Most recent analyst report on 12/3/04:
(SEE PAGE THREE FOR DISCLOSURES & DISCLAIMERS)
60 South Sixth Street, 30TH Floor, Minneapolis, MN 55402 612-455-5555 800-444-7884
Chad M. Bennett (612) 455-5849; cbennett@mjsk.com December 3, 2004
Norstan, Inc. (NRRD $4.25)
BUY
MJSK – NRRD – Q2 RESULTS EXCEED EXPECTATIONS – BETTER THAN
EXPECTED MARGINS INCREASE ESTIMATES GOING FORWARD
Market Capitalization: $57.4 million
Price Target: $7.00
Price Range: $5.00 - $2.33
Shares Outstanding: 13.5 million
Daily Volume: 69,000
Institutional Ownership: 33%
Insider Ownership: 6%
Debt to Total Capital: 15%
Est. 3 – 5 Yr. Growth: 10-15%
Book Value Per Share: $1.40
Norstan is a full-service telecommunications solutions company offering new and refurbished voice and data
solutions, call center design and implementation and messaging, infrastructure conferencing and mobility
solutions.
EPS Jul Oct Jan Apr FY P/E Growth
2003A $0.00 $0.03 $0.01 ($0.08) ($0.03) NM NM
2004A ($0.15) ($0.07) $0.02 $0.09* ($0.11)* NM NM
2005E $0.08%A $0.10A $0.11 $0.14 $0.44 9.7x NM
Rev(mil) Jul Oct Jan Apr FY P/S Growth
2003A $52.1 $57.1 $58.8 $59.0 $226.9 0.25x NM
2004A $56.9 $56.4 $55.0 $57.5 $225.8 0.25x (0.5%)
2005E $54.4A $56.7A $56.0 $58.5 $225.6 0.25x 0%
Historic revenue and EPS are continuing operations, restated to exclude Consulting and Network
services. 2002 Q4 & year exclude income tax benefit of $8.9 million. EPS taxed at 39% in 2003.
% Excludes $0.01 one-time gain for sale of Norstan CDG
* Pro-forma EPS excluding restructuring and other one-time charges of $9.4 million and
assuming a 39% tax rate on earnings.
ESTIMATE CHANGES
Q305: $0.11; increased from $0.07
Q405: $0.14; increased from $0.10
FY2005: $0.44; increased from $0.32
• Q2 results ahead of expectations– EPS from continuing ops. of $0.10 exceeded our $0.06 estimate.
Revenue of $56.7 million was $1.7 million ahead of expectations.
• Gross margin eclipses 30% and reaches highest level in two years. Resale and Solution/Services
gross margin showed solid increases both yr/yr and sequentially.
• Guidance for FY05 – Business pipeline and opportunities continuing to improve. New strategic
focus should continue to drive higher profitability going forward.
• Raising FY05 estimates reflecting higher than expected margins. FY05 EPS increased to $0.44
from $0.32.
Norstan, Inc. Page 2 Miller Johnson Steichen Kinnard
• Reiterate BUY – Management continues to improve profitability, pay down debt, and increase
cash. Future top-line growth is dependent upon the company’s participation in its existing and
new customer transition to rapidly growing VOIP products. Norstan has reported four
consecutive quarters of solid profitability. We believe the market will begin to value the stock
based on sustainable earnings growth or P/E multiple from distressed private company type
valuations based on enterprise value/cash flow. With margins and earnings improvements, we
believe the stock can trade closer to historical cyclical growth P/E multiples in the mid-teens
multiple on forward earnings. At 16x FY05 fully taxed EPS of $0.44 we are raising our price
target to $7. We note the stock is still trading at less than 4x EV/EBITDA. Even if we remain
consistent with our previous valuation method of 5.5x EV/EBITDA valuation, our price target
would still increase to $7 price target. A comparable group of business services peers carry P/E
multiples in the low 20x.
