Ness Technologies Inc Q3 2008 Earnings Call Transcript

Nov. 3.08 | About: Ness Technologies, (NSTC)

Ness Technologies Inc (NASDAQ:NSTC)

Q3 2008 Earnings Conference

Nov 3, 2008 8:30 am ET

Executives

Sachi Gerlitz - President and Chief Executive Officer

Ofer Segev - Executive Vice President and Chief Financial Officer

Drew Wright - Investor Relations

Analysts

Mark Vitovitch - Piper Jaffray

Devang Kothari - JMP Securities

Ziv Tal - Oscar Gruss

George Milos - MKH Management

Moshe Katri - Cowen & Co.

James Friedman - SIG

Operator

Good morning. My name is Crystal and I will be your conference operator today. At this time I would like to welcome everyone to the Ness Technologies third quarter conference call. (Operator Instructions) I would now like to turn the conference over to Mr. Drew Wright of Ness Technologies Investor Relations. Please go ahead, sir.

Drew Wright

Thank you, Crystal. Good morning everyone and welcome to the Ness Technologies third quarter 2008 earnings call in which we’ll discuss our results for the quarter ended September 30, 2008. First our Safe Harbor statements.

Except for historical matters discussed herein, the matters discussed on today’s earnings call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are often preceded by words such as believes, expects, may, anticipates, plans, intends, assumes, will or similar expressions.

Forward-looking statements are based on management’s current expectations and beliefs about future events as of the date of this conference call and can involve certain risks and uncertainties. As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances and Ness’s actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors.

Some of the factors that could cause future results to materially differ from recent results of those projected in forward-looking statements are the risk factors described in Ness’s annual report on Form 10-K filed with the Securities and Exchange Commission on March 17, 2008. Ness is under no obligation to and expressly disclaims any obligation to update or alter its forward-looking statements whether as a result of such changes, new information, subsequent events or otherwise.

The audio from today’s call is being webcast live on the internet. A replay of the call will be available online at the Ness Technologies website www.Ness.com under Investor Relations. Also available on the Ness Investor Relations website are today’s press release and related 8-K filing.

Our call today will be led by Mr. Sachi Gerlitz, President, and CEO; and by Mr. Ofer Segev, Executive Vice President, and CFO. Sachi, please tell us about the quarter.

Sachi Gerlitz

Good morning. We had a very good quarter despite the world economic storm. This is the outcome of two important achievements: first, cashing in on our SAP transaction when we did; and second, to successfully address several business units that needed attention in prior quarter; third, regarding SAP, in August we closed the previously announced sale of our Israeli SAP license sales and distribution division to SAPAG. Especially considering what the software industry is experiencing now, our timing and the value we realized from this deal were excellent.

You should know that despite the downturn in the software industry, our SAP system integration business remains strong. Second, we significantly improved operation in our India unit, increasing operation margins for software product less business from 4% in the first quarter to 7.7% in the second quarter and to 11.7% in Q3. Third, we improved our Technology & Systems Group’s or TSG’s operating margins from 6.3% in the second quarter to 14.2% in Q3, even though the shekel remained very strong against the dollar throughout the quarter.

Fourth, we’re continuing to do well in Ness Israel where we have achieved a substantial improvement in the operating margins versus prior year. Fifth, we’ve been growing revenue strongly in central and Eastern Europe with continuing to notch up operating margin and finally we’ve now generated positive cash flow for five consecutive quarters, a very significant record for Ness. In the first nine months of 2008, we have generated over $18 million of operating cash compared to the first nine months average of $95 million over the five prior years.

We’re not immune to the macroeconomic situation, of course, but through good planning and some luck, Ness has been less affected than many others and we delivered a very solid quarter. This is due in part to our low concentration of US revenue combined with the fact that much of our US revenue comes from client software R&D spending rather than discretionary IT spending and fortunately, none of the banking or insurance firms in the news over the past weeks are amongst our customers.

We did, however experience a slowdown in the 4% of our revenue that comes from the US financial services sector and the 8% of revenue that comes from our NessPro distribution service line. We’ll explain how this affects us and what we are doing about it. Bottom-line our core business is doing well and we believe we‘ll continue to grow in 2009 despite the economy.

