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NaviSite, Inc. (NASDAQ:NAVI)

F1Q09 Earnings Call

December 9, 2008 5:00 pm ET

Executives

James W. Pluntze - Chief Financial Officer, Treasurer

Arthur P. Becker - President, Chief Executive Officer, Director

Analysts

Mark Kelleher - Canaccord Adams

James Breen - Thomas Weisel Partners

Dave Coleman - RBC Capital Markets

Jonathan Atkin - RBC Capital Markets

Jonathan Schildkraut - Jefferies & Company

Srinivas Anantha - Oppenheimer & Co.

[Jeffrey Link - Invamed]

Operator

Welcome to the first quarter 2009 NaviSite earnings conference call. My name is Kristen and I will be your operator for today’s call. At this time all participants are in a listen-only mode. We will conduct a question and answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Jim Pluntze, Chief Financial Officer.

James W. Pluntze

Welcome to NaviSite’s first quarter fiscal year 2009 earnings conference call. Arthur Becker, NaviSite’s CEO is also with me today. We will be discussing our financial results and sharing key business highlights from our first quarter of fiscal year 2009 which ended October 31, 2008. We’ll also provide an outlook for the second quarter of fiscal year 2009.

Before we get started please be aware that the information we’re about to discuss includes forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Such statements involve risks and uncertainties. The company’s actual results could differ materially from those discussed on this call. Factors that could contribute to such differences include but are not limited to those items noted and included in the company’s SEC filings.

The forward-looking information that is provided by the company in this call represents the company’s outlook as of today and we do not undertake any obligation to update forward-looking statements made by us. Subsequent events and other developments may cause the company’s outlook to change from that which is discussed today.

We will also discuss NaviSite’s EBITDA performance for the first quarter of fiscal year 2009. Please note that EBITDA is not a recognized measure for financial statement presentation under United States Generally Accepted Accounting Principles, US GAAP. The company believes that the non-GAAP measure of EBITDA provides investors with a useful supplemental measure of the company’s actual and expected operational and financial performance by excluding the impact of interest, taxes, depreciation and amortization. The company also excludes impairment costs, stock-based compensation, severance, costs related to our discontinued operations and other non-operational charges as such items are considered to be non-operational in nature. EBITDA does not have a standard definition and therefore may not be comparable to similar measures presented by other reporting companies.

Management uses EBITDA to assist in evaluating the company’s actual and expected operating and financial performance. These non-GAAP results should not be evaluated in isolation of or as a substitute for the company’s financial results prepared in accordance with US GAAP. A table reconciling the company’s net loss as reported to EBITDA is included in the condensed consolidated financial statements in NaviSite’s first quarter fiscal year 2009 earnings press release.

Now I’d like to turn the call over to Arthur Becker, NaviSite’s Chief Executive Officer.

Arthur P. Becker

We are pleased to report our results for the first quarter of fiscal year 2009 and I’d like to begin by sharing our financial results, review operating details and then share our outlook for the second quarter of fiscal year 2009.

As reported in our press release earlier today, revenue for the first quarter of fiscal year 2009 that ended October 31, 2008 was $39.9 million representing an increase of 10% compared to $36.1 million reported in the same quarter last year despite a decrease in our professional services revenue of 35% over our last fiscal year. First quarter revenue represents a sequential decrease of 1% over the $40.3 million reported in the fourth quarter, again due to the anticipated 34% decline in our professional services revenue during that quarter.

Recurring revenue from our enterprise hosting business was $35.4 million for the first quarter representing a year-over-year increase of 16% and a 2.5% sequential increase over the fourth quarter of fiscal year 2008. We will continue the reporting of the hosting revenue to provide more insight into our core business.

As mentioned, revenue from our professional services business declined 35% from the first quarter of fiscal year 2008 and declined 34% from the fourth quarter of fiscal year 2008. We had anticipated this decline and discussed this expected revenue impact on our fourth quarter earnings call as well as the actions we took to rationalize the professional services expenses to more closely match these lower revenues.

EBITDA excluding impairment costs, stock-based compensation, severance costs related to discontinued operations and non-operational charges for the first quarter was $8.5 million representing a year-over-year increase of 23% over the first quarter of fiscal year 2008. Sequentially excluding the one-time settlement gain of $1.6 million realized in the fourth quarter of fiscal year 2008, EBITDA was flat, marginally up actually.

