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NaviSite, Inc. (NASDAQ:NAVI)

Q3 2009 Earnings Call

June 4, 2009 5:00 pm ET

Executives

James Pluntze – CFO

Arthur Becker – President & CEO

Analysts

James Breen - Thomas Weisel Partners

Operator

Good day ladies and gentlemen and welcome to the third quarter 2009 NaviSite earnings conference call. (Operator Instructions) At this time, I would now like to turn the call over to your host for today’s conference, Mr. James Pluntze; please proceed sir.

James Pluntze

Thank you, good afternoon and welcome to NaviSite’s third 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 third quarter of fiscal year 2009 which ended April 30, 2009. We’ll also be providing an outlook for the fourth 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 in this call. Factors that could contribute to such differences include but are not limited to those items noted 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 third 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 operating 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 third 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 Becker

Thank you James and good afternoon everyone. We are pleased to report our results for the third quarter of fiscal year 2009. I’d like to first start with the financial results, discuss the operating results for the quarter, and then share our outlook for the fourth quarter of fiscal year 2009.

As reported in our press release an hour ago, revenue for the third quarter of fiscal year 2009 that ended on April 30, was $37.3 million which was at the upper end of our guidance range of $36.5 million to $37.5 million for the quarter.

Revenue this quarter represents a slight decrease of 5% compared to $39.3 million recorded in the same quarter last year and is down 1% from the $37.7 million reported in the second quarter of this fiscal year.

The decline in both the year over year and sequential revenue continues to be related to lower professional services revenue as we’ve discussed in our previous quarterly calls. Recurring revenue from our enterprise hosting and application management business was $35.4 million for the third quarter, within our guidance range of $35 million to $36 million and representing a year over year increase of 7% and flat sequentially.

The flat sequential revenue is mainly the result of slower installations of some of our larger and more complex enterprise hosting bookings during the first half of this fiscal year. We expect these accounts to begin generating revenue in the fourth quarter of this fiscal year.

Our professional services revenue was $1.8 million for the third quarter, a decline of approximately $4.2 million from the $6.2 million recorded in the same period last year and down from $2.0 million recorded last quarter. These declines reflect the decision we took earlier in the fiscal year to focus our offerings on our core recurring revenue business and to integrate the professional services unit as part of a life cycled management approach to our application services offering.

EBITDA excluding impairment costs, stock-based compensation, severance costs, and costs related to discontinued operations and other non-operational charges for the third quarter was $9.0 million representing a year over year increase of 4% and a sequential increase of 2%.

Income from operations for the third quarter was $1.7 million representing an 11% year over year decrease and a sequential increase of 12%. Net loss attributable to common stockholders for the third was $3.2 million or $0.09 a share as compared to a net loss attributable to common shareholders of $2.5 million and a loss per share of $0.07 in the previous year.

Moving on to a discussion of some of our key business metrics and operational highlights, we reported bookings of approximately $500,000 of new monthly recurring revenue, what we call MRR, during the third quarter. This is a slight decrease from $700,000 booked in the second quarter of the fiscal year and down from the $1.1 million booked in the third quarter of fiscal year 2008.

This level of bookings is modestly lower then our earlier expectations and reflects the slower pace of opportunities moving through the pipeline. Similar to the outlook expressed last quarter we do see this pace changing to the good, basically accelerating, and expect that some of these larger opportunities with enterprise customers that have been in our pipeline for some time will close during this current fourth quarter.

In the third quarter 49% of our MRR bookings came from new customers and 51% came from the existing installed base representing an approximate MRR booking per new customer of 3,760 compared to MRR bookings of approximately 2,500 for customer for our existing base.

Average contract length for the bookings in the third quarter was 22 months, down slightly from the 27 months in the prior quarter and 37 months for the third quarter of fiscal year 2008 when we closed a large collocation deal in the UK.

As I mentioned the lower bookings in the third quarter reflects our continued focus on larger enterprise transactions which do take a longer time to mature as well as the continued slower pace at which all of the opportunities seem to be progressing through the pipeline. We have seen a continuation of this pattern that first appeared three quarters ago and which deals are being escalated within the prospects organization to the C level managers for final approval and this extra step and its iterations have extended the time for deals to get done.

However our pipeline is appearing to remain quite strong and we have indications that some larger enterprise transactions will close during this current quarter. A few more metrics, NaviSite signed contracts with 54 new customers this quarter and we do see a continuation of our ability to attract a diverse set of customers and new customers because of our ability to provide a broad range of services.

With regard to the larger transactions which we have defined as those greater then $25,000 a month, we closed only one transaction during the third quarter that was greater then that and this transaction booked an MRR total of $47,000 per month. That is compared to the large deals that we booked in the second quarter of fiscal year 2009.

Despite the challenging economic times we have seen a growing interest from our enterprise customers for our application management solutions and complex managed services offerings. I’d like to take a moment to mention a few of the transactions that we closed during the quarter and give you some detail on actually the nature of the service that we’re providing.

So we’ve been attracting a number of these enterprise customers to our quite differentiated skill set and expertise which both lower the total cost of delivering service as well as simplifying the complexity of the full lifecycle of packaged applications.

Our particular expertise centers on the various business applications like Oracle or PeopleSoft, Lawson or Kronos. And the fact that most of these particular applications are relatively horizontal, has also helped us win customers in various industry verticals such as financial services, healthcare, business services, hospitality, and education.

For example a leading reprographics company in the US chose us to provide a total care managed service for their Kronos applications. Eastern Maine Healthcare Systems has selected us recently to provide a fully managed application service for their Lawson Software ERP systems which include activities such as migration upgrades, management, and the support of the application in the environment. Similarly a leading bank in the Western US also selected NaviSite to manage their PeopleSoft environment.