As we believe in Ness’s long-term prospects for growth and considering our ongoing commitment to increased shareholder value, the board has just approved a share repurchase program. Since everyone’s eye is on the detail, I have asked Ofer to take you through the numbers first. Then he will turn it back over to me. Ofer, please.

Ofer Segev

Thanks, Sachi. Good morning, everyone. During the call today, I’ll refer continually to non-GAAP numbers. To help you understand the performance of the company, today’s earnings press release contains standard non-GAAP reconciliation table that excludes the net gain from our SAP sale and other charges net of taxes. The non-GAAP analysis also excludes two recurring non-cash items that always appear in our non-GAAP tables, stock-based compensation expenses, and amortization of intangible assets net of value.

Total revenues for the third quarter were $164.1 million. On a non-GAAP basis, third-quarter revenues were $167.3 million, up 21% compared to $138.7 million in the third quarter of ‘07, while organic year-over-year revenue growth was 18%. Backlog at the end of the quarter was $764 million, up 14% year-over-year despite the fact that the stronger dollar reduced our September 30 non-dollar backlog by about $30 million during the Q3 period.

Revenue by customer geographic region for the quarter were Europe 34%, Israel 33%, North America 28%, and the rest of the world 5%. Gross profit for the quarter was $43.2 million. On a non-GAAP basis, gross profit was $46.3 million or 27.7% of revenue compared to $39 million or 28.1% of revenues in the third quarter of last year. This shows that we were able to maintain our gross margin almost flat despite lower-than-expected high margin software sales through improvements in the gross margin of our core service business.

Operating income for the quarter was $23.1 million. On a non-GAAP basis, operating income was $12.4 million or 7.4% of revenue, up 20% compared to $10.3 million or 7.4% of revenues in Q3 last year. EBITDA for the quarter was $27.9 million. On a non-GAAP basis, EBITDA was $15.2 million or 9.1% of revenues up 22% from $12.5 million or 9% of revenues in the third quarter of last year.

We had financial expenses of $1.2 million in the quarter compared to financial income of $100,000 in the third quarter of last year. These financial expenses are primarily due to interest expenses on the long-term loans we took for prior acquisitions. Our tax rate in the quarter was approximately 25% above our normal range due to taxes on the operating gain from the SAP sale. If the net gain and other charges had not been recognized in the quarter, our effective tax rate would have been approximately 21.4%.

Quarterly GAAP net income was $16.1 million. On a non-GAAP basis, net income was $9.4 million, up 10% compared to $8.5 million in the third quarter of last year. Quarterly GAAP earnings per diluted share were $0.41. On a non-GAAP basis, diluted EPS was $0.24 compared to $0.22 in the third quarter last year.

At the end of the quarter, cash, and cash equivalents, restricted cash and short-term deposits were $81.7 million compared to $46.1 million at year-end and on top of that, we have excess to over $70 million remaining in our credit facility. We have about $18 million of short-term debt and about $71 million of long-term debt, of which about $10 million is due before the end of 2009.

Most of the long-term debt is five year long taking over the last year to fund acquisitions. These long-term loans typically have fixed interest rates in the range of 5% to 7% and a two-year grace period. Bottom line we are in our comfort zone regarding liquidity.

Credit receivables were $182.9 million compared to $194.9 million in June 30, while unbilled receivables short and long term were $59.7 million, down $600,000 sequentially. Unbilled receivables as a percentage of total trade receivables were 25% at the end of the quarter, flat year-over-year.

Day sales outstanding as of September 30 was 81 days compared to 84 days a year ago and 84 days at the end of the second quarter. Remember that in calculating DSOs, we exclude VAT and software vendor pass through from our trade receivables since these amounts do not represent revenues for Ness. We continue to focus on improving our DSOs going forward. We target DSO to be between 70 to 80 days.

We delivered operating cash flow of $3.5 billion in the quarter. At the end of the quarter, we experienced a delay in payments from quite a few customers, mainly public companies until after September 30, but we collected about $6 million more of AR in the first 10 days of this quarter than we normally collect in any quarter. We will continue to push our positive operating cash flows every quarter.

Now I’ll give you a quick summary of our segment results. As Sachi mentioned, our core business; Ness SPL, Ness Europe, TSG and Ness Israel did well in Q3. Ness North America delivered a combined operating margin of 10.6% with a year-over-year organic revenue growth of 20%.

