Nice Ltd (NICE) 2003 Q3 法說會逐字稿

I would like to welcome everyone to the NICE Systems third quarter 2003 results conference call. This conference is being recorded October 29, 2003. I would now like to turn the call over to Ms. Rachela Kassif.

Thank you. Good morning or afternoon to everyone.

This call may contain forward-looking statements as the term is defined in the Private Securities Litigation Reform Act of 1995. Such statements are based on the current expectations of the management of NICE Systems only, and are subject to a number of risk factors and uncertainties, including, but not limited to, -- changes in technology; market requirements; decline in demand for the Company's products; inability to timely develop and introduce new technology, products and applications; difficulties or delays in absorbing and integrating acquired operations, products, technologies and personnel; loss of market share; pressure in pricing resulting from competition; an inability to maintain certain marketing and distribution arrangements, which could cause the actual results or performance of the Company to differ materially from those described herein.

We undertake no obligation to update these forward-looking statements. For a more detailed description of the risk factors and uncertainties affecting the Company, refer to the Company's reported files from time to time with the Securities and Exchange Commission.

Now, I would like to turn over the call to Haim Shani, President and CEO.

Thank you Rachela, and good day to everyone. We have another good quarter to report on today. Once again, we showed sequential improvement, with especially strong performance on the contact center/financial trading floor segment. This reflects the fact that we are beginning to leverage the ex TCS customer base and relationship. As we approach the first anniversary of the TCS acquisition, we believe that we have potential to leverage the ex TCS channel.

This week we had a major annual event in Europe with over 70 partners in attendance, including large global partners such as Avaya, as well as some of the other local distributors we had retained after the TCS acquisition. Some of our major European end-user customers also made presentations in the meeting in order to help our partners understand the benefits of our solution. One presentation, which was enormously successful, was given by the Vice President of customer support customer division in Israel.

Haim explained the important role of the contact center in (indiscernible) operation, the service concept, how key the customer service of those entities (indiscernible) the agent is, and the role that NICE solutions played in improving the efficiency and quality of their service. This was also backed by complete statistical measurements of improvement since they had introduced the NICE solution.

We are extremely pleased with our performance in the contact center and financial trading floor segment. The overall IT spending environment has been far from robust. Yet, we have continued to increase revenue each quarter. Every indication we have, including the latest independent research, confirms that we continue to gain market share in this highly competitive environment. Another important indicator for us is that the NICE user group, NUG, as we call it, has by now over 300 members.

As I mentioned on the last call, I think some of our recent market share gains are probably attributable to our leadership in the area of voice over IP. As you know, this has been a major area of focus this year, and we now have over 80 customers using our voice over IP solutions across all geographies and regions.

We're pleased that Cisco, one of the leaders in voice over IP infrastructure, recognized the flexibility and effectiveness of our solution with an award at the recent innovation event. We also continue to receive additional validation of our strategic direction and encouragement over the prospects for our near-term product roadmap.

Just recently, ten days ago, I was in Atlanta visiting key customers, including one particular major U.S. corporation in this area. During my visit, the customer emphasized the fact that the contact center is becoming more and more critical to the entire business, and that many other departments depend on what happens in the content center to make business decisions. Which makes the value of our product far more important than the traditional concept of (indiscernible).

Turning to the security business. We participated in the largest security related tradeshow for the year in September, and at this show, we confirmed our leadership, particularly in the transportation sector and the large campus environment. As I have mentioned in the past, we established a specific Homeland Security initiative that includes executives from headquarters in each operating unit (indiscernible) strategic relationships with the major companies, which will be key to benefiting from increased spending in this area.

In addition to the business we are doing for the (indiscernible) group, we also signed a seven-figure deal with a major non-U.S. law-enforcement agency for its command and control operation. I'm also pleased to report that we have recently signed a major agreement with one of the largest (inaudible) of security products in Europe, and have already received the order from them, (indiscernible) a major European airport. (indiscernible) size is getting larger and the same cycle is more unpredictable as (indiscernible) with various government agencies on Homeland Security-related opportunities.