Increased profitability from our hosting practice was offset by lower profitability from our declining professional services practice in the first quarter.

Income from operations for the first quarter was $400,000 representing a 48% increase over the first quarter of fiscal year 2008. Net loss attributable to common shareholders for the first quarter was $3.5 million or $0.10 per share representing a reduction of 25% from the loss of $4.8 million in the first quarter of fiscal year 2008.

Moving on to a discussion of some of our key business metrics and operational highlights.

We reported bookings of approximately $0.6 million or $600,000 of monthly recurring hosting revenue, MRR, during the first quarter consistent with the seasonally lower $700,000 booked in the first quarter of fiscal year 2008 and down from the almost $1.0 million booked in the fourth quarter of fiscal year 2008. In the first quarter 40% of our MRR bookings came from new customers and 60% came from the existing installed base representing an approximate MRR per new customer, what we call ARPU, of $4,000 compared to ARPUs of approximately $8,123 for the existing base of customers.

For the first quarter total contract value of all bookings was $15.7 million compared to $23.6 million a year ago and $42.7 million in the fourth quarter of fiscal year 2008. Total contract value in the first quarter of fiscal year ’09 represents the seasonality that we have seen traditionally in our business and may also highlight delays in contract signings due to the economy. Signed professional services contracts had a total value of $2.3 million during the first quarter, a decline from the $4.2 million signed in the previous quarter and a decline from the $3.8 million signed in the first quarter of 2008.

NaviSite’s signed contracts with 48 new customers. This excludes by the way our customers of under $500 of MRR which we find in our dedicated hosting practice and these 48 new customers were booked in the first quarter of this fiscal year. As we continue to attract a diverse set of new customers attracted to our ability to provide an integrated solution comprising our enterprise class hosting and our broad range of services for hosted applications.

With regard to the larger transactions we had two deals booked this quarter over $25,000 a month with an MRR total of $58,000 as compared to the no deals that we booked in the first quarter of fiscal year 2008.

I would like to take a moment to mention a few of the deals we closed in the first quarter of this fiscal year.

The [inaudible] of the growing acceptance of virtualization and our application services offering connect EDU, a leading provider of technology solutions for high schools and colleges, has chosen NaviSite’s virtualized computing platform app structure to be able to quickly scale their IT environment on demand and increase the performance of their solution. This customer win reflects the growing acceptance and revenue traction that we’re seeing with utility based services.

We also signed a major health care services firm, MedicalEdge to provide application services for their Lawson application.

A leading online gaming company, Outspark, chose our managed hosting solutions to meet their growing IT infrastructure needs.

NaviSite was also selected by one of the leading suppliers of network solutions technology to broadband service providers, a company called BigBand Networks, to host and manage their Hyperion performance management application, one of our new offerings around the Oracle suite of products.

A leading manufacturer of engineering components, Progressive Components International Corp, also chose NaviSite to host and manage their Microsoft dynamics application.

We’ve also seen some growing traction in our dedicated hosting solutions targeting the small and medium size business.

We have a number of renewals this quarter which demonstrates our core strategy to expand our relationships with existing customers and cross sell our product portfolio. Norwalk Hospital, a not-for-profit acute care community hospital and our customer since 2004, chose to expand and upgrade their PeopleSoft environment with us this quarter. Similarly a leading media and communications company, DirecTV, has expanded its co-location contract with us. And a leading trade publisher has renewed their contract to host and manage their messaging platform on Microsoft Exchange.

A bit later I will discuss our guidance for the second quarter of fiscal 2009. I’ll also provide an update on the progress we’ve made with America’s Job Exchange. But at this point I’d like to turn the call over to our Chief Financial Officer, Jim Pluntze, for a more detailed look at our financial performance in the first quarter.

James W. Pluntze

As Arthur previously mentioned, revenue for the first quarter of fiscal 2009 was $39.9 million, down 1% sequentially but up 10% over the first quarter of fiscal year 2008 and in the middle of our guidance range.