Our Software Product Labs business or SPL, which makes up 78% of Ness North America, delivered margin of 11.7% and year-over-year organic revenue growth of 32%. The remainder of Ness North America, which is local system integration business, has been steadily improving operating margin quarter-by-quarter under strong management turning in margin of 6.2% in Q3.

Ness Europe grew revenue 36% year-over-year and operating income by 61% year-over-year and in spite of its seasonally weak summer vacation quarter turning in a margin of 9.8%. TSG. Our Defense and Homeland Security business grew revenue by 2% year-over-year and exceeded our expectation with an operating margin of 14.2% despite the continued strength of the Israeli shekel against the dollar.

Ness Israel, our commercial and public sector business in Israel, grew revenue by 6% year-over-year on a non-GAAP basis, despite the two business units we spun out also this year. Excluding the operating gain from our SAP sale, Ness Israel achieved a margin of 7.3%, which is quite impressive when you realize that (a) the Israeli portion of our NessPro Software License Distribution business suffered the same slowdown as our global NessPro business, and (b) we didn’t receive up to $1.5 million of potential off deal commissions from SAP or about $0.03 to EPS attributable to Q3.

These commissions are amounts payable to us by SAP through the end of 2009 following their purchase of our SAP sales and distribution division. The commissions are contingent on sales of licenses by our former license sales team and are available only following the end of each calendar year. At the time of the sale, we estimated the commission to be about EUR1 million or $1.5 million per quarter.

Considering the news from SAP recently, we recognize the commissions when they are actually paid. The dollar amount to be recognized is also subject to currency fluctuations of course. The two parts of our business that were affected in Q3 by the economic slowdown are Ness IBS, our US based financial services group and NessPro, our Software License Distribution group. Both of these are in our other segment, which significantly underperformed in Q3 with an operating loss of $300,000 instead of the planned healthy profit.

Before we go to guidance, I’d like to mention one more point about our balance sheet. Under Israeli law, we must provide severance for all our employees in Israel. We fund the severance through monthly deposits and externally managed funds invested mostly in conservative investments such as government and corporate bonds. Any net changes between the severance liability and the correspondence asset affect our balance sheet and therefore our operating results.

Due to the capital market meltdown, these externally managed funds lost value in October, because we can’t predict the year end value of the assets, we have no visibility into the need for a possible future, non cash adjustment on our income statement.

Now let’s talk about guidance. Since Sachi and I came in on board, our earnings releases have included quarterly supplemental results on a non-GAAP basis, excluding stock based compensation, amortization expenses and any onetime gains or losses. This has been important to understand the core performance of the company, especially given the non-cash intangible amortization charges that appear on our income statement in the quarters following each acquisition.

In light of this and the unpredictable severance pay fund situation, we’re going to give our guidance on a non-GAAP basis from this point forward. Based on feedback we’ve received from analysts and investors, this will make our performance easier to track and put us on equal footing with other companies in our sector.

To compute our guidance, we do take a conservative approach to our whole business, specifically discounting several items including taking a conservative position on the growth and earnings of our NessPro Software Distribution business and our US financial services system integration business, which both have reduced visibility now and not including the potential commissions earned from SAP about $0.06 for 2008 until they are actually received. Our guidance for the remainder of 2008 is a non-GAAP diluted net earnings per share of $0.24 to $0.31 and revenues of $175 million to $185 million.

That concludes the financial overview. Back to you, Sachi.

Sachi Gerlitz

Thank you, Ofer. Good explanation. Now that you’ve had a look at the numbers, let’s see what it all means. The bottom line is that our core business did well in the third quarter and we believe that it will continue to exhibit good fundamentals. We underperformed in two of our smaller business units, both parts of our other segment, together representing about 12% of our revenues and we’re taking steps to adjust them now.

Let me give you a few business highlights from the quarter and I’ll comment on the macroeconomic environment in each geography as we go. In Europe, which is 90% Central/Eastern for us, we’re doing well. The world economic crisis is beginning to be felt there, especially in Hungary, but our pipeline still feels okay, even in the financial services verticals.

We had over 20 new wins in Europe in Q3, eight of which were $1 million plus, so such clients are Surf, Telefonica O2, Chase, Comercia Bank, Valdeve Poxey and others. Several of these are SAP implementation, including an almost $10 million SAP implementation with Jabes in Slovakia.

