credit Suisse

Ray, did you give us a number on what the enterprise contribution was versus service provider on the SBC?

Ray Dolan

No, we didn’t. No, we didn’t break that out.

Paul Silverstein – Credit Suisse

Is that something you contemplate breaking out down the road? Or you don’t have those numbers yet?

Ray Dolan

We don’t have those numbers yet, Paul, but I’ll think that through and I’d be happy to talk with you about the pros and cons there. We want to give you as much visibility as we can.

Paul Silverstein – Credit Suisse

I appreciate that. Can you talk in terms of the customer count on SBCs, how much of that was enterprise versus service provider?

Moe Castonguay

The new customers, if that’s what you’re referring to, were mixed between both enterprise and service providers.

Paul Silverstein – Credit Suisse

All right. And one final from me before I pass it on, can you update us on the channel effort?

Todd Abbott

Launched – this is Todd Abbott – launched the Partner Assure in June. We have – we’re right on track with what our recruitment targets are, so we’ve got a number of global partners that have signed up and a number of more that are in the final signing stage. So we’ll have a lot more to share with you in September. It really required the 5100 and the 5200 3.0 release that we just GA’d here in the last few weeks as a critical component. That’s the channel-ready product. So we would expect to start to see some results from the channel a little bit in Q3, not much. It really becomes a ramp into Q4 and into 2013.

Paul Silverstein – Credit Suisse

Right. Thank you. I’ll pass it on. Thanks, guys.

Ray Dolan

Thank you.

Todd Abbott

Thanks, Paul.

Operator

Thank you. And our next question comes from the line of Catharine Trebnick with Northland Securities. Please go ahead. Ms. Trebnick, your line is open, please proceed.

As there is no response from this line, we will continue to our next question. Our next question comes from the line of Subu Subrahmanyan with TheJudaGroup. Please go ahead.

Subu Subrahmanyan – TheJudaGroup

Thank you. Ray, if you could talk about the overall CapEx environment and talk about why it appears to be impacting your media gateway business more than expected, while your SBC business is not impacted versus your guidance? Is it a more secular impact on your media gateway business? Is it a lack of focus? I mean, can you break out between kind of the change in the environment and the disproportionate impact on that segment of the business?

Ray Dolan

Sure, Subu, thanks. Yeah, there’s probably two things impacting our gateway business. One’s the regulatory environment that’s shifting in real time towards IP interconnect. And the other is, frankly, the CapEx pressures that exist globally on service providers and their view that TDM’s just having a tough time competing with other important priorities. So that’s really it. It’s not a lack of focus.

Subu Subrahmanyan – TheJudaGroup

And do you think that 20% kind of decline this year – is that a trend line at this point, Ray? I mean, how should we think about that trend in the media gateway business?

Ray Dolan

Well, it’s too early to guide, but it is a trend that I think in my mind is likely to stay in place for the foreseeable future. I don’t think the regulatory environment is going to get any easier and I don’t believe that the CapEx environment, until we see that change, would merit us re-guiding. So that’s why we got out in front of that with some cost reduction initiatives to make sure that the profit engine in the future in the SBC side has a chance to drive us to profitability, and cash flow breakeven, and beyond and that we’ll manage our gateway business accordingly.

Subu Subrahmanyan – TheJudaGroup

And could you talk about the competitive environment at the SBC market? And what kind of applications are specifically driving your share gains?

Todd Abbott

Subu, this is Todd. So I think we’re still getting the bulk of our growth coming out of the interconnect business and there’s still a fairly healthy pipeline of activity in that business that really gives us the confidence from the guidance for the remainder of this year. We’re getting some early traction relative to entering into the enterprise SIP Trunking space with some of the new products, getting through the various test stages and such. And, as well, a lot of the UC environment, UC federation across multiple UC environments within enterprise that are leveraging SIP infrastructures, but the bulk of the activity to-date is in the interconnect business.

Subu Subrahmanyan – TheJudaGroup

Got it. Thank you.

Ray Dolan

Thanks, Subu.