This is having the effect of creating a certain amount of lumpiness in the revenues of the security business. We saw some of it this quarter. At the present time, there is something like 15 to 20 million worth of video, of digital video and law enforcement business pending, where we have been selected as the vendor, but the timing of the order is still open.

I will ask Lauri now to go over the financial metrics in Q3, and then we will discuss the outlook for the Q4 and beyond before taking your questions.

As usual, I will start with the revenue breakout. As you saw in the press release, product revenue was $43.7 million in Q3 versus $43.9 million in Q2 and $30.7 million in Q3 of 2002. Service revenue was $14.4 million compared with $12.4 million in Q2 and only $7.9 million in Q3 of 2002.

As a matter-of-fact, year-to-date service revenue is up 119 percent over the same period a year ago, reflecting our emphasis on leveraging our service organization. Revenue from contact centers and financial trading floors was $43.5 million, or 75 percent of total revenue. Security revenue was $14.5 million, or 25 percent of the total revenue.

The geographic breakdown in Q3 was as follows. The Americas accounted for $30.5 million, or 52.6 percent of revenue; EMEA accounted for $18.8 million, or 32.4 percent of revenue; and Asia-Pacific was $8.7 million, or 15 percent of revenue. Product gross margin improved to 62.1 percent from 60.8 percent, due mainly to a greater proportion of higher margin products in the mix.

Gross margin on services increased 26.1 percent from 16.3 percent in Q2, due mainly to a higher utilization ratio. Gross margin improvement has been a strong factor in our improved profitability. Year-to-date, we've managed to increase gross margin by more than 4 margin points versus the corresponding period of 2002.

Operating expenses, excluding restructuring charge, totaled $27.2 million, up a little from the $26.5 million we reported in Q2. The increase reflects an increase in marketing expenses related to our customer summit in August and to the largest security-related tradeshow of the year in September. Since the rules now require that the costs associated with restructuring, involuntary terminations and office closures be recorded when incurred rather than as a onetime charge, we reported just over $800,000 in such charges in Q2, and we had another $464,000 during Q3.

On a GAAP basis, we reported net income of $3.5 million, or 21 cents a share. And excluding special charges, we reported net income of $4 million, or 24 cents a share. Net operating cash flow in the third quarter was $9.8 million, again reflecting an aggressive collections effort, particularly of older receivables. DSO declined to a new record low of 73 days compared with 81 days in Q2. Cash and equivalents increased to $93.2 million at September 30.

To update you on the status of the receivables and the [Palace] group in connection with the assets we acquired, the balance is currently the subject of a binding arbitration process. The background is as follows.

We had a number of purchase price adjustment mechanisms that were specified in the original acquisition agreement. In the case of one of them, since it was anticipated that there could well be a disagreement between accounting firms, a mechanism for submitting the matter to binding arbitration was provided for in the original acquisition agreement.

This does not represent any surprise to either side, because as I said, the process was contemplated in the agreement both parties signed originally. We expect to know the outcome during the fourth quarter. If the decision were in our favor, we would expect the receivable to be paid either in Q4 or in Q1, if a decision is received toward the end of the quarter. Any amounts determined that are not in our favor would be shifted to goodwill and not impact the P&L.

Now, I will turn the call back to Haim to discuss the outlook for the remainder of the year.

In Q4, we are expecting revenue to be between 63 million and 68 million, with the size of the range relating to the number of large Homeland Security-related projects, which I mentioned earlier. It's difficult to predict the exact size and the timing of the revenue, even though in some cases, our solution has actually been selected. We expect our EPS for the year to be at least 80 cents per share on a non-GAAP basis.

Looking out towards 2004, we see a continuation of the pattern of topline growth coupled with improving gross margin, as we have been experiencing. We do expect to see some improvement in the overall business conditions next year. Beyond the impact of some improvement in the macro environment, we see a further positive impact from greater penetration of our traditional solutions in Europe by leveraging our installed base. Also, the continued proliferation of voice over IP is likely to have a positive impact again next year.