As also mentioned, the slower revenue growth was mainly due to the anticipated decline in our professional services practice which was down 35% from the prior year and down 34% from our last quarter of fiscal year ’08. About 9% of our total revenue this quarter was from professional services and 2% from the resale of hardware and software during the quarter. Recurring hosting revenue was $35.4 million for the first quarter representing a year-over-year increase of 16% and a sequential increase of 2.5%.

NaviSite generated a gross profit of $12.1 million or 30% of revenue for the first quarter of fiscal year 2009 as compared to $11.1 million or 31% of revenue for the same fiscal quarter of 2008 and $12.6 million or 31% of revenue for the fourth quarter of fiscal year 2008. Excluding the $200,000 of severance costs incurred related to the reduction of staff in our professional services business, gross margin would have been 31% for the quarter.

In looking at cash gross margin excluding depreciation, amortization, severance and noncash stock compensation that adjusted cash gross profit was 46% for the first quarter of fiscal year 2009 compared to 45% for the same quarter in fiscal year 2008 and 45% for the fourth quarter of fiscal year 2008. The increase in cash gross margin occurred despite the lower profitability from our professional services practice during the quarter and resulted mainly from the growth of our enterprise hosting revenue during the quarter.

Income from operations was $0.4 million in the first quarter of fiscal year 2009 as compared to income from operations of $0.3 million in the first quarter of fiscal year 2008 but down from the $1.5 million reported in the fourth quarter of fiscal year 2008. The sequential decline was mainly due to increases in severance related to the reduction in headcount in our professional services organization in the first quarter, higher depreciation and amortization expense, slightly higher sales and marketing costs, additional legal expenses in the quarter, and a slightly higher bad debt expense in the first quarter.

The increased sales and marketing costs were related to a couple of trade shows that NaviSite generally participates in in the first quarter of the year, legal expenses were up due to an ongoing arbitration against a former customer of one of our acquisitions, and bad debt expense increased during the quarter due to a customer who went out of business. We do expect increased legal expenses in Q2 as we complete the arbitration, and given the economy we are planning for slightly bad debt expenses going forward.

NaviSite reported a net loss attributable to common shareholders of $3.5 million or a loss of $0.10 per share for the first quarter of fiscal year 2009 which declined from the net loss attributable to common shareholders of $4.8 million or a loss of $0.33 a share for the first quarter of fiscal year 2008.

NaviSite reported $8.5 million of EBITDA excluding impairment costs, stock-based compensation and costs related to discontinued operations and other non-operational charges representing a 23% increase over the $6.9 million of EBITDA reported in the first quarter of fiscal year 2008.

Customer churn, as defined as the loss of a customer or a reduction in a customer’s monthly revenue run rate for all of our customers this quarter, was approximately 1.4% per month compared to 2.5% per month in the first quarter of fiscal year 2008 and compared to 1.2% per month for the fourth quarter of fiscal year 2008 but below our planning number of 1.5% per month. The increase from the fourth quarter was mainly due to the loss of one significant customer during the quarter whose business was acquired.

The company’s cash balance at the end of the quarter was $5.2 million which was up from the $3.2 million in the fourth quarter of fiscal year 2008. Cash generated from operating activities was $9.0 million for the quarter, up from $3.9 million in the fourth quarter of fiscal year 2008 and up from $0.1 million in the first quarter of fiscal year 2008. Of the increase, $5 million represents the increase in cash in operating activities due to the return of the UK data center deposit that we talked about before.

The outstanding balance on our revolver at the end of the fiscal quarter was $3 million.

During the first quarter we invested approximately $3.7 million in capital expenditures, about 70% of which was for customer installations with the remaining amount used for internal use and infrastructure upgrades. This is up slightly from the $3.1 million in the fourth quarter but consistent with our strong bookings in the third and fourth quarters of fiscal year 2008.

The company’s DSO or days’ sales outstanding increased to 45 days in the first quarter of fiscal year 2009 from 42 days in the fourth quarter of fiscal year 2008. We continue to maintain a strong focus on collection activity and will be particularly vigilant given the economic climate.

With that said, I’ll turn the call back over to you Arthur.