Operator

Thank you. We go back to the line of Catharine Trebnick. Please go ahead.

Catharine Trebnick – Northland Securities

Hi. Thank you, guys. Can you hear me this time?

Ray Dolan

Yes, we can.

Catharine Trebnick – Northland Securities

Great, thank you. All right. I missed some of the call bouncing in and bouncing out of the call here, quick question, could you give us some color, how you’re doing internationally versus domestically? And then also follow-up on some of the tight CapEx trends you’re seeing on the carrier side, just give us more color on that? And RFP activity, if it’s down, or up, or about the same? Thanks.

Todd Abbott

This is Todd. On the international side, the SBC growth is growing exponentially for us off of a small base, but growing exponentially. We’ll see anywhere from an eight to 10X growth year-on-year in the international theaters, so that is on a nice path.

From an RFP deal engagement activity – I think is your last part of your question – we’ve got a number of opportunities in the funnel. Our funnel’s actually quite strong, which is one of the driving factors with our guidance in the second half. So we’ve got a number of different opportunities, whether they be in RFP, RFQ or an actual proposal stage, various stages. The funnel activity looks quite strong across all segments, both interconnect, trunking, as well as enterprise.

Catharine Trebnick – Northland Securities

Okay. And then when you do win, any particular reason, anecdotally, you can give us to the customer saying why they’re selecting you over someone else? Thanks.

Todd Abbott

Yeah. We do quite well when we get into lab tests. Our second generation box scales much – very nicely, especially in multiprotocol environments, where decoding is a critical requirement, our architecture performs exceptionally. As well as those customers that are much more mature and larger, where scale of the overall network plays and policy becomes a critical requirement, those tend to become two of the key drivers of our success rate.

Catharine Trebnick – Northland Securities

Okay. Thank you very much.

Ray Dolan

Yeah, Catharine, this is Ray.

Catharine Trebnick – Northland Securities

Yes?

Ray Dolan

I know – I realize that’s the same kind of answer that – because this question keeps coming up, why do you win? I’ve had a lot of opportunities to talk to C level execs amongst our existing customers, as well as prospects. And we have a very solid reputation for building resilient products. Let me just give you two examples, all right.

One, when the tsunami hit in Japan, our network infrastructure stood up throughout that entire process. And some of the most rigorous customers in the world reaffirmed that Sonus has a reputation for building and maintaining reliable products. A lot of those were gateways at that time, but the SBC products were emerging, okay.

Second, on Facebook Friday, those members of the financial institution that used our products watched them stand up while a lot of other things rolled over. We’re engaged with people with a good reputation for scalability, reliability, complexity as they move their business models to UC in the cloud using service providers. So those are the reasons we are winning.

The issues beyond that like the specific competitive issues are really, from my point of view, not going to be things that we get into on these calls, because we don’t want to tip off our competitors. But we have a very good product portfolio and when we bring NET in and continue to innovate ourselves, we will continue to expand that SBC portfolio.

Catharine Trebnick – Northland Securities

Well, thank you. That was very good. I appreciate the answer. And then one last question is are you seeing any pricing at all when you do these competitive bids? Any?

Todd Abbott

Yeah. We’re seeing – we’re clearly seeing some changing activities based upon some of the competitive landscapes, but nothing that is causing us any concerns relative to our business model.

Catharine Trebnick – Northland Securities

Okay, great. Thanks, guys.

Ray Dolan

Thank you.

Operator

Thank you. Our next question comes from the line of Ryan Hutchinson with Lazard Capital Markets. Please go ahead.

Ryan Hutchinson – Lazard Capital Markets

Hey, good afternoon, guys. I have somewhat of a follow-up. I just – I want to understand the confidence going into the fourth quarter there with the huge ramp, just understanding that would be helpful? And then does the guidance include any enterprise? And if so, how much? And then I have one follow-up.