SECOND QUARTER RESULTS
Norstan reported second quarter revenues of $56.7 million, up 4.2% sequentially. Revenue exceeded our estimate of $55.0 million
driven primarily by outperformance of the company’s Resale segment due to the termination of the company’s resale alliance with
Siemens. The terminated alliance resulted in Norstan Resale recognizing 100% of the sales instead of 50%. Resale revenue of $9
million was $1 million above expectations. Communications Solutions & Services revenue of $47.6 million was $700k above our
expectations, but focus on a more profitable customer base and selling efficiencies resulted in a 130 basis point sequential
improvement in gross margin to 30.0% and up from 27.4% a year ago. Communications Solutions & Service revenue consisted of
$27.8 million of Services and $19.8 million of Solutions. Services revenue was flat sequentially, while Solutions revenue
increased 10% sequentially. Solutions gross margin increased to 22.3% from 20.1% last quarter, and 19.8% last year. Solution
gross margin improvement was primarily due to management’s focus on more profitable business in the company’s existing
Siemen’s installed base. The company has directed roughly 20% of its sales force to focus on upgrading its Siemens circuit
switched PBX base to Siemen’s IP enabled HiPath offering. Norstan has only converted 3% of its existing Siemens installed base
to this product and is targeting 10% annual conversion going forward with its renewed sales focus. With Siemens being the most
business of all of its equipment partners, we believe Solution gross margin could trend into the upper 20% range. Services gross
margin increased to 34.2% from 33.2% last quarter, and 32.4% last year. Operating expenses increased $1 million sequentially as
a result of the reorganization of the resale business that shifted expenses from COGS to operating line items. Norstan reported
operating income of $2.9 million, or 5.1% operating margin, continuing the company’s trend of improved q/q operating
profitability. As a result, the company’s EPS from continuing operations of $0.10 (taxed @ 38%) beating our $0.06 estimate. The
company generated $4.5 million of EBITDA, which was up sequentially.
The balance sheet showed solid improvement. Cash improved to $5.9 million from $4.5 million. Total debt decreased by $1.6
million to $18.4 million. Debt to Total Capital decreased to 15.6% from 16.7%.
We believe the company could potentially reduce its existing debt expense with its annual review coming up this month. Last
December the company entered into a new five-year $27.5 million bank agreement with Wells Fargo Foothill consisting of a $5
million revolving line of credit and a $22.5 million term loan. The company is currently paying 350 basis points above prime. We
believe Norstan’s substantial financial improvement over the last year could result in a 100-200 basis point reduction in its cost of
debt, resulting in between $200-$300k cost savings annually.
The company did not provide any forward guidance other than to say the change in strategic focus may result in lower revenues,
but deliver higher profitability in FY05 than in FY04. We are raising our FY05 EPS estimate to $0.44 from $0.32 partly due to the
outperformance in the quarter, slightly higher margin assumptions, and a roughly $3 million increase in revenue.
REITERATE BUY
Management continues to improve profitability, pay down debt, and increase cash. Future top-line growth is dependent upon the
company’s participation in its existing and new customer transition to rapidly growing VOIP products. Norstan has reported four
consecutive quarters of solid profitability. We believe the market will begin to value the stock based on sustainable earnings
growth or P/E multiple from distressed private company type valuations based on enterprise value/cash flow. With margins and
earnings improvements, we believe the stock can trade closer to historical cyclical growth P/E multiples in the mid-teens multiple
on forward earnings. At 16x FY05 fully taxed EPS of $0.44 we are raising our price target to $7. We note the stock is still trading
at less than 4x EV/EBITDA. Even if we remain consistent with our previous valuation method of 5.5x EV/EBITDA valuation, our
price target would still increase to $7 price target. A comparable group of business services peers carry P/E multiples in the low
20x.
Norstan, Inc. Page 3 Miller Johnson Steichen Kinnard
ANALYST CERTIFICATION
I, Chad Bennett, hereby certify that the views expressed in this research report accurately reflect my personal views about the
subject securities and issuer. Additionally, no part of my compensation was, is, or will be directly or indirectly related to the
specific recommendations or views contained in this research report.
VALUATION METHODOLOGY FOR PRICE TARGET
Our $7 price target is based on 16x our FY05 EPS estimate. By stringing together four consecutive quarters of solid profitability
we believe the market will begin to value the stock based on sustainable earnings growth or P/E multiple rather than distressed
private company or deep value based valuations that are predicated on enterprise value/cash flow. With margins and earnings
improvements, we believe the stock can trade closer to historical cyclical growth P/E multiples in the mid-teens multiple on
forward earnings. At 16x FY05 fully taxed EPS of $0.44 we are raising our price target to $7. We note the stock is still trading at
less than 4x EV/EBITDA. Even if we remain consistent with our previous valuation method of 5.5x EV/EBITDA valuation, our
price target would still increase to $7 price target. A comparable group of business services peers carry P/E multiples in the low
20x.
MAJOR RISKS TO ACHIEVEMENT OF PRICE TARGET
• Norstan’s business is largely dependent upon overall spending levels associated with IT budgets. Our FY04 estimate
assumes some improvement in IT spending.
• Norstan is largely dependent on partners for next generation product and solutions to enter into growth markets.
• Despite significant balance sheet improvement, Norstan remains a highly leveraged company and any further
deterioration in its business may adversely affect its overall financial condition.
• Readers should recognize that the risks outlined above do not represent a comprehensive list of all risk factors that may
impact price target achievement. |
