Intelligroup Q1 2009 Earnings Call Transcript

Intelligroup, Inc. (ITIG)

Q1 2009 Earnings Call

May 01, 2009 10:00 AM ET

Executives

Norberto Aja - Investor Relations, Jaffoni & Collins

Vikram Gulati - Chief Executive Officer and President

Alok Bajpai - Chief Financial Officer

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Intelligroup First Quarter 2009 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded Friday, May 1, 2009.

I would now like to turn the conference over to Mr. Norberto Aja. Please go ahead, sir.

Norberto Aja

Thank you, Solana and thank you everyone for joining our 2009 first quarter call. In a moment, Vikram Gulati, President and CEO, along with Alok Bajpai, CFO, will review the quarter and then we will open up the call to questions.

Before we get started however, I'd like to remind everyone of the Safe Harbor statement included in the press release and that the precautionary statements applied to today's conference call as well. During the course of the call, the company may make forward-looking statements that reflect management's current expectations regarding future performance or events, including those related to market demand for our services, strategic partnerships, future share repurchases as well as future sales.

Although management believes that the expectations reflected in such statements are reasonable, they give no assurance as such expectations will prove to be correct. And you should be aware that actual results could differ materially from those that are contained in the forward-looking statements.

Forward-looking statements are subject to a number of risk and uncertainties, including, but not limited to the continuation of a current global economic crisis or further deterioration of the global economy, variability of quarterly operating results, continued uncertainty of the IT market, loss of one or more significant customers, reliance on large projects, concentration of revenue, ability to attract and retain professional staff, dependence on key personnel, various projects associated risks, including termination with short notice, substantial competition and volatility in quarterly operating results, caused by fluctuations in the currency markets and risk associated with intellectual property rights, which associated with international operations and other risk detailed from time-to-time in the company's filings with the SEC, including the company's Form 10-K for the fiscal year ended December 31, 2008.

The company's forecast are dynamic and subject to change; therefore this forecast speaks only as if the date of this conference call and webcast, today May 1, 2009. The company assumes no obligation to update the information contained in today's call.

With that, I would now like to turn the call over to Vikram Gulati, President and CEO. Vikram?

Vikram Gulati

Thank you, Norberto and good morning to everyone in the U.S. and good evening to those in Asia. We are very happy that you are able to join us today. I will spend a few minutes discussing the operational side of the business, what we have experienced so far in this year and what we think the near term prospects look like for our company.

Afterwards, Alok Bajpai, our CFO will discuss the quarter's financial results in greater depth. The first quarter results are a reflection of both, the difficult economic environment and the efforts on part of everyone at Intelligroup, to quickly adjust to this new market paradigm. Q1 business environment proved to be even more challenging that the one we faced in Q4, as current and prospective customers delayed or halted a range of projects in order to reduce their costs.

In many instances, IT services decision making was delayed or put on hold for a greater part of the quarter, as companies struggled to assess their own outlook, privatize projects and formulate and revise their 2009 budgets.

This behavior extended to both new as well as existing clients. In certain instances, it manifested itself in price compressions, renegotiation of contractual terms, project start delays or smaller contract sizes.

In spite of this, we were able to add 32 new customers on a global basis during the first quarter. Having seen this environment take hold during Q4 itself, we had already begun to be keenly focused on actively monitoring the status of our business, and I am taking on immediate action to adjust our cost structure and staffing to be inline with the revenue challenges we face.

To that end, everyone at Intelligroup put forth an extraordinary effort and despite year-on-year and sequential declines in revenue, we were able to actively manage our staffing levels in operation to improve our business performance on a year-on-year basis.

More importantly, a good deal of the benefit of our cost reduction actions taken in Q1 will be fully realized in Q2 and subsequent quarters. Beyond driving improved utilization, we also continue to work to move our business to increase the offshore component.

One bright size of the challenged economy is that more companies are much more willing to entertain offshore solutions. This is an exciting opportunity for our company, as the overall margin potential of offshore business is substantially higher than those of onsite projects.

We remain convinced of the strategic sense of our business focus on ERP and our core base of industry verticals. However, we will not shy away when an opportunity presents itself and where we feel that we can succeed. An example; why we were continuing to remain focus on our existing verticals of consumer products, life sciences, high-tech and discreet manufacturing we have now formed a new vertical on alternate energy. In these verticals, we have substantial experience and expertise, and we know that we can make a difference and continue to excel.