Ray Dolan

Yes, so, Ryan, this is Ray. The basic question is how do we account for the confidence in Q4, given the spread between the Q3 and the Q4 guide? It’s basically a function of the timing of our backlog as it scores to revenue and the visibility that we have into the funnel throughout all the theaters around the world. And so we’re confident that we have enough visibility and that’s why we’ve guided to those numbers. What’s your follow-up question?

Todd Abbott

Enterprise.

Ryan Hutchinson – Lazard Capital Markets

Does that include any enterprise and then I have one more.

Todd Abbott

Well, there is enterprise in the second-half business as there is every quarter but we don’t – we haven’t broken that out. But it’s certainly not the big contributor on the ramp.

Ray Dolan

Yep.

Ryan Hutchinson – Lazard Capital Markets

Okay. And you touched on it, gave us some color on product revenue for SBC in 2013. I’ll just ask it a different way, what’s the implied decline in the legacy business? If we’re looking around 20% this year, is that the working assumption to get to the 50% product revenue for SBCs in 2013?

Ray Dolan

No, we haven’t really guided to a specific number in 2013. So if your question is do we need to lose gateway business in order to crossover, no. We’ll grow organically through the crossover point, but we likely will also have a continuing decline in the gateway business.

Ryan Hutchinson – Lazard Capital Markets

And I assume that includes the acquisition revenues? Is that correct?

Ray Dolan

Yes. As a matter of fact, NET is going through the exact same pivot and is in the mid-40%s from the standpoint of their growth engine, which is their UX revenue as a percentage of their total product revenue. And my guess is, we have not gotten underneath the numbers but we will soon after the acquisition. They will also independently pivot to beyond the 50% mark and the combined company will make that pivot together.

Ryan Hutchinson – Lazard Capital Markets

Okay, that’s helpful. Thank you very much, guys.

Ray Dolan

Thank you, Ryan.

Operator

Our next question comes from the line of James Kisner from Jefferies. Please go ahead.

James Kisner – Jefferies

Hi, guys. Congrats on reiterating your SBC guidance; it’s impressive. So just for clarification, first on your guidance, I’m doing some math here. It looks to me like you’re guiding for the Q4 media gateway revenue to be up pretty strong in Q4. Can you confirm that and explain that a little bit?

Todd Abbott

Yeah. We have some project level stuff in backlog and we probably have some end period VSR guiding into that. Because remember, we do have a significant customer base and they always every quarter do some level of growth with us. So that’s what that uptick will probably be, James.

James Kisner – Jefferies

Okay. Can you do – what about the application? Is it interconnect? Is it completely unrelated to the SBC ramp?

Ray Dolan

Are you asking about the media gateway piece?

James Kisner – Jefferies

Yes, for the media gateway, I’m just trying to understand like if the application – I mean, is it – I mean, media gateway could be access or trunking, right? So is it – can you give any color on that?

Ray Dolan

Yeah, it’s completely de-correlated to the SBC growth drivers...

James Kisner – Jefferies

Okay.

Ray Dolan

I’d say these are just either projects that have been in works for a while that’ll score to revenue or growth with our organic customers.

James Kisner – Jefferies

Okay. Okay, so back to the SBC business, in the past I think you have said that one of your challenges has been just sort of getting a seat at the table at some of the large deals. And I’m wondering, just given your recent success, might you – are you seeing more interest in your product for access application? Are you bidding into Tier 1s for VoLTE, or is that a challenge getting at just the opportunity to bid on these larger access deals globally?

Todd Abbott

We’re not having any difficulty bidding on the larger access deals.

James Kisner – Jefferies

Okay. That’s good. Okay. And just sort of one clarifying question on cash. It’s good to hear that you are planning to generate cash next year, but do you have any kind of estimate on what your integration cost – cash integration costs might be or perhaps your trough cash might end up at some point between now and the end of 2013, recognizing it is difficult to guide? But do you have any idea for what your integration costs would be from a cash perspective?

Moe Castonguay

Well, included in our outlook for $290 million to $300 million, it’s reflective of the cost that we expect to incur, acquisition-related costs this year. As we look out into next year, as Ray indicated, certainly our goal is to be cash flow positive next year and be profitable.