One of our recently completed projects, the Free Cadesa Portal, won best IT Project of the Year in Slovakia. I’d like to remind you that at the beginning of October we closed our previously announced acquisition of Logos in the Czech Republic. With this acquisition we believe we are now the number one IT services provider in the Czech Republic and let me take this opportunity once again to welcome our Logos employees to the Ness family.

In Israel the economy is feeling some effect from the worldwide financial crisis, though the primary effect for Ness Israel is NessPro Israel Software Distribution business. Our commercial business in Israel delivered key milestones on a number of engagements, one of which won the Champion of the Champions, Best Internet Site of the Year Award in 2008 Israeli Webby Awards competition. We also had several new wins, including nice outsourcing deals for Texas Instruments and we had several project extensions, including one for our Next Generation electronic core system.

TSG, our Defense and Homeland Security business came through strongly in Q3 with excellent execution and very good operating margin recovery. TSG is feeling the effects of the economy less than the other business units. In fact, it’s possible that some additional international opportunities may be opened for us now.

We had a number of new wins this quarter and our pipeline is quite healthy. We won a contract for unmanned aerial vehicle command and control center recording systems and a tender for a fighter jet cockpit based intelligence system. We completed a major deliverable in an air defense command and control system for a foreign air force and received a memo for a large upgrade from the same customer and we’re doing well on the development of the large command and control system we announced a few months ago.

In our Software Product Labs business, the pipeline feels healthy, but we’re being watchful. One of our clients has experienced a slowdown based on their on-clients exposure to the financial services verticals and several longer-term labs have slowed or stopped growth until the economy perks up; in some cases even asking us not to replace attrition.

On the other hand, we signed four new labs during Q3, a multiyear multimillion dollar agreement with GS1 you hit and a supply chain solution and worldwide barcode standard organization for a Ness lab in India, which we won against a field of 15 competitors.

A multimillion-dollar engagement with XEGO System, which specialized in virtualization solutions for large data centers foreign Indian labs. An engagement for a well-known U.S. based mobile assistance and application service provider to provide engineering customization services from India and the US which we won against Accenture, IBM and Capgemini and we also won a SPL business for Eastern European delivery, including a lab for a leading UK company in the sales automation solution.

All told, we have over 50 software product lists. We have also had a good headcount growth in Europe in our newer larger labs meeting or exceeding planned ramp up rates and we’ve been able to increase some of our billing rates.

In our US-based system integration business, which includes our US financial services vertical and our US life science and health care verticals, we’re working as quickly as possible to adjust to the new economy reality. We have hired a senior sales focused executive as the President of the combined US-based Systems Integration business, Larry Scott, who served at a senior executive role at Sun Microsystems, Cambridge Technology Partners, CSC Consulting and others, has been with us since September 3 and is already making a difference.

We are consolidating under large leadership the non-SPL part of Ness North America with Ness by BS, so that all our US System Integration business and $80 million business unit, will be under common management, and we will be happy to realize the important synergies in sales, delivery and back office operations. The combined group will cover the life science, health care and commercial vertical, as well as the financial services. This new unit will be called Ness Global Industries.

The life science and commercial part of the business is well in Q3, clearly benefiting from the 85 to 90 low margin software implementation provisions, we eliminated in the first half of the year. In the quarter we had a couple of nice million dollar plus wins, at Genworth and at Cushman & Wakefield.

Backlog for the non-financial services part of this business unit is growing nicely, despite a more challenging pipeline and we are continuing to convert former staffing customers to solutions accounts. Ness APAC, our systems integration business in Asia-Pacific, did well in Q3, achieving an operating margin of at or above the Company average. Our decision to reduce about 100 low margin staff system implementation positions in the first half of the year was a good one.

We are feeling the economic slowdown in Asia-Pacific, especially in Singapore, and as a result, we’re beginning to diversify away from financial services customers. We’ve significantly expanded our Oracle applications business in APAC so that it is now 40% to 45% of that business. We added six new customers this quarter including the ninth Oracle Apps win for a major technology provider in the hospitality industry.

Our headcount increased to 7965 in the third quarter. Our percentage of billable employees remains about 87%. In India we ramped down some employees due to the slowdown in our US financial services pipeline, which is delivered from India. In addition as I mentioned, a small number of SPL clients reduced growth or choose not to replace attrition. We anticipated that our headcount growth in India in Q4 will be modest, although our Indian operation improvement manufactured itself in SPL’s good results.