The market and ecosystem at large, continues to recognize our contribution in many, many ways. Just recently, we won the Relationship Management Award from the Outsourcing Institute for the Customers' Favorite category. We are particularly pleased with this news, since it recognizes the relationship aspect of the business which is so critical in these times.

We are also now considered the finalist in three categories for the SAP Pinnacle Award. The SAP Pinnacle Award is the highest award that SAP gives out to its partners globally. The winners will be announced on May 11 at SAP's Annual SAPPHIRE event in Orlando, Florida.

Also the very prestigious U.S. based Supply Chain Council has given us an award for excellence in the Technology category. These awards underline the positive impact that we continue to have on the marketplace.

Before I turn over the call to Alok, let me just reiterate my remarks from our call in February. Though the environment have been very challenging, we continue to have confidence on the long-term vision and differentiated strategy, and continue to look growing the business as opportunities present themselves. We enjoy a very strong financial position with no debt. Our cash and short-term investment position of nearly $16 million and a healthy access to capital.

We believe this strength enable us to endure this challenging environment and emerge stronger when the cycle re-launch. Though, visibility has yet to improve for many of our parental potential clients and therefore for ourselves, we do believe that there is an increasing ways of pensive demand, as halted or delayed projects are ultimately signed in future periods. We can't predict when this will happen, but we can manage our business to ensure that we remain strong and well positioned for that inevitable turn in business cycle.

With that, I would now like to turn over the call to our CFO, Alok Bajpai, who will review our financials for the quarter end and for the quarter end.

Alok Bajpai

Thank you, Vikram, and many thanks to all of you for listening today. I will review some of the key financial line items and drivers behind each after which, I will offer some thoughts on our performance in Q1.

Let me begin, by saying that against this challenging backdrop, we have focused our efforts on the elements of our business and strategies that we could control, delivering great service and value to our customers, and driving disciplined operational and working capital management.

We have taken and continue to take actions to realign the business, to remain profitable and cash-flow positive. These efforts have helped us to offset the impact of the revenue decline in our recent Q1, and we expect to see further benefit in subsequent periods of the year.

Now let's review the quarter results. Revenues for the first quarter decreased 19.7% to $30.9 million, versus $38.5 million during the first quarter of 2008 and by 17.3% as compared to Q4 of '08. The decrease in revenues was primarily the result of the ongoing softening of the global economy which has negatively impacted our ability to source new projects or cause delays in new project authorizations.

Managing our cost structure to align to these changing business trends, we reduced our overall head count by approximately 11% versus Q1 of '08, bringing our total employee strength to 2052. Hence, our utilization improved to 72% for the quarter, versus 69% in Q1 of '08 and 70% in Q4 of '08. We also were able to improve our onsite offshore mix to 66% and 34% from 72% and 28% in the year-ago period.

With regard to the billing rates, average onsite bill rates held steady at $106 as compared to the first quarter of 2008. Average offshore rate declined by about a $1 to $22 as compared to $23 a year ago. Though the pricing environment, as a whole was even more severe than these figures in most cases Intelligroup was able to demonstrate its value adds and competitive advantage in order mitigate clients' requested price reduction.

Within this backdrop, our gross profit decreased 15.8% to $9.6 million versus Q1 '08 and declined by 20.6% versus Q4 of '08. We were however, able to improve our gross margin by 150 basis points to 31.2% in Q1 of '09 versus 29.7% in the year-ago period, driven by the ongoing efforts to manage personnel and achieve additional leverage from our offshore capabilities. As compared to Q4 of '08, gross margin declined by 130 basis points.

Moving down the income statement. We were able to contain our selling, general and administration expenses to $7.8 million or 25.3% of revenues, down from 9.7 million in Q1 of '08 and 9.2 million in Q4 of '08. While, we were able to bring G&A expenses down more rapidly in the period, we still kept the sales and marketing expenditures at higher level in an effort to develop revenue opportunities.

Q1 '09 operating income was $1.8 million or 5.9% of revenues, a 150 basis points improvement from 1.7 million or 4.4% of revenues in Q1 of '08, but down 200 basis points from operating income of 2.9 million or 7.9% of revenue in Q4 of '08.

Our foreign exchange loss for Q1 '09 was $600,000 reflecting the impact of further weakening of the rupee against the dollar on our ForEx hedges. This compares to a foreign exchange gain in Q1 of '08 amounting to about 400,000 and a loss of 1.4 million in Q4 of last year.