James Kisner – Jefferies

Does that mean in Q4 your cash balance is unlikely to go down relative to Q3?

Moe Castonguay

Actually we did provide outlook relative to cash. We did indicate that we expected cash in our third quarter to end approximately at around $300 million and that we expected our Q4 ending cash to be $290 million to $300 million. Obviously, it’s a function of shipments.

Ray Dolan

Hey, James, this is Ray. The NET integration costs will be completed at that point in time. We expect to close, which we mentioned on the call, in late August. So that guide includes all of that. Second, we guided to a penny loss to a breakeven for the balance of this year. We expect the NET pro forma company, while it will be already integrated into the company, to be accretive to us next year. So when we guide to next year, we’ll discuss that but we won’t be carrying integration costs as a burden to our cash or our earnings going forward.

James Kisner – Jefferies

Perfect. Thanks, guys. I’ll pass it.

Moe Castonguay

Thank you.

Operator

Thank you. Our next question comes from the line Jonathan Kees with Capstone Investments. Please go ahead.

Jonathan Kees – Capstone Investments

Great, thanks and hi, guys, thanks for taking my questions. Wanted to start, if I can, with a couple of housekeeping – actually a couple of housekeeping and a clarification. The housekeeping questions are what’s book-to-bill overall, as well as, for the peering products?

Second, there was a good amount of SBC revenues that were brought into this quarter and you maintained the guidance for SBC revenues for the year, so that’s great. Just curious, just a little more elaboration on that?

And then the clarification is did you say that two-thirds of the revenues for this last quarter were from the 5200s, so it was a flip from what’s traditionally have been more of the 9000s? And then I have a couple of real questions after that.

Moe Castonguay

Maybe I can answer one of them. In the quarter, book-to-bill was below 1.0. With respect to the new customers, two out of three of the new customers...

Patti Leahy

Four out of six ...

Moe Castonguay

Four out of six were 5200.

Jonathan Kees – Capstone Investments

Four out of six were 5200. Okay.

Moe Castonguay

That was the two-thirds number.

Jonathan Kees – Capstone Investments

Okay. Okay and then the pull up of the SBC revenue, they were above your guidance for Q2, just a couple more details about that or an elaboration about that, if you could?

Ray Dolan

Yeah. So Jonathan, this is Ray. That wasn’t a pull-up, that was just we beat our expectations.

Jonathan Kees – Capstone Investments

Okay, but you maintained the same SBC revenues for the year. So it sounds like that came in from Q3?

Ray Dolan

Well, we’ll discuss that and more as we move through Q3 and see where the environment is. So, maybe some of both, but it’s largely an outperforming Q2.

Jonathan Kees – Capstone Investments

Okay, all right. I will pass that on. Now for the deeper questions, wanted to ask you, Moe, you mentioned a lot of the growth you’re seeing is from like growth in the interconnect. So are you seeing, especially from the market share gains, more because you’re now the second source supplier and the service providers are saying: we want to appropriate so much to a second source supplier, we’re going to have a second source supplier and then we are going to appropriate so much from that? How much of that is playing a factor in terms of your share gains for the SBCs?

Moe Castonguay

I’ll tell you, very little. This is much more in net new projects, net new networks. There’s not a lot of dual sourcing going on right now as a general purchasing philosophy for this technology in the telco space. It tends to be much more new project-related.

Jonathan Kees – Capstone Investments

Okay. All right, so that could still be an opportunity then in 2013 as a second source? So, all right. The – I guess, the last question I wanted to ask is, maybe it it’s more related to visibility in the funnel. I mean, you talk about your confidence based on visibility in your funnel, as well as from your backlog. Did you do anything different this last quarter?

I mean, you’ve given – you’ve reiterated SBC guidance for the year. You brought down total revenue guidance because of media gateway. You’re now cutting back OpEx expenses. So – and I’m just curious, was there anything different in terms of how you determine your visibility in the quarter? Did you convene your sales team globally to try to figure out what’s going on and try to validate some of the macro trends that may be starting to buffet you guys? Anything different in terms of determining your visibility?