Marketing activities in the quarter included being named in the 2008 InformationWeek 500 List, an annual ranking of the 500 most innovative users of business technology in the United States. We were included in the International Association of our Staffing Professionals.

Global outsourcing hundred, chartered in two categories including in the 20 best companies offering product research and development. We were named Software Magazines, Software 500 Ranking of the World’s Largest Software and Services Provider for the fourth year.

We unveiled a new major release of our Financial Data Enterprise product at the FEMA Asia show in Singapore. We’re ranked by Dataquest-IDC in the Top 20 Best IT Employers in India based on the survey of employees across the Indian IT sector and we advance six places to the 11th place in the company Image category since last year.

We took the first position in Dun & Bradstreet 2008 Israeli Computer Services and IT Outsourcing ranking and we were rated as one of the 10 Most Attractive High-Tech Employers in Israel by the Israel Globe Newspaper in partnership with all jobs, based on a survey of employees and job seekers.

So how are we doing overall? We feel that we have been smart and lucky, as a result of which our core business did well in Q3. We believe that we are not as badly affected by the macroeconomic situation as many others. We do have a couple of problem areas which we are working quickly to improve.

It is possible that the world economic situation could significantly worsen, affecting all geographies and verticals; in that case we would be affected, too. We hope that this doesn’t happen, but to be conservative and realistic, we’re now assuming that our top-line growth into 2009 will be in the 5% to 10% range rather than in the 10% to 15% range we previously articulated. In other words, we still believe that 2009 will be a growth year.

Despite the solid performance of our core business in these uncertain times, our stock price has taken a beating as global financial markets have retreated. Our Board has decided to take advantage of this. They approved a stock buyback plan which will allow us to repurchase up to 4 million shares of stock for about 10% of the outstanding shares over the next 12 months. Please refer to this morning’s press release for all the details.

Before we go to Q-and-A, I want to let you all know that we will be hosting an Analyst & Investor Day in New York on the morning of Friday, November 23. We will have the President of four of our segments, along with several customer speakers. Our goal for the event is to give you a detailed look under the hood. We hope you all join us there.

We are proud of the solid quarter we delivered in such uncertain times and we plan to continue running the business as well as we can. Thank you to our over 8300 in 18 countries for your continuing hard work and commitment day and night, we couldn’t do it without you. That concludes our prepared remarks. Crystal, lets take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Marostica - Piper Jaffray.

Mark Vitovitch – Piper Jaffray

It is actually Mark Vitovitch for Mark Marostica. I just had two questions. As it relates to deferred revenue, can you remind us again how you account for that line item and also explain the sequential drop that we saw in Q3 and then, secondly can you elaborate on the visibility both in your R&D and discretionary segments of your business and specifically if you have seen any cancellations or delays; specifically in the R&D side? Thanks.

Ofer Segev

So, on the deferred revenue, the drop is mostly due -- probably I don’t have the exact number in front of me, but mostly due to the SAP sales because this is where we have the prepaid maintenance revenue, and this was taking off when they purchased the unit. Regarding visibility on the SPL business, the R&D we did not see any significant or I would say any change in the third quarter. We didn’t have any cancellations, we booked new deal and actually we believe that this turndown of the economy is probably a good opportunity for us as this offering is an incentive offering.

Mark Vitovitch – Piper Jaffray

Okay. Just on the deferred revenue side, can you just quantify the SAP impact?

Ofer Segev

Well, I will have to get back to you. It’s probably close to $3 million, but I don’t have the exact number in front of me.

Mark Vitovitch – Piper Jaffray

Okay and excluding that then can you be a little more specific as to what accounted for the sequential drop?

Ofer Segev

That is probably just the timing of prepaid or advances from customers that we get and we start to utilize on projects. Apart from the software maintenance, most what you see there is really advances from customers.

Mark Vitovitch – Piper Jaffray

Okay and just one final question; you mentioned $6 million - you collected quarter-to-date from prior from Q3 deals, can you just quantify what concentration that $6 million is of, what you have outstanding in terms of collections for Q3?

Ofer Segev

Well, again we saw from many public companies that want to look better on the balance sheet at the end of the quarter, just paying a few days after the quarter. So again, the $6 million is on top of what we really collect. Just the average difference above the normal collection, the first 10 days after any quarter, which actually I think it shows that we don’t really have any collection problems. It is just that some people are trying to play the number to get on the balance sheet.