Reflecting the decline in revenues, first quarter net income decreased to about 800,000 or $0.02 per diluted share compared to Q1,'08 net income of 1.9 million, or $0.04 per diluted share. On a sequential basis, net income was marginally down from $1 million, which was also $0.02 per diluted share in Q4 of '08. Free cash-flow for the quarter continue to be strong, coming in at $6.2 million, as compared to about $800,000 in Q1 of '08 and 4.7 million in Q4 of '08.

As previously disclosed, we initiated our share repurchase program during the later part of the fourth quarter of 2008, and since that time, through March 2009, we have purchased over 660,000 shares including approximately 585,000 shares to-date in 2009 at an average cost of $1.48 per share. Subject to our cash-flows, liquidity comfort and the price performance of the shares, we expect to continue our share repurchase activity.

During the quarter we won 32 new customers that compares to 34 in Q4 of last year. The total value of the new contract entered into during this period, including new engagements from existing customers was $29 million. Currently, we have an active client base of 205 customers.

Moving to the balance sheet; we ended the first quarter with cash and cash equivalent, net of outstanding line of credit balance of $40 million; including short-term investments that figures increases to $15.7 million. This compares to cash and cash equivalents of 2.6 million at the end of Q1 '08 and 11 million at the end of Q4 of '08.

In summary, while we have taken actions to mitigate the impact of a challenged marketplace, we are clearly not satisfied with the end results. We will continue to act on these to further improve the operational efficiencies, thus ensuring higher margins and stronger financial footing.

With that, I think we are now ready to proceed to the Q&A. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of Chattel Alan (ph) from Kaufman Brothers. Please proceed with your question.

Unidentified Analyst

Goes back into the conference.

Unidentified Analyst

Hi, thanks for taking my question. You mentioned you're entering the alternate energy verticals, so if you could elaborate a little bit more on the opportunities you see there. And also, if you could just comment on some of the traction you're seeing in your other verticals like, high-tech and life sciences? Thanks.

Vikram Gulati

Sure. So, in the alternate energy vertical, what we have started seeing is a fairly good uptake in investments happening, especially in the solar sector. We now have three clients for which we are doing a variety of SAP and Oracle works, some SAP, some Oracle both in terms of long-term support as well as new projects.

So that's... we see a good traction there. What's happening in the vertical is that, companies are still evolving to define their space within the value chain, so unlike the conventional energy vertical, like the oil or the coal sector where each company has very well identified what its role is.

In the solar and the alternate energy sector, these positions are not yet clearly defined, but there is a lot of new investment and ERP is getting well accepted in that marketplace. What we have also done, is that we have been working very closely with Oracle, who actually helped define the Oracle footprint or the Oracle landscape for solar companies, solar power companies. So, that's working very well to our advantage. Primary location for all these customers happens to be California, but we... I guess that's going to be much more across the country as well in the near future.

With regards to some of the other verticals, we've continued to see that the hardest hit has been manufacturing vertical; manufacturing and discreet.... both high-tech and discreet manufacturing. Clearly I think, after Q4 onwards into Q1, that vertical that had been spared until that point of time started experiencing some significant downturn, and clearly investments and new projects have been drying up there.

Life sciences continues to have some very good traction. We've picked up new projects in that, especially in the Biotech space and the medical devices space. The conventional pharma space still seems to be slow, but biotech and med devices seem to have some reasonably good uptick.

Unidentified Analyst

Great, thanks. And just one follow-up if you don't mind. Just around your SAP Implementation business, that's a large part of your service offering. And SAP just recently reported some maturely down licenses. Wondering, if you're seeing any effects of that, and if there is any shift in kind of your business you just mentioned, you are doing lot of work with Oracle and Alt. Energy towards may be some other service offerings like Oracle.

Vikram Gulati

Yes, SAP is obviously the largest, 70% of our business is around SAP. So, at no point of time can we ignore SAP and yes, when SAP has had a significant downturn in terms of its license revenue, it's bound to have a slower effect in what we do. However, we believe that, since we are more in the business of maintaining existing applications, it is still our job to go out and win those long-term annuity contracts with our new customers, as well as keep our existing customers, to keep our revenue flow as well as our margins going.

So yes, to some extent we are connected with what happens to SAP from a new license revenue, because obviously, newer implementation projects to that extent will slowdown, but that should not prevent us from going out and winning annuity business to maintain older footprints of SAP that have already been sold in the marketplace.

With regards to Oracle, yes we have seen Oracle business to actually grow a bit faster than the SAP business in second half of last year and Q1. Some of our larger wins have definitely been around Oracle. But again, that's... it's not for me to say as to which is doing better in the marketplace.

