Can Sonus Cross The 'Border' To Accelerating Growth And Margin Expansion?

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Sonus articulated its vision, product roadmap as well as its near term and intermediate term financial targets yesterday.

Sonus' high growth product segment, SBC, has crossed over 50% of sales and is likely to continue to grow as a percentage of sales.

Sonus has outlined for the first time financial targets of double digit revenue growth and operating margin to be achieved in 2015.

This week Sonus (SONS) articulated its vision, product roadmap as well as its near term and intermediate term financial targets. Sonus has been undergoing a multi-year turnaround since Ray Dolan took over as CEO in October of 2010. While this turnaround has been lengthy in process, and required a revamping of the management team and product line offering over that period, it now appears the company has turned the corner and is likely to hit an inflection point within the next year if the company can continue to execute on its plan. The higher confidence management has in its strategy and business plan was also reflective this week in the company giving forward year 2015 targets for both revenues and margins; a first for the company since Ray took over the CEO role. Clearly Sonus is feeling more confident about its future after many years of organic product development, market and product expanding acquisitions and changes to the management team and Board of Directors.

High Growth Products Now Represent Over 50% of Sales

The main breakthrough in 2013 for Sonus was its high growth business in the Session Border Controller (SBC) market comprising 55% of total sales in 4Q13. It is expected that SBC revenues will contribute approximately 58% of total sales in 2014. In addition, the company's recent entry into another high growth market segment of Diameter Signaling Routing (DSR) via the acquisition of Performance Technologies, will add another long-term growth driver to the story. The company has clearly come a long way from 2011 when SBC revenues comprised only 20% of total sales and the legacy, and now declining Gateway business, comprised 80% of sales.

Table 1 shows how Sonus has transformed its business composition in the past three years and how this transformation is likely to continue in 2014. Analysis of this table becomes significant when one also extrapolates the secular growth expectations of the SBC and DSR businesses, which combined, are expected to have a five-year 2013-2018 compounded growth rate 25%-30%. Industry analysts and Sonus management estimate the total SBC market grew 43% in 2013 to $750 million (DSR market was immaterial in 2013 at much less than $100M) with 2018 expectations of $2.25 billion for the SBC market and $1.0 billion for the DSR market. While Sonus's legacy Gateway business is expected to continue to decline over this period, the larger and rapidly growing SBC/DSR business will more than offset the decline in the Gateway business and potentially allowing the company to grow 10% in 2015 and easily greater than 10% in 2016. Note that company management has only guided through 2015 with guidance of 10% overall revenue growth.

Table 1: Sonus Revenue Percentage By Technology Segment















Source: Company Reports and Guidance. * - Includes about 2% of sales of new DSR revenues in 2014.

SBC and DSR Products Critical To Expanding VoIP and VoLTE Traffic

SBC and DSR products can be simply viewed as necessary and critical components of communications networks that facilitate session set-up/control/teardown, security, authentication and policy enforcement for voice over IP, VoIP, and wireless based voice over LTE (VoLTE) traffic and signaling information. Future growth of the SBC and DSR markets will be tied to proliferation of VoIP residential and enterprise services, the hosting of such services in the cloud, inter-connection of such services across different service providers and the ultimate transition of wireless based voice to VoLTE.

Operating Margins Expanding

Not only has Sonus transitioned its revenue composition to one of higher growth, the company seems to have reached a point of sustained and improving profitability. Specifically, Sonus went from a pro-forma operating loss and negative cash flow from operations in 2012 to a pro-forma profit and positive cash flow from operations in 2013. The operational improvement in 2013 allowing pro-forma operating margin to hit 3% is expected to continue in 2014 and 2015 with the company guiding pro-forma operating margin of 5% in 2014 and 10% in 2015. I think the stock could hit an inflection point sometime by mid 2015, if Sonus can execute on its plan allowing for double digit and accelerating revenue growth together with the company reaching double digit operating margins in 2015.

Tighter Partner Relationships May Accelerate Sonus' Plan

I think that Sonus could enhance its path towards double digit revenue growth and operating margins if it could leverage some of its existing and/or new global partners in a more formal way. Sonus is still a relatively small company with total revenues in 2013 of $277 million, yet it sells into the global enterprise and service provider markets. The company does have what I would consider "loose" partnerships with companies like Broadsoft, F5, Juniper and Microsoft, to expand sales reach and/or technical solutions, but history has shown in the communications equipment market that smaller companies that sell to both the global enterprise and service provider markets can accelerate sales and operating leverage by establishing tighter distribution relationships with properly aligned larger global partners.

The breadth of Sonus's product offerings and these products spanning both enterprise and service provider end markets is reflected in the company's high operating expense ratio of roughly 55%-60% of sales. On the other hand, Sonus's very attractive gross margin of roughly 63%-64% is reflective of the company's high software content and technically complex products. Thus, if Sonus can establish more compelling distribution agreements with global software and/or communications equipment companies, the road to its goals of double digit growth and operating margin may come easier or in a more timely manner.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: NT Advisors LLC is a consulting firm servicing the technology industry. Sonus in the past was a client of NT Advisors LLC.