Operator

Your next question comes from the line Devang Kothari - JMP Securities.

Devang Kothari – JMP Securities

Actually, it’s Devang Kothari from JMP Securities. So, a couple of questions on the guidance and I understand there’s a few moving parts here given the SAP divestiture that you had, but given that you’re going from a GAAP EPS guidance to a non-GAAP EPS guidance. Could you give us a feel for how much of the reduction in guidance is because of the weakness that you are seeing in a couple of the divisions and how much of it is just a function of taking out amortization and stock-based compensation and things of that sort?

Ofer Segev

I would say that there are three parts to it. Their amortization and their stock option is about 6% or 7% in Q4. Then the software distribution business, which includes the SAP commission, is the biggest part. That is probably somewhere close to $0.10 and then the small part probably $0.03, something around that, is the financial services piece.

Devang Kothari – JMP Securities

Okay. So, if I was to look at your non-GAAP guidance, if I ignore everything related to the SAP divestiture, I can add back $0.06 or $0.07 because of the amortization and stock-based compensation, and then when we’re doing the apples-to-apples comparison, the reduction in guidance is $0.03 because of the weakness; is that accurate?

Ofer Segev

Yes.

Devang Kothari – JMP Securities

Okay great and then my second question is around the Software Labs business in India, and I noticed that you had some leadership changes there. I just wanted to get an update on where you are in terms of finding a permanent replacement for the head in the US for the Software Labs business.

Ofer Segev

First, I would like to thank Holly Ripley-Boyd who is running this division at this point in time and doing an excellent job as we see in the performance. We see the improvements in the performance of SPL, and as I said, it is a very strategic part for us. We believe that this is a defensive offering that is very good for this downturn of the economy.

As we saw, we had a major improvement in India that is mostly attributed to the SPL business, and we are running a profit. Hopefully, we will be able to conclude it soon and let the street know for assigning a replacement for all leaks in the SPL division. As well as that we’re in the process of appointing a permanent head of Ness India to replace Doug that is positioned there and doing a great job.

Devang Kothari – JMP Securities

Okay. Would you expect these announcements to come in Q4?

Sachi Gerlitz

You know how these things are going; I would prefer to announce when the time is right.

Operator

Your next question comes from Manish Hemrajani - Oppenheimer.

Manish Hemrajani - Oppenheimer

Two questions if I may. Can you talk more about SPL margins and how much higher do you think they can go short term versus long term?

Sachi Gerlitz

I think we always said that the long-term target for the SPL division is 15%. I think, the short term, it should get to closer to 13% probably next year and again, to go from the 13% to the 15%, we just have to be a little bit bigger there to take advantage of the fixed costs but I’d say that after this quarter, I’m pretty confident that we can get to the 15%.

Manish Hemrajani - Oppenheimer

Okay and a question on Logos in the quarter and can you also throw some light on the Eastern Europe environment?

Sachi Gerlitz

Well, Logos did not do anything in Q3. We closed the deal October 1.

Manish Hemrajani – Oppenheimer

Okay. This quarter?

Sachi Gerlitz

Yes. Then what was it, Eastern Europe?

Manish Hemrajani – Oppenheimer

Yes.

Sachi Gerlitz

Well, Eastern Europe, we are in four countries, and I would say that the place where we see the riskier environment in Hungary. Although our business there, which is a company we acquired exactly a year ago, is actually doing very well, very well. In the other places that we operate, the Czech Republic and Slovakia, probably in decent Czech rather than Romania, but we are currently looking at it on a daily basis. We don’t believe we can command the growth that we saw the first six months of the year, but we believe we can continue to grow.

Manish Hemrajani – Oppenheimer

Got it. On the FX side, what level of Shekel are you assuming in your guidance, and can you also remind us again on the impact of the Shekel movement on your EPS?

Ofer Segev

Okay. So first, Q3 was very similar to Q2 on an average of the Shekel versus the dollar. It is the Shekel is weakening against the dollar over the last month or so. It is really not that significant, and actually over the last few days, it has started to retreat a little bit. Our guidance assumed I think around 3.6 Shekel to dollar versus I think it was 3.4 or 9 in Q3. So it is a slight improvement, but not a real major one.