For us, it just so happened and we have seen much more traction around Oracle and certain verticals, primarily being life sciences and the new Alternate Energy vertical. So, yes we have seen that shift happening. Plus, what we did about a year, year and a half back, have started paying dividends. We essentially surrounded our core ERP strength that support service lines like infrastructure support, like testing, like the E-Business service line.

Those service lines have started growing and started becoming increasingly important in our revenue mix. So even if we see SAP decline a bit in terms of license revenues and to that extent we get impacted, we hope to offset that with both Oracle as well as the Surround service line that we have now created over the last year, year and a half. So we are not just completely anchored to SAP, though it's still a huge part of our portfolio.

Unidentified Analyst

Okay, great. Thanks. And good job in managing the business in this tough environment.

Vikram Gulati

Thank you.

Operator

: (Operator Instructions). And our next question comes from the line of George Melas (ph) from MKH Management. Please proceed with your question.

Unidentified Analyst

Thank you. Good morning, Vikram and Alok. How are you?

Vikram Gulati

I am fine, George, how are you?

Alok Bajpai

Thank you. Good morning.

Unidentified Analyst

Good. Very well, thanks. May be to elaborate on the last question... further questions, can you give us a little bit of your revenue mix between new implementations in some of your maintenance work which I imagine has held up... a bit better?

Vikram Gulati

Sure.

Unidentified Analyst

Is it a bit better?

Vikram Gulati

Right. So, we look at our revenue stream as composed of three large components. And this holds growth across technologies, across SAP, across Oracle, across everything else that we do. We basically classify them into three large buckets, one is the annuity business. This typically is long-term support, including infrastructure support. Second is projects; these are projects where we have control on the project that need not be on a fixed price basis, it could be still on a P&L basis, but these are places where we are running the project on behalf of the customer.

And the third bucket is placement; where we are doing the traditional placement business where we do not control it and we are only providing the resources to run the projects or something else that the client wants to do.

So, if you look at these three buckets, our annuity business has actually grown, as expected. We were about 42% in '07; we grew to 43 in '08 and in Q1 of '09 we are close to 45%, in fact we are 45% in our annuity business, its a long-term support business.

Our projects business has actually also grown, from 37% to 39% in '08, 37 in '07 to 39 in '08 and it had remained steady in Q1 of '09 at 39. So what has come down is our placement business because that was the one... that was one that the clients were easily able to get rid of the positions and not early projects. So that has come down from 21% in '07 to 18% in '08 and now down to 16% in Q1 of '09. So that gives you a feel as to how the shift is happening across our business components if you may.

Unidentified Analyst

Right, okay. But then the annuity bucket on a dollar basis seems to have declined in the first quarter. Is that...

Vikram Gulati

It has and that is because of people have renegotiated... see the way the annuity business works is that you have a certain staffing level or a certain amount of money that the client is willing to spend for a certain SLA, for a certain Service Level Agreement.

What people have been able to do is that, they have been able to negotiate with their own business, the IT and the companies have been able to negotiate with their businesses to reduce the SLA's and have a lower spend with their vendor.

So though we haven't had customers getting out from what we do for them as support, the amount that they are spending with us for long-term support has gone down. Obviously those SLA's that they haven't term committed to their businesses are not something that they're comfortable with in the long-term. So those should readjust upwards and as they readjust upwards obviously the spend that they'll have to do with us also readjusts upward.

So you're right in saying that the total dollar revenue has decreased in the annuity business. Most of it has been due to exactly what I just told you.

Unidentified Analyst

Okay great. And were you surprised by sort of the effected customers have been willing to reduce the SLA?

Vikram Gulati

Not really.

Unidentified Analyst

How do you see that for?

Vikram Gulati

No. Not really because we have had situations in the past as well when customers were undergoing various transitions though it was not across the board, the way it has happened right now. We've kind of been... the way we run our support business is that we can sort of dial up and dial down the level of support based on what is the SLA that the client wants us to do.

So we have a fairly good metric in terms of how we start and how we run the long-term engagement based on the affiliate that the client is wanting us to deliver. If they want 15 minute response obviously, we'll need more people than they have, they are willing to leave with one hour.

Unidentified Analyst

Right. And on... and when did you see the SLA come down or at least the request for that? And how is that stabilized or do you think that they still pressure there?