Arthur P. Becker

Now I’d like to take this opportunity to discuss a few details of our strategic actions that we’ve taken that continue to improve our operating performance amid the economic uncertainties we face and to make sure that we accomplish our growth objectives for the fiscal year 2009.

As I mentioned during our call last month, we’ve consolidated the sales group for applications and professional services into the field sales organization for enterprise hosting. We have also consolidated the service deliveries group into our application management organization. The consolidation of these two practices will allow us to use previously redundant capabilities in a much more efficient and cost-effective manner.

We’ve also made some changes in our application management strategy which will now focus primarily on the installed base of Oracle, Lawson and Kronos customers with a service offering that packages migration implementation, hosting and lifecycle management into one packaged price which will be very compelling on a competitive basis.

In addition we continue to expand the capabilities of our underlying ad structure utility platform to deliver these packages. This platform combined with new licensing options creates the lowest price of entry for outsourced services available while creating even more operational efficiencies for us.

Also announced during our call last month we launched the comprehensive dedicated hosting solution designed to cater to the needs of the small and the medium size business. To address these customers we’ve conveniently packaged, automated and priced an offering that is simple to purchase online and serviced by our inside sales team. This solution also leverages our common platform of infrastructure capacity and customer service with a low-cost sales model to drive incremental revenue at attractive margins.

Finally, I want to report our progress with America’s Job Exchange. Traffic to the career search portal reached more than $1.6 million in October with more than 33,000 registered employers. Total bookings for the first quarter were $430,000 down from bookings of $525,000 in the prior quarter primarily due to the impact of one multiyear large contract sold in the prior quarter and a slight decline in job postings generally in October.

Per earlier projections, the AJE operation was cash flow positive in Q1 and we plan to continue growing the business in an EBITDA/cash neutral fashion while we explore strategic alternatives for the business.

I’d now like to take a minute to discuss guidance. Looking ahead we project hosting revenue for the second quarter of fiscal year 2009 to be between $35 million and $36 million and total revenue to be between $37 million and $38 million. We are projecting modestly lower revenue due to the impact of foreign exchange rates on our UK subsidiary which will alone generate lower revenue by approximately $600,000 in the second quarter itself.

We also project our professional services revenue to continue to decline from Q1 to Q2 by approximately $2 million as this unit becomes integrated with our application management practice and reflecting the lower bookings and the decline in bookings generally that we’ve seen in this practice for the past few quarters.

We expect demand for our hosting services however to continue to be strong and anticipate that bookings for the second quarter will be stronger than the first quarter as we’ve already seen an uptick in activity during the first month of this quarter itself.

EBITDA excluding impairment costs, stock-based compensation, severance, costs related to discontinued operations and other non-operational charges is projected to be between $8.2 million and $8.7 million for the second quarter of fiscal year 2009. This guidance for EBITDA does reflect a $300,000 to $500,000 negative fx impact from our UK subsidiary due to the stronger dollar.

On behalf of NaviSite I’d like to thank you for your attendance today. Now we’re going to open up the phone lines to questions from our listeners. So I’ll turn the call over to the operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Mark Kelleher - Canaccord Adams.

Mark Kelleher - Canaccord Adams

Good quarter in a tough economic time. Can you maybe give us an indication of what you think cash flow would be in the next quarter based on those EBITDA numbers?

James W. Pluntze

I would think that they would be generally consistent with the quarter we’ve seen. If you think about this quarter, we delivered about $8.5 million so if our cash from operations was around $9 million and we had a benefit from the return of the UK data center deposit, so in the $4 million range. I think cap ex will be smaller in the second quarter given the fact that bookings were lower in the first quarter so I would think that cap ex would be in the range of the mid- to high twos and then we‘ll have our same financing costs related to interest payments and that kind of stuff.

Arthur P. Becker

A slight improvement I think.

Mark Kelleher - Canaccord Adams

How about the London data center? Can you give us an update on that? You talked about the fx effects but how about the business in general there?

James W. Pluntze

How are bookings or how is revenue? What’s your question?

Mark Kelleher - Canaccord Adams

Yes. How are bookings? How is revenue? How is that building filling up? I know it’s not scheduled to come on line until next summer.