We also expect continued strong growth from the digital video business. This is likely to come from additional strategic partnerships, greater market penetration in Europe and more funds for the Homeland Security budget in the U.S. We are also looking at the prospect of some very large orders relating to public safety projects next year, both inside and outside the U.S. But at this stage, what (indiscernible) they will develop is difficult to predict.

Although the revenue from the Asia-Pacific region is relatively small, we expect continued strong growth, driven by the outsourcing market, in several areas of this region. We expect that North America will continue to be a growth engine this year, as we continue to leverage our installed base for Fortune 1000 companies with more advanced solutions.

Finally, we expect that the acceptance of our new technologies will begin to impact revenue in the second half of the year. So despite our overall optimistic view, we continue to operate in the low visibility environment, and therefore, we decided to take a step-by-step approach to 2004 and to first complete our internal planning. Overall, we are looking forward to another growth year in 2004.

Now, we would be very pleased to take your questions.

(indiscernible).

I have a few questions. First of all, regarding the revenue mix, can you explain why the service revenues were up so high this quarter, whereas the product revenue was flat? If you can, explain -- some color on that?

We always said we have a strategic target of reaching the service part to be approximately 30 percent of our business. We are moving into this direction by a combination of both maintenance contracts and the addition of professional services to the (indiscernible) of an (indiscernible) project. So many of those things now involve not only a product side, but also an integration of project management, to make a successful implementation.

The mix between them can vary from quarter to quarter. One quarter it can be slightly up or slightly higher, but overall, our strategic target is moving to move into a 30 percent (indiscernible) between products and services.

Were you basing your revenue guidance in the previous quarter on this mix?

I'm not sure that I understand the question.

Was this the expected breakdown when you gave the guidance in the previous quarter?

When we give guidance in our type of business, which is -- as I always say -- with relatively low visibility, we're taking several statistical elements into consideration and not only one particular point.

Second question. Can you give us the breakdown between -- in the security division -- between video and the rest of the business?

Video sales this quarter were $6.5 million. That means $8 million for the balance of the security business.

Going forward, can you give us a sense on the fourth quarter? Would most of the growth come from the products versus services, or in between the different segments or between the regions?

Excellent question. We expect the growth in Q4 to come basically from all the areas in the business. We see opportunities both on a regional basis in all geographies, and also opportunities for growth in all types of businesses. Whether it's in the call center market, on the product side, on the services side, in the public safety sector, the video sector. So overall, our expectation to grow in Q4 is -- I believe, what we are currently looking at -- growth in all the segments of the Company.

As I said initially, the gap between 63 and 68, which is a relatively large range, is attributable to the fact that specifically in the security area, we are involved -- and this is, say, a relatively new trend -- we are involved with some relatively large projects that the total of all of them is between 15 to $20 million. The majority of them relate to the video business, but not only. And if they will appear is not 100 percent certain. But with the exception of (indiscernible) the major growth in Q4 compared to Q3 is expected to come from all segments, markets and geographies. This is in terms of expectation, of course. Afterwards, things can vary between a different region or different type of (indiscernible).

[Witness], in their conference call, gave a guidance for a growth of 12 to 18 percent in 2004. That gives us an average of 15 percent. Is this something that you would expect to see with NICE as well? Would you expect to see your growth in the 10s, mid teens, something like that?

First of all, we made it customary not to relate to any specific company in this conference call or in any discussion with the investment community. We can only talk about NICE. Of course, everyone is expecting (indiscernible) the growth rate ;depends on which base are you starting. It's also a question of from where you start and not just an absolute number.

Overall as I mentioned before, we are expecting, and we hope to see growth. What is even more important, we hope to see the continuation of a trend that has been there for the several last quarters, of capturing market share from competition in this specific segment.

[Robert Katz], (indiscernible).