Vikram Gulati

I think at a moment of broader level not just in SLA's, we've seen... if you ask me from the middle of Q4 or towards the early part of Q4, so I think towards the end of February of Q1, there was... I mean we were facing almost a frozen situation in the marketplace, where clients almost suspended discussions on everything, on a bunch of things. And it was almost like a deer in headlights kind of situation for a large, large number of our customer.

Towards the latter half of Q1, I would say, March and may be the early part of April, we have started seeing people opening up discussions, getting back onto those projects that they had kind of started discussing about.

So that's the trend that we have seen over the last six months. I am not sure, as to whether this is just a six to eight week activity that we'll plan out in the future or it's just a momentary thing. It's difficult to make any forecast these days, but we've definitely seen toil if you may of frozen discussion that what there for most part of Q4 and the early part of Q1.

Unidentified Analyst

Okay. Great, that's very helpful. The effect of the rupee in the quarter, what was the effective rate of... or the average rate for the rupee, for your P&L in the quarter?

Alok Bajpai

For the quarter it was at 50, 50.20.

Unidentified Analyst

50.20, okay. So you had basically no hedges, you had a market rate, you operated pretty much at the market rate, right?

Alok Bajpai

Yeah, but we had the hedges which will continue actually for this year as well, but obviously the amounts of the hedges is becoming smaller, as the hedges are expiring. And we may not have more impact coming now unless the rupee weakens further, because the product load that we did was beyond 50 rupees and it has been hanging on at that level now. So, assuming that it remains at that level, we may not have too many more negative impacts coming in the first, second quarters.

Unidentified Analyst

Okay. Are you continuing to lay your new hedges or why are you actually not doing that?

Alok Bajpai

No, as of now we are holding on not doing any new hedges, once the clarity comes in the ForEx market, then only we will resume that.

Unidentified Analyst

Okay, great. And what is the value of the quarter that you have that is still outstanding?

Alok Bajpai

What we still have for the balance of the year is approximately only about 7 million. But most of these are options with 1 is to 2 kind of arrangement. So since we are underwater on all of the... it basically goes up to 14 million in terms of the total value.

Unidentified Analyst

Okay, great. And then, I think you mentioned that on the cost cutting that you did, you didn't get the full benefit of that in the first quarter. Can you elaborate a little bit of that and say how much more sort of cost you have taken out, that's not reflected in the first quarter.

Alok Bajpai

Yes, George. See what happens is that, as we said in the beginning that we started seeing this downturn coming even in Q4. And obviously, we started looking at what are the cost cutting measures that we can take. One of the major initiative that we took was to somehow our staffing level so that our utilization doesn't worsen. Actually it has improved in the last quarter. So there was staffing level that we had to adjust.

Now that happens over a period of time, so it happened over different months of Q1 and there is always a cost associated which continues for may be a month or two months depending on the particular contractual obligations with the employee.

So now, all that has happened mostly in Q1, during those three months of Q1and the full benefit of that cost reduction on the payroll will of course come in Q2 and onwards. Similarly, anything that is related to staff in terms of travel expenses and those kind of expenses are also going to be definitely reduced in the quarter coming forward.

Unidentified Analyst

Okay. That's all for me. In fact you've done a great job managing your business. So congratulations.

Alok Bajpai

Thank you.

Vikram Gulati

Thank you George.

Operator

And there appear to be no further questions. At this time, I would turn the call back to you.

Vikram Gulati

Thank you operator. My hope for today's call is to leave all of you with a better sense of the current state of Intelligroup and our strategies and thinking. Though we can not predict how long or how deep the slowdown will be, we continue to focus on what we can control, which is exceeding our customers' needs and adjusting our cost structure to the reality of the industry demand.

We will selectively take advantage of growth opportunities and make investments in areas that allow us to recognize lasting competitive advantages. We believe that our efforts during the past few quarters will help better align our business with our customers and enhance our ability to act on their needs with even greater speed and efficiency.

As we continue to navigate our ways through un-chartered waters of the global economy and the IT sector, the value proposition of outsourcing and off-shoring persist. And in fact the off-shoring component with its very clear cost advantages has even become more attractive now than ever before.

In an effort to expand awareness of our company and to build our base of investment community relationships in the next week Alok Bajpai and I plan to visit investors in New York, Boston, San Francisco on a non-deal road show organized by Susquehanna Investment Group.

If you have any further questions or would like more information about the company, please contact our IR representative Norberto Aja at 212-835-8500 or via e-mail at [e-mail].

I thank all of you for joining us today. We look forward to keeping you inform of our progress at every quarter. Thanks again.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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