Arthur P. Becker

What we’re finding is that generally demand for co-locations within the [M25] ring in the UK continues to be very strong. What we’re hampered by is long lead times out there so selling co-location stays in November for occupation in May or June continues to be a challenge for us. I think that we’re believing that we’ll still be able to fill up that 10,000 feet that we leased of which 20% or so is already pre-leased but we’re finding it a little bit challenging right now to identify customers that have such long lead times because our particular customers are smaller ones rather than the larger ones that need long lead times.

So I guess the answer is generally favorable but no real traction.

Mark Kelleher - Canaccord Adams

If we go from the churn numbers and we look at the bookings that you’ve seen in the strong Q1, it would seem that the macroeconomic environment isn’t really affecting you that much. Is that accurate?

Arthur P. Becker

I think if you pierce through the fx exchange impact on our revenue and EBITDA, which has been a little bit negative, and if you take out the PS business which we’re trying to illustrate to investors, our hosting business continues to be pretty good. We’ve seen a little bit of extension of our DSOs but I know Jim is focused on shortening those. We saw a slight dip in the churn but we don’t think that’s a change in trend as that customer has been ready to go for six or nine months and it finally occurred in Q1.

And bookings which even though they were a little disappointing in Q1 as opposed to where we had hoped and where they were a year ago reflecting some I think deferrals of decision making by customers, we don’t see that same pattern in Q2 impacting the level that we saw in Q1. I think we may not see what we saw a year ago but I think we’ll be stronger than what we’ve just done in Q1.

So I think you’re generally right.

Operator

Our next question comes from James Breen - Thomas Weisel Partners.

James Breen - Thomas Weisel Partners

Along the same lines as the last question, just more generally what are you seeing from your customers in terms of their propensity to buy the services? Is it taking longer periods of time? Are they just buying less on a year-over-year basis?

Secondly could you comment on the types of services that you’ve had the most success with over the course of the last quarter?

Arthur P. Becker

Jim, do you want to try your hand at that or do you want me to?

James W. Pluntze

I think you better go for that one.

Arthur P. Becker

We are seeing deferral and escalations of decisions. That’s what we’re seeing. We’re seeing a general slowdown in the inertia of decision making. Nothing you can really point your finger at but there is some qualitative sort of slowing down of decision making in the pipeline. We haven’t seen the pipeline change measurably to the negative but we’ve seen it slow a little bit.

At the same time the value proposition that we offer which is a lower cost alternative to in-sourcing and a method of financing IT infrastructure through one to three year contracts continues to be pretty compelling. We won a materially large deal already this quarter and I can’t say that there’s any particular service line that seems to be benefiting from others. I think broadly the enterprise hosting piece of our business continues to be prospering at this point but it’s difficult to really measure that against the dedicated hosting solution which is really in its infancy.

James Breen - Thomas Weisel Partners

On an individual basis in terms of the hosting side, have you seen pricing be relatively stable within the markets themselves?

Arthur P. Becker

Yes. I’ve seen no change in pricing at all. We’ve seen some consumption patterns change. Two of our larger customers that buy power as part of co-location and buy bandwidth as part of their agreements with us, we’ve seen some consumption change there which may have to do with flattening of ecommerce activity but again those are on the margin. Not a great number but we have seen some of it.

Operator

Our next question comes from Dave Coleman - RBC Capital Markets.

Dave Coleman - RBC Capital Markets

Taking a look at the $35.4 million of hosting revenues reported this quarter and you compare it to the previous $34.4 million, it seems to me there’s a bit of a shortfall. I’m trying to determine where the shortfall’s coming from? You’ve done $1 million of MRR bookings over the three previous quarters, you back out churn, it seems you’re about $1 million short. I would have expected actual revenues to be closer to $36.5 million. I’m just trying to understand where I’m missing about $0.5 million of revenues from your reported number.

James W. Pluntze

I would say that the hosting revenue was within the range. It was at the low end of our range for hosting revenue so that’s where we were guiding people that our results were going to end up. We did lose a little bit of ground in the quarter due to fx also, probably a couple hundred thousand dollars. As Arthur mentioned, we’ll lose a little bit more next quarter. And we did have a couple of reserves we took this quarter against a couple customers but nothing significant. Like I said we were in our range so it was where we expected to be.