I have as few questions. For starters, where do you think your gross margins will end up, both on the product and services side? What type of guidance can you give to that?

That was the first question?

That's the first question.

We hope to continue and improve both the product and margin, as our mix of products continues to shift towards application and more and more software (indiscernible) -- or actually, to be fair, the majority of our products today have mainly software content anyway. But in terms of the application side of the solutions, we'll see more and more, and therefore, we hope to continue and improve our gross margin (indiscernible) of the mix.

We also hope to continue to leverage our service organization. We hope to see continuous growth in the service organization. Obviously, we'll have also to expand this organization, and we want to see growth. But overall, we hope to see efficiency improve also there.

And specific numbers, Lauri, if you want to refer to --?

We had given some time ago a long-term model that spoke about overall gross margins in the 58 to 60 percent range.

To get a little more granular on that, how many people do you have in your services organization now?

At the end of the quarter, it was 276.

Are you adding people in that area?

Yes, we are adding people. As I said, we are adding. But we think that some of the infrastructure that we have put in place is relatively fixed, and therefore, we can still leverage while increasing, of course, people to provide better service. But it's not necessarily in a direct relation to the growth of the business.

Looking at services revenue in the past quarter, they seem to be up. Would that be a leading indicator for product revenues, as sort of follow-on to services in the upcoming quarters? Is that a way of looking at the general health of your business?

I think as I said, we have put a strategic target of reaching the split of 37 (indiscernible) between products and services. We hope to achieve this goal in the coming quarters. It's not automatic, of course. It can be one quarter (indiscernible), another quarter can be a little bit less. But overall, if you look where we were a year ago, two years ago and where we are now, we're definitely on the road to achieving this target.

About operating expenses, what type of guidance are you looking for there? Are you keeping them flat or are they going to keep going up a little bit each quarter?

That's a good question. Overall, we have said in the past that the infrastructure that we've put in place, in terms of sales, marketing, our distribution organization, we have created a platform. By now, we have a platform that is worldwide. We have a very strong operation in America. We have now a very, very strong operation in Europe. We have started to build a Pacific operation.

So the infrastructure has been put in place, and this infrastructure can hold or can support continuous growth of business without increasing the expenses at the same rate. It doesn't mean that the expenses will not increase, but definitely not at the same rate. We are actually seeing this happening already, that we have grown the business without the same rate of increasing in expenses.

In the past quarter, how much of the revenues were turns revenue, sort of order booked within the quarter? And has there been a trend where you're getting better visibility into a quarter? And where do you stand in the current quarter?

For obvious reasons, as some of our competitors are very interested to know how we are doing -- so for this reason, we are not discussing specifically our order intake mechanism. All I can say is that, obviously, with service business growing, it improves slightly our visibility in the model. Which is good news.

But overall, as a Company, we're still (indiscernible) remain operating in a relatively low visibility model. I have been repeating this statement for the last 10 quarters or so, and this hasn't changed.

So far, we're able to make more or less what we expected, but this is not automatic. We're still operating in a relatively low visibility model. I don't see it changing dramatically. As I said, with the increase of the service business, it does improve somehow the visibility of the Company.

Would you say that your pipeline is growing faster than your revenue line?

What I can say is that it fell back to what I've said before. We are now engaged in several large projects. The total of these projects is between 15 to 20 million. All of them are in the security-related area. Most of them include a major component of video. The magnitude of this type of activity, we have not seen in the past.

Were there any 10 percent customers in the past quarter?

No, I don't think so, no.

Walter (indiscernible), Wallace Partners.

I had a question about the voice over IP product line. You said you're up to 80 customers there. Could you explain what the key factors are that are driving that part of the business?

Yes. What we are seeing is that companies in Europe and Asia, and recently also in the U.S., are starting to install voice over IP infrastructure (indiscernible) vendors. And once they do it, and as they overhaul their telecom infrastructure, of course, they are looking to renew or replace also their recording technologies. This has started over the last, I would say, few months. We have started to see a big jump in the business in this segment. -

As I said the last time, we have won the largest voice over IP recording project a few months ago. So I think that our customers start to realize the benefit of our technology. So the combination of the overall market growth and market acceptance of this technology, and the quality of our solutions, help us to increase our business in this area.