Ray Dolan

So, Jonathan, the answer, if I understand your question is, no, we didn’t do anything differently. We’re just executing according to our plan. The things that have changed slightly are the headwinds in the gateway business, which I said are related to regulatory changes and CapEx pressure, TDM relative to IP projects.

The good news is we’re executing on the SBC side product-wise and the results are showing up. In this case, they happen to be sufficient to absorb that decline and they will continue to be and that’s what we’re saying. So that’s really where it is. Now the OpEx tightening is a commitment that we’re making as a team to drive profitability as we drive growth. It’s always been our plan – drive growth, transform the company from a media gateway business to an SBC business and drive profitability, generate cash. So that’s the transformation that we’re going to at Sonus.

Jonathan Kees – Capstone Investments

If I can sneak one more question in, if I can here, I guess more in response to what you just say, Ray, my understanding was this year was going to be an investment year, a building year. You’re going to get the channel out, you’re going to ratchet up on sales and marketing, you’re going to ratchet up on R&D to get the 5100 product out. And now, you’re cutting OpEx, you’re cutting your investments. Is there a change there because of the macro? Is there now a slowdown in terms of the building up for both the sales and marketing as well as the R&D?

Ray Dolan

Yeah, what – how I would label this is across the board looking at greater productivity, fine-tuning our organization and driving the profitability consistent with the macro environment that we’re in.

Jonathan Kees – Capstone Investments

Okay, all right. Fair enough...

Ray Dolan

Thanks, Jonathan.

Jonathan Kees – Capstone Investments

I’ll pass the word on. Thanks a lot, guys.

Moe Castonguay

Thank you.

Operator

Our next question comes from the line of Steve Cohen from Provo Partners. Please go ahead.

Steve Cohen – Provo Partners

Hi, continuing on that subject, the restructuring, can you give some more color in terms of the number of people that you expect to be reducing? What functions they might be coming out of? How much would be domestic versus international, et cetera?

Ray Dolan

Steve, it’s Ray. Thanks for the question. There’ll be in the range of about 90 people. It’ll be across a number of functions and across all geographies.

Steve Cohen – Provo Partners

Thanks.

Operator

Great. Thank you. (Operator Instructions)

Patti Leahy

Operator, do we have any other questions at this time?

Operator

Yes, we do. We have a follow-up question from the line of Paul Silverstein. Please go ahead, sir.

Paul Silverstein – Credit Suisse

If you all already addressed this either tonight or previously, my apologies and we can take it offline, but if not, can you talk a bit about your gross margin expectations relative to when NET comes on board, in terms of how that’ll change the model? And can you review – if I remember correctly, historically, your margins for the media gateway business had been running above corporate average and for the SBC below. But maybe you could refresh my memory, if you’d be so kind?

Ray Dolan

Yeah, so, Paul, on the second question first, the gateway business really does vary. It may be marginally above because so much of the business is add-ons. But the SBC business, as it matures, especially as the initial chassis are sold, should have relatively the same profile as our existing media gateway business, okay. So that’s the second question you asked on the refresher.

With respect to the NET piece, their current margins are lower than ours in many ways because they sell very small boxes with very low initial session densities. We expect to improve upon that. We’ll give you more information on that as we get the company integrated and guide to next year.

Paul Silverstein – Credit Suisse

And, Ray, I know it’s hard enough predicting next quarter, let alone next year, but when you look out to the future is there any reason why your SBC margins shouldn’t go up over time as the business continues to grow? I recognize you’re just talking about near-term, but is there any reason why the margins shouldn’t improve from here?

Ray Dolan

No.

Paul Silverstein – Credit Suisse

Okay, so when you talk about them getting to media gateway that’s just a near-term outlook, as opposed to long-term?

Ray Dolan

Correct. I’d say that over time we’ll approach industry-standard margins as we continue to compete, broaden our portfolio, improve our go-to market to include the comprehensive channel and the enterprise and sell into greater and greater density installations, Paul.