Arthur P. Becker

I’m not sure I know your math, Dave. I’m happy to listen to it but do you want to report your math again so we can address it?

Dave Coleman - RBC Capital Markets

If you take $34.4 million of hosting revenues last quarter, you assume 1.4% monthly churn on that number, you add in about $3 million of revenue from the three prior quarters’ bookings, I would get to about a $36.5 million hosting revenue number this quarter and you came in at $35.4 million.

Arthur P. Becker

I don’t think it’s quite as simple as that. I think that obviously as you know if you do 1.4% churn on the $3.5 million, that’s like whatever that number is, that’s $160,000 a month times six. That’s almost $1 million of churn right there. Then you’ve got the $3 million, you right the [inaudible] but I think I’d have to go through it offline with you. We did have a reasonably significant fx impact because that’s over $600,000 just from the foreign currency. The dollar got so strong in the last quarter. That impacted us by over $600,000 just on the top line.

Dave Coleman - RBC Capital Markets

The churn you mentioned that one significant customer churned during the quarter. Was that towards the beginning of the quarter? Mid-quarter? Late quarter?

Arthur P. Becker

I think it was right in the middle of the quarter. And again we’ve been waiting for that shoe to drop for nine months because they got acquired about nine months ago and we’ve just known they were going to go. We just didn’t know when.

Dave Coleman - RBC Capital Markets

On the bookings you anticipate the second quarter to be stronger than the first. Is there any expectation built into that as far as spending around the holidays? I would assume that that’s going to be a longer sales cycle because of seasonality around then? Is the pace right now running that significantly faster than the past quarter that even if there is any kind of seasonal impact, you should still be able to report a better bookings number than the past quarter?

Arthur P. Becker

We sure as heck hope so. Remember our quarter ends at the end of January this quarter so we’ll be able to get through the holiday seasonal. Hopefully if there are deferrals, which inevitably there will be, we’ll hopefully close those in early January and just carry on. We do think that the quarter looks reasonably good. We’ve already had a pretty good bookings month in November and the pipelines do continue to be reasonable.

So it’s just a matter of how much time is the slowing inertia going to impact us and how much longer into the future are these deals that we think we’re going to close take to close. That’s a hard one to know. On the margin though I think we’ll be stronger than we were certainly in the Q1.

Operator

Our next question comes from Jonathan Atkin - RBC Capital Markets.

Jonathan Atkin - RBC Capital Markets

Another couple questions regarding retail and sales trends. Can you talk about the portion of the business that you’re seeing coming from brand new logos, new relationships and would that mix change at all in the current environment?

And I’m wondering about the new hosting business that you are bringing in, the Kronos or the Lawson. I’m just curious whether the wins there are displacing another hosting provider, another application provider or are these contract wins to businesses that are brand new to outsourcing?

Arthur P. Becker

I think your first question is the mix and the second was sort of more detail on how we’re winning application management business.

The mix was 40/60 this quarter where bookings were 60% from existing customers and 40% from new. I think what we’re finding is that we’re improving our traction with our installed base. We’re improving it by the lower churn we’ve seen the past three quarters despite the slight dip this quarter which we don’t think is a trend changer. We’re seeing it in the kind of quality of dialogues we’re having with our customers and the fact that the bookings from the customers this quarter, while they were below our expectations and our plan, still we’re seeing better performance from our installed base.

I think that going forward in this economic climate we’ll continue to invest heavily or will invest let’s say directly in making sure that our installed base of customers are getting the kind of attention that we believe that they deserve and mine the opportunity for new business from those existing customers that we think is there. It’s a lower risk proposition for us in terms of finding new customers although I wouldn’t say that we’re in any way deterred from going out there and winning deals against the competition.

I like the mix though of 60/40. I don’t mind it growing a little bit slightly and I like the fact that as we use a multichannel approach to sales we’ll see the dedicated hosting picking up the smaller customers with an automated portal, we’ll see an inside sales force which we’re really newly invigorating to make sure that we’re closing deals under $5,000 a month on the telephone with a very direct and action-oriented sales team, and that our field sales guys really do the solution selling across the territories in the country where we’re trying to win those deals that are north of $25,000 a month.

