Sunday, May 26, 2013

NICE Guys Coming First

It’s been a disappointing earnings season for technology stocks. A marked reluctance among telcos and enterprises to sign off on big deals has caused company after company to miss earnings and lower guidance. In this environment any company that merely hits guidance is a 'winner.' With these thoughts in mind the market liked the recent results from NICE Systems(NASDAQ: NICE). In fact I got the impression from the tone of the questions on the conference call that the analysts were rather surprised at how well it all went.

NICE guys come first

Nope not a throwback to before the dark ages of feminism but a reference to NICE Systems earnings in the quarter

  • Q1 Revenues $225 million vs. internal guidance of $220 million-230 million

  • Q1 EPS of $0.61 vs. internal guidance of $0.57-$0.62

  • Q2 Revenue guidance of $220 million-230 million vs. analyst consensus of $231.9 million

  • Q2 EPS guidance of $0.58-$0.64 vs. analyst consensus of $0.62

  •  Full year revenue guidance of $940 million-970 million vs. analyst consensus of $957 million

  • Full year EPS guidance of $2.55-$2.65 vs. analyst consensus of $2.61

The results were pretty much in line and the guidance for the full year was left unchanged. This is good in relation to what others have been reporting but it is also encouraging for NICE shareholders because the company is becoming more back end loaded in its results. In other words, earnings are being pushed towards Q3 and particularly Q4. It’s great when they come in as expected but investors will always have concerns when in Q1 & Q2. I discussed some of the reasons why in an article linked here.

NICE Systems earnings drivers

In essence NICE is seeing larger deals coming in (a notable contrast to the rest of the tech world) as it is able to sell on more advanced applications solutions to its customers. While this is obviously good news it also means that bookings may take longer to translate into revenues. In addition the sales cycle will be longer with these types of complex deals. All of which means that earnings and revenues are becoming more back end loaded (a lot of deals will be signed in Q4).

A graphical depiction of what to expect can be seen here.

The company is looking for bookings of above $1 billion in 2013. A quick look at the revenue guidance of $940 million-970 million confirms that the book to bill is expected to be above one this year. Another good sign is that it claimed the growth was coming from its existing customers, which implies that it has good opportunities to sell its advanced applications into its installed base. 

With all this good news going on, investors are entitled to ask how it hit guidance when so many had missed?  For example TIBCO Software (NASDAQ: TIBX) gave a horrible set of results recently and this company has questions to answer over its guidance. Although not strictly speaking a competitor, TIBCO is exposed to enterprise spending on big data analytics.TIBCO needs to demonstrate that it can turn around its poor performance with its US sales execution. In addition it has spent a year blaming this region for its problems but now its European operations are performing poorly too. My guess is that this because its solutions maybe tied to expansionary spending expectations (marketing budgets etc) rather than the sort of efficiency gains that NICE offers.

Moreover IBM also missed estimates (a rare event in itself) amidst discussion of a weaker macro environment. Its analytics results were relatively stronger and there is a suggestion that it is taking market share from TIBCO. However it was hardly a strong statement regarding the overall spending environment. 

Why NICE Systems is doing so well

Some reasons why it did so well are that other than the opportunity to sell its advanced applications to a mature and large installed base I think its solutions are somewhat non-discretionary. Whereas a corporation may hold back on investing in new marketing expenditures (TIBCO) and on upgrading its IT (IBM) if a company is facing increasing security, money laundering or regulatory & compliance requirements it will need to invest. Indeed NICE has a deal with IBM to incorporate its analytics solutions within its services.This gives both companies advantages to sell through services particularly with financials.

Moreover NICE’s new solutions largely involve analyzing customer interaction data that its systems are already capturing. In other words it is a proposition largely based on productivity and efficiency gains rather than purely growth.It also means companies can buy a range of solutions from one supplier.

Longer term there is always going to be speculation over a potential tie up with its rival Verint Systems (NASDAQ: VRNT). The companies are good potential partners thanks to complimentary end markets and customers. NICE is strong with financials and call centers while Verint has more strength with Government business and security solutions. Indeed Verint’s recent results were quite good  and I think its guidance may prove to be conservative. Verint's focus on security should enable to grow as there is no shortage of worries over cyber attacks and in particular with Government agencies. A deal between the companies is a real possibility due to complimentary end markets, a common culture (both are Israeli) and they are likely to share many shareholders in common as a consequence.

 Where next for NICE Systems?

Anyone predicting that he had found a corner of tech that is oblivious to the slowdown in Q1 would have been left with egg on his face, or rather an omelet. So I would be cautious with expecting too much here. 

With that said NICE seems to be on track to hit its full year guidance. In terms of evaluation the current PE may seem high at 33x but its cash flow conversion is excellent. This business has generated an average of nearly $126m in free cash flow over the last few years. Compared to its market cap of $2.18 billion and enterprise value of $1.85 billion this makes the stock good value and I think the analyst consensus target of $40 is achievable.

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