Where we are affected clearly is the TSG business. Here the dollar is getting stronger. We’re doing better on margin and, of course, operating profits. On an overall the dollar versus the Shekel, that is three on the operating margin. We said I think at the beginning of the year, it’s about 50 or 60 points negative effect.

Manish Hemrajani – Oppenheimer

Yeah and you also said in the past that you’re looking at year-over-year improvement about 8,200 basis points for next year. Now given that’s your guidance you’re looking at 5% to 10% growth for next year, where do you see operating margin coming in next year?

Ofer Segev

I think it is a little bit too early to give the exact numbers, because we are just in the early process of detailed planning for next year but my guess is that it will be lower improvement than we expected, just because the growth is lower, and the environment is tougher but I think we will improve on our margin from ‘08 to ‘09.

Operator

(Operator Instructions) Your next question comes from Ziv Tal - Oscar Gruss.

Ziv Tal - Oscar Gruss

Can you elaborate a little on your cash buyback? What was the reason behind it? I mean entering quite a challenging 2009?

Ofer Segev

Well, I think our cash position is pretty good. If you look at our balance sheet alone over the last few quarters, we still have pretty decent access to capital here in Israel. We don't see. We have not seen any of the stuff that other companies see mainly in the US and Europe and we generate cash. So, basically if you look at our plan, in size, it is very similar to what we generate free cash flow on an annual basis. So we felt that giving the stock price, currently this was probably a good time to do the split.

Operator

Your next question comes from the line of James Friedman - SIG.

James Friedman – SIG

Okay, thanks. Sachi, could you repeat what you were saying about the headcount in Ness North America, Ness India specifically?

Sachi Gerlitz

I think there are two different segments. In Ness India what we are -- what we saw is two moving parts. On one hand, we show as planned or even better than planned growth on the largest, newest SPL labs that we have created mostly during 2008 or the latter part of 2007.

The other moving part is that for some other customers easier that our exposed to financial services and these customers did experience some reduction of headcount or other customers that has reduced their growth plans or ask us not to replace attrition until the economy perks up. All in all, we anticipate for Q4 a modest growth on our billable headcount in India.

In the US we, at the beginning of the year, the first half of the year, we had reduced some low margin stuff supplementation position, and we believe that we will be addressing the onsite component of the business mostly with regards to financial services in Q4.

James Friedman – SIG

Okay. That makes sense. So, you are essentially taking a higher percentage of the headcount and costs offshore. You occasionally give a metric about headcount in India. If you could refresh us as to what that was in the Q3?

Sachi Gerlitz

Q3, our billable headcount in India grew short of 100 people. I think like 80 or something like that.

James Friedman – SIG

That is helpful. Thank you and then with regard to Ness Israel, the company has been public now for four some-odd years. Historically, well I guess there’s no clear pattern, but the Q3 in Ness Israel historically has been up in revenue relative to the Q2, at least two of those three-quarters. This quarter it came down and I'm trying to understand was that due to the SAP sale or something more profound?

Sachi Gerlitz

It is mostly the SAP, and the other part is the other Software Distribution. Basically we led the Software Distribution business; mainly of course, the SAP, which we did not have half of the quarter, which is usually the strongest part of the quarter.

James Friedman – SIG

So, when you were saying in your comments that there is $1.5 million or $2 million related to that SAP business, I thought you were talking about the operating income. What would be the associated revenue?

Ofer Segev

No, no. It is a little bit complicated I agree but so we sold the SAP, so it is off our P&L as of August of this year. That is total revenue that was gone out. It is probably, I don’t know, $3 million or $4 million at least, maybe a little bit more than that and then it is the commission that we are about to get from SAP, which affects our operating margin, our operating income not sales. So the number I referred to, the $1.5 million, this is just the commissions from SAP, which we’d probably do not show as revenue. We probably show as a deduction of expenses.

James Friedman – SIG

Okay. So just to recap, because I think this is important, how much of the sequential decline in revenue in Ness Israel, which went from 52 to 45.7, how much in your mind was related to the sale of SAP Israel?

Ofer Segev

I think most of it.

Operator

(Operator Instructions) Your next question comes from Avishai Kantor - Cowen & Company.

Moshe Katri - Cowen & Co.

Given the fact that the elections in Israel will be taking place in a couple of months, will that in your view delay anything related to funding of projects that are related to the public sector side, and will that impact '09 in any way? Thanks.