With respect to your second question now that I’m going to prove that I can remember it, it’s rare that we win a deal from another vendor that’s already installed. There’s a lot of stickiness issue here and it’s rare that a customer will get so fed up with an existing provider that they’ll just want to turn it away and go to another provider. That happens more with mergers and consolidation activity than just a customer deciding to deselect their current vendor and moving to another.

I think that what we’re seeing is that the value proposition of the total cost of ownership really is compelling for customers that are managing their own applications. We’ve got a team of people from the net aspects group that have been very successful in their string-based theory of selling one customer from another that’s another installed base customer that have affinities with each other. I think we’re going to adopt that strategy in selling Oracle and Kronos and Lawson application management services. From one customer to the next really showing the compelling value prop. That’s kind of the answer there.

Operator

Our next question comes from Jonathan Schildkraut - Jefferies & Company.

Jonathan Schildkraut - Jefferies & Company

On the booking trends, during your prepared remarks you noted that bookings activity in the last month, I assume that’s November, was up over what you saw during the first quarter of fiscal year ’09. Could you give us a sense as to what it might have looked like through the course of the quarter? Was there good bookings in September and then things slowed down in October and then picked up in November just to give us a sense as to whether some of the things we saw in the public markets and some of the news events impacted the trends over the course of the quarter?

Arthur P. Becker

The good activity we had in November was from large customer so we don’t have enough samples to give you a feeling of whether or not the bookings we have reflect some of the changes in the economic climate or the mood of the country from September to November. We could have had a great quarter if we had won the deal in November in October. It would have been a very good bookings quarter. It would have exceeded Q1 of last year and we’d be saying seasonality no longer exists. But now we’re saying seasonality exists.

It’s tough to say. If we’d won a whole bunch of deals in November that made us feel a little bit more optimistic about Q2, we might be able to have some kind of way of thinking that the metrics that we reflected had something to do with the economy. But I don’t think so. I think it just had to do with the deal cycle of that particular transaction.

Jonathan Schildkraut - Jefferies & Company

The second question here has to do with the percent of customer spend that they’re currently doing with NaviSite. I know that there are some analysts who are more familiar with the company than I am on the line but could you give me a sense as to what percent of customer spend you are currently getting from your customers, because seeing that 60% I believe of your bookings came from the installed base, just to give us a sense as to what the revenue opportunity still is from that installed base over time?

Arthur P. Becker

I don’t know if I can answer that question. It’s a tiny single-digit number I’m sure. Obviously it depends on whether the customers are large or small. That’s one thing. But I would say that something like 82% of our customers are only buying one service from us. Now what’s the definition of a service? That’s a whole other question.

We see there’s a significant opportunity for us to continue to inform our customers about other choices they can make with us as a vendor if they continue to like us as a vendor for their current service. I don’t think I can give you a macro number to help you estimate what that activity is but I think it’s significantly more than what we’re currently providing. I’m sorry I can’t give you a better quantitatively based answer.

Jonathan Schildkraut - Jefferies & Company

The final question has to do with any leverage that might be developing in terms of your ability to purchase the equipment necessary to provide your service. It appears that there are certainly negative demand trends for servers and things like that and there also appears to be an emerging gray market for equipment. I was wondering if you were able to leverage any of the current environment to maybe drive down some of the costs for the equipment that you use?

Arthur P. Becker

We’d never admit to being a gray market buyer so that’s one thing. But I would say that the market for equipment has gotten more competitive. Jim, why don’t you just make a comment or two if you can?

James W. Pluntze

We recognize our position as a buyer of infrastructure puts us in a position of opportunity with respect to getting the best prices for our customers so we think we do have a pretty significant opportunity to using competition or referring different partners, hardware or software, to obtain pretty significant discounts for ourselves and our customers. So I guess the answer is yes.

Operator

Our next question comes from Srinivas Anantha - Oppenheimer & Co.

Srinivas Anantha - Oppenheimer & Co.

Arthur with all the changes that you guys have done on the professional services, what do you think is a sustainable revenue run rate or do you think over time this segment of the business is something that’s probably just going to continue to decline? And with all the restructuring being done, is this business currently cash flow positive?