Is that one of the reasons why the Company is increasing its market share?

This can be one reason. Could be other reasons, but this is definitely a good one.

The unstructured data analysis technology -- can you give us an update on where that stands?

Yes. I can give you an update that we are making progress, and I know that many of our competitors would like to receive a very different update of where we are. And unfortunately, I will try to avoid it. So all I can say is that we are making progress and we are satisfied from the progress that we are making, and we're getting very good feedback from our direction.

Finally, the cash has continued to increase. Are there any plans, or is there any possibility of making additional acquisitions or technology purchases?

Obviously, there is a traditional answer to this type of question, so you can expect the answer to be that we never comment about these types of things. The only thing I can say is that as a Company, we had the opportunity to prove to ourselves that with the cash balance that we had, we didn't hesitate to take an opportunity and to use it to make an acquisition, that by now we feel quite confident that this is a successful acquisition. So we have taken the opportunity to use our cash position. And we will not hesitate if it's relevant and it is within our strategic plan.

[Dan Howard], (indiscernible).

This is Dan in place of [Will Manuel]. On the financial institution side that you said was strong, was that mainly due to the TCS channels, or are you seeing any improvement in the business environment there, given that the financial institutions are beginning to report (indiscernible) results themselves?

We are grouping our solutions to the enterprise world by solutions to the call center and trading floor together. In some cases, it is difficult to split the exact revenue between the trading itself, the back office (indiscernible), and in some cases, also the contact center that supports (indiscernible). In many cases, it's the same customer. But overall, of course with the TCS acquisition, (indiscernible) to say that the significant percentage of the financial (indiscernible) in the world captured today are using the NICE technology.

It's a very significant percentage of the financial call centers are using NICE technology initially for this field management and risk management, and now more and more, also for additional applications. So obviously, the presence in this part of the market helps.

And just in terms of how the environment is changing there, on the demand side?

The general IT market is continuing to be a tough market. No one sees a major jump in demand, and we're operating in the same space, of course. What I can say, which is encouraging, is that despite the relatively difficult IT environment, (indiscernible) seeing a lot of change, the value of our solutions -- even in the general IT environment or difficult environment (indiscernible) solution -- are realized by customers to improve efficiency and to provide better service. Even in difficult times, they are (indiscernible) their purchasing list of companies.

Nothing is easy of course, but the value is there, and I just quoted (indiscernible) that operates in a tough market in this country in a competitive environment. They have used our technology and they've seen how it can help them to gain market share, to improve service and improve efficiency. We see from other customers, as well.

(indiscernible)

Can you give us some update on your progress with new distribution deals in the business? Specifically, you said that you were thinking of going into the European market with your video solution?

We didn't hear you very well.

I was asking about any distribution deals in the video business, specifically in Europe. You said last quarter that you were targeting this business as well, following your successful penetration of the U.S.?

Yes, very good. We have started to see the initial signs of this focus. In addition to the one that we have established already with the Palace video operation, or secure operation, we have signed an agreement with one of the largest security integrators in Europe. This was done just recently. We already actually received the first order for one of Europe's largest airports as a result of this distribution. So we feel quite optimistic that this will lead to further business in the coming quarters.

There are no further questions at this time. Before I ask Mr. Shani to go ahead with his with closing statements, I would like to remind participants that a replay of this call is scheduled to begin in two hours time. In Canada and the U.S., please call 1-866-500-4953. In Israel, please call 03-925-5950. Internationally, call 972-3-925-5950. Mr. Shani?

Thank you again, ladies and gentlemen. We look forward to see you and talk to you again in our Q4 earnings release next year. Thank you and have a nice day.

This concludes NICE Systems' third quarter 2003 results conference call.