Paul Silverstein – Credit Suisse

And the reason for the disparity currently – your current SBC margins and where a lot of your competitors are at – that’s a function of low density, low-end volumes? What are the key drivers of the increase over time?

Todd Abbott

Without the – this is Todd, Paul. So without the 5100 we’ve had to use a higher cost box and a 5200 that’s really designed for a higher entry point from a session density standpoint. So we’ve had to utilize that to compete into some of the spaces in preparation for the 5100.

Additionally, when you’re coming into a lot of these new sites, they tend to go in at a low session density, where you’re covering the cost of the platform versus coming in at a maxed-out session density, with a lot more license counts that’s much higher margin content...

Paul Silverstein – Credit Suisse

All right...

Todd Abbott

Go ahead.

Paul Silverstein – Credit Suisse

Thanks, Todd. One more from me on GM. Going back to a question Catharine asked earlier, how much – can you give us some sense for the pricing issue in terms of how aggressive you’re being or how aggressive others are being in the marketplace? How much is that related to the current level of gross margin?

Ray Dolan

Yeah, Paul, I don’t see that being a principal issue. It’s still early days and most of our wins are competitive wins based on our box, not on price.

Moe Castonguay

And when we’re winning, we’re typically not the lowest price.

Paul Silverstein – Credit Suisse

All right, if I could push you, the rate of price erosion in the market that you’re looking at, can you characterize it?

Ray Dolan

I don’t...

Moe Castonguay

Not really seeing a – we just don’t think in those terms, we’re not seeing a price erosion on a quarter-to-quarter basis at this stage.

Paul Silverstein – Credit Suisse

Perfect. All right. Appreciate it. Thanks, guys.

Ray Dolan

Thanks Paul.

Operator

Thank you. And our last question is a follow-up question from the line of James Kisner with Jefferies. Please go ahead.

James Kisner – Jefferies

Thanks for taking my follow-up. Just a – thanks for providing that statistic on the win – that your awards for the 9000 versus the 5200, but just to totally completely clear the issue, could you provide the sort of a basis? I think you said percent of award. Is that based on revenue? Is that based on sessions? Can you just clarify that statistic and perhaps repeat it for us again?

Ray Dolan

Okay, James. Yeah, this is Ray. We gave you two numbers. One was over the last four quarters our revenue averaged 26%, 5200; 74%, 9000, okay. Let me just give you some color. One, that’s competitive issues and, two, it moves around as people choose different solutions. We have large Tier 1s that choose the 9000 for reasons that are compelling to them and others choose the 5200. So that number varies, but by averaging it over four quarters what I’ve tried to do is give you an indication that it has now reached a material level of our competitive portfolio, and I expect it to continue that way. And we’re no longer going to guide to that specific number, because it’s competitively sensitive.

Second, we gave you a number that said two-thirds of the six new customers that all bought SBC, two-thirds of them bought the 5200, one-third bought the 9000. So those are the two data points that we gave you indicating accelerating traction of the 5200 and more and more material contribution to our results, which we believe, drives the principle value we’re creating for our shareholders: SBC growth, profitability and cash flow generation.

James Kisner – Jefferies

That’s perfect, and just one other quick follow-up. On your Q4 guide for SBCs, could you help us understand – this is a hard question, but the customer concentration you’re expecting in Q4, I mean, I guess really what I’m getting at is there a particular customer that’s going to – I mean, would the profile of your SBC business in Q4 be more concentrated than the rest of your business would be perhaps as to the whole quarter?

Ray Dolan

We don’t see any greater concentration there, James.

James Kisner – Jefferies

Perfect. All right. Thanks a lot, guys. Congrats.

Ray Dolan

Thank you.

James Kisner – Jefferies

Thank you very much.

Patti Leahy

All right, thanks, everyone. We really appreciate the time you’ve taken to be with us this afternoon and we look forward to seeing many of you at our Investor Day on September 13 in New York or sooner during our outreach period. Thank you and have a good night.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and please ask that you disconnect your lines.

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