Sachi Gerlitz

You know how it works in Israel, actually we are in a very interesting situation in Israel because there is no budget approved for '09 yet and because we have this interim government and there is no budget, the law says that they take 2008 budget and divide it by 12, and the government is allowed to spend every month 1/12 of the budget.

So, in essence, there is no reduction in budget from 2008, and there is no increase in budget from 2008.

Looking at the timing, probably we will not have a new budget before May of next year if everything works well. So I don’t think there is going to be a big change either direction during that time.

Moshe, our concentration on the public sector in new bids, from the time we started in this campaign of bettering the revenue and focusing on higher margin has reduced. So I would not attribute too much in our predictions for the next year to the election and the ramification of the budget approval.

Moshe Katri – Cowen & Co.

Okay and then given some of the delays that you have seen during the quarter, is there any way to kind of give us a feel on visibility, maybe looking one quarter ahead, maybe two quarters ahead today versus your typical visibility? You know, looking at a December quarter, you have 95% of your guidance kind of booked here, or the visibility, is that significantly below where it is historically?

Sachi Gerlitz

Let me address the issue of visibility. Predominately we're talking about two different lines of business. The Software Services that practically we have not lost any of the visibility to it. What we had in the past, this is the same visibility that we have now.

And the other line of service is the Software Distribution. Typically the Software Distribution sales are happening in the very last week, sometimes days of the quarter. Always this business had lower visibility because of this nature. There's no backlog to this kind of business but historically we have experienced, we have created some capability to have a good prediction.

Following the downturn of the economy, it is very difficult to predict this time what this sector will do as we had the major difficulty of this sector by the end of Q3. So for that part of the business, we prefer not to address the visibility issue.

Operator

Your next question comes from [George Milos - MKH Management]

George Milos – MKH Management

Hi gentlemen, it is a follow-up on Jamie’s question. I’m trying to understand the commissions that you’re not recognizing from SAP either this quarter and I understand you do not have any guidance for the fourth quarter. I’m trying to understand what do they depend on? Is there certain metrics or hurdles that you need to reach in order to be able to actually collect that cash and then recognize it? I think it’s a little complicated, but it would be great to get some explanation.

Sachi Gerlitz

Okay. So the deal is such that over 18 months, actually through the end of '09, to get the commission based on sales of the division that was sold to SAP. This really was a budget, the budget of this business, and they need to get to 80% of the budget for us to get any payment.

Now it is divided between 2008 and 2009. However, what we don't make in 2008 is moving to 2009. So, in essence, even if Q3 was not great for SAP and who knows what will be Q4 for SAP, but if they make up until the end of 2009, you still could be at the same position just getting everything at the end of 2009.

So this is how it is done. We will get reports from them once they finish the year and there is a percentage, and that is it, and we get paid. On that, it is not that complicated.

Operator

Your next question comes from the line of Ziv Tal - Oscar Gruss.

Ziv Tal – Oscar Gruss

Hi, an additional question. You did give us some sort of an outlook for 2009. Are you expecting to cut on the operating expenses or headcount as a result of that?

Sachi Gerlitz

Can you repeat the question?

Ziv Tal – Oscar Gruss

Yes, you have given us a growth expectation of between 5% to 10% for 2009.

Sachi Gerlitz

Yeah.

Ziv Tal – Oscar Gruss

As a result, are you expecting to cut on your operating expenses? Are you expecting to maintain the same operating expenses structure and maybe a reduction of headcount?

Sachi Gerlitz

Our business is mainly coming as a function of the billable headcount that we have. Throughout 2008 we were reducing headcount on those parts of the business that generated low margin and increased headcount on those parts of the business with higher margins. We will continue to do it in the fourth quarter and throughout 2009 because this is the main way that we can expand our corporate margin.

As this economy is turning down, of course we will try and manage to run a tighter ship with much focus on all other expenses.

Operator

At this time there are no further questions in queue. Mr. Wright, are there any closing remarks?

Drew Wright

Sachi, you want to close us?

Sachi Gerlitz

Thank you for joining today’s call. We will speak to you again when we report our year-end results around the beginning of February. That concludes today's call. Thanks and have a good day.

Operator

This concludes today’s Ness Technologies Third-Quarter Earnings Conference Call. You may now disconnect.

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