Arthur P. Becker

I think we anticipate that pro services as defined should be a 50% of what they did in FY08. So we’re planning it down 50% and that comes from three things. It comes from a decline that we saw generally in Q3/Q4 and Q1 of the last three quarters. It’s also a changing focus from us. We’re sort of subscale to have a bench that really is strong enough to support contracts coming in and out and we’ve changed the leadership a little bit there.

I think the real strategy is to reflect on the fact that decline has been softer for us, we’ve trimmed our group down to make it economically more beneficial for the business, and we’ve realigned the way we’re going to bid on professional services contracts to make sure that they’re part of hosted application services.

So we’ll see two declines. We’ll see a decline from demand that we experience; and two, a decline in the bench that we’re providing against professional services; and three, a change in what we’re going to call professional services as we really make it part of a package of managing applications which is really the core focus for us as a hosting business, to continue to have lifecycle management for customers of either their infrastructure or their application needs. So that’s the first thing.

The second question you were asking about cash flow positive. Are you asking that about the business or the pro services practice?

Srinivas Anantha - Oppenheimer & Co.

The pro services.

Arthur P. Becker

We don’t think about it from a cash flow point of view although obviously there are implications there. We think about it from a gross margin contribution basis and we’re going to make sure that we maintain the business to be gross margin positive. That’s a commitment that we have to the way we run that business.

Srinivas Anantha - Oppenheimer & Co.

On the hosting side could you just comment about the average deal sizes today? Has that come down from what you guys have been seeing let’s say even three months ago given the macro environment that we are in currently?

Arthur P. Becker

I wouldn’t say that we’ve seen a general trend. Our ARPUs from the customers were slightly lower than the existing ARPUs. There are a couple of things that happens there. Your initial ARPU of a customer may be lower than your subsequent ARPU because you’re cross selling and up selling that customer later. So that would be expected. That’s number one.

Number two, the number of large deals we had this quarter 57,000 into the $570,000 or $600,000 of bookings is less than 9% of the bookings were large deals. We’ve seen that in the last few quarters be a little bit larger as a percentage of the overall bookings per quarter and I think that this quarter the blended rate of ARPU is a little bit lower than we’ve seen in the past, probably not an indication of trend or quality of customer but just an indicator of the anomaly of how many large deals we closed during the quarter itself.

Srinivas Anantha - Oppenheimer & Co.

I know you talked about increased provision for bad debt. Is it now completely done or should we expect at least for a couple more quarters bad debt expense to impact your EBITDA?

James W. Pluntze

That was one factor of increased expenses or lower operating income for the quarter. The nominal number we’re talking about was not that significant. We generally book $20,000 or $30,000 a month. That’s kind of our budgeted number and this quarter we had probably an extra $100,000 due to one specific customer.

My comment about potentially having a higher rate going forward, just given the economic climate that we’re in I would just err on the side of caution in terms of having a little bit of elevated bad debt expense given the company’s potentially having difficulty. But we’re not planning on any significant increase and it wasn’t related to one significant customer that we’re thinking of having more exposure to.

Operator

Our next question comes from [Jeffrey Link - Invamed].

[Jeffrey Link - Invamed]

A question on the issues with the NASDAQ listing and the fact that you may be in violation of some of the requirements. Has that been addressed at all or can you even comment on that now?

Arthur P. Becker

Yes. Certainly it’s been addressed and there are a couple of things. NASDAQ is obviously being organized about the way that they talk to their customers that are in violation as you say of their rules with respect to listing requirements.

At the same time they have taken a rather soft hand towards enforcing these requirements. I think that if they did, they might lose 30% or 40% of their customer base. That’s my own prognosis. Needless to say, we have responded to NASDAQ with our plans and the collections activities that we have to regain our listing status. I think that we haven’t heard officially back from NASDAQ but I think the sense and sensibility from NASDAQ is that I think they’ll err on the side of trying to be accommodating. But nothing more qualitative than that.

Operator

At this time there are no further questions. I would like to turn the conference back over to Mr. Arthur Becker.

Arthur P. Becker

Thank you very much for attending and we look forward to talking to you in another 60 days.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: NaviSite, Inc. F1Q09 (Qtr End 10/31/08) Earnings Call Transcript

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