We continue to enroll customers as well for our core enterprise hosting offerings both on dedicated and cloud based platforms which I want to talk about for a minute, but before that I’d like to just say that eBay, the world’s largest online marketplace, selected NaviSite for its pro stores subsidiary for managed hosting services including SaaS enabling commerce applications for its users and related support services.

A leading healthcare technology and services provider selected us to manage all of their IT infrastructure and email messaging platform and similarly a leading media and communications company selected us to manage their entire server environment.

So just a quick note about existing customers because growing our existing customers with our broad suite of services is also a very important part of the stickiness and for example, Hyatt Hotels chain, a recent customer, recently selected us for additional services for Lotus Notes applications that now includes their European properties and the Hyatt Select brand in the US.

We’ve also now expanded the management of their PeopleSoft application environment to include their international markets in Europe, Asia, and South America. One of our longer-term customers, the largest private school of arts and design, chose us to add application management services for their PeopleSoft environment and another customer of ours, a web browser used in Blackberries around the globe also expanded its environment with us during the quarter.

As a general observation we’re seeing a positive traction in the ISV segment with current new prospects leveraging our platform and enterprise cloud capabilities to offer their software in a software as a service or subscription based model.

There is growing pressure on ISVs to be SaaS based, software as a service based, and we are engineering solutions to meet their specific needs. This is one area we are clearly being driven by market demand and the combination of our application management skills, good sized SaaS customer base and our technology platform position NaviSite to capture significant market share.

On the [S&V] front as well our platform-based offerings are seeing some growing momentum. We expanded our offerings during the quarter by adding hosted exchange to the service portfolio. I’d like now to turn the call back over to James, our CFO, for a more detailed look at the financial performance during the quarter.

James Pluntze

Thanks Arthur, as Arthur previously mentioned revenue for the third quarter of fiscal year 2009 was $37.3 million, down 1% from the second quarter of fiscal year 2009 and down 5% over the third quarter of fiscal year 2008 but within our guidance range.

This revenue decline as we mentioned was due to the expected lower revenue from our professional services business throughout the fiscal year which is down 71% from the same quarter last year and down 10% from the prior quarter.

Recurring revenue from our hosting and application management services was $3.5.4 million for the third quarter representing a year over year increase of 7%, essentially flat sequentially. Hosting revenue was also within our guidance range of $35 million to $36 million for the quarter.

NaviSite generated gross profit of $12.5 million or 33% of revenue for the third quarter of fiscal year 2009 as compared to $12 million or 30.6% of revenue for the same fiscal quarter of 2008 and $12 million or 32% of revenue for the second quarter of fiscal year 2009.

Our cash gross profit which excluded depreciation, amortization, and noncash stock compensation was 51% for the third quarter fiscal year 2009, up from 46% for the same quarter in fiscal year 2008 and up from 48% recorded in the second quarter of fiscal year 2009. The increase in gross profit and cash gross profit for the third quarter mainly reflects the decline of our lower profit professional services business during the fiscal year.

Income from operations was $1.7 million in the third quarter of fiscal year 2009 as compared to income from operations of $2 million in the third quarter of fiscal year 2008 and $1.6 million in the second quarter of fiscal year 2009.

The decline in income from operations compared to the prior year reflects increases in G&A expenses in the third quarter of fiscal year 2009. We saw increases in bad debt expense of about $300,000 due a couple of companies filed bankruptcy during the quarter and increased legal expenses of about $600,000 from our continuing arbitration with a former Jupiter hosting customer.

NaviSite reported a net loss attributable to common shareholders of $3.2 million for a loss of $0.09 per share for the third quarter of fiscal year 2009 compared to the net loss attributable to common shareholders of $2.5 million or $0.07 a share for the third quarter of fiscal year 2008 and compared to a loss of $3.3 million or $0.09 per share for the second quarter of fiscal year 2009.

The increased loss from the prior year reflects the higher G&A expense as well as increased interest expense for the current period. NaviSite recorded $9 million of EBITDA excluding impairment costs, stock-based compensation, costs related to discontinued operations, and other non-operational charges representing a 4% year over year increase and a sequential increase of 2% over the $8.8 million of EBITDA reported in the second quarter of fiscal year 2009.

The increase in EBITDA was mainly the result of our improved gross margin partially offset by increases in bad debt expense and legal expenses incurred in the quarter. Customer churn as defined by the loss of a customer or a reduction in the customers’ monthly revenue run rate for all of our customers remained low this quarter at approximately 1% per month compared to 1.3% per month in the third quarter of fiscal year 2008 and compared to 1% per month for the second quarter of fiscal year 2009.

Cash generated from operating activities was $5.4 million for the quarter which was up 46% from the $3.7 million generated in the third quarter of fiscal year 2008 and up 116% from the $2.5 million generated in the second quarter of fiscal year 2009.

Operating cash generation increased during the quarter mainly due to strong collection efforts which reduced our DSO or days sales outstanding, to 44 days for the third quarter from 47 days in the prior quarter and down from 46 days in the third quarter of fiscal year 2008.

During the third quarter we invested approximately $3.2 million in capital expenditures, about 76% of which was for specific customer installations with the remaining amount used for internal use and infrastructure upgrades. This is up from the $2.5 million invested in the second quarter of fiscal year 2009.

The company’s cash balance at the end of the quarter was $2.9 million which was about the same as the cash balance at the end of the second quarter as our increased cash generated from operating activities was used to fund the increased capital expenditures during the quarter and to pay down our debt by about $1.3 million during the quarter.

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

Arthur Becker

Thank you James, I’d like now to take this opportunity to discuss a few details about some strategic actions that we’ve taken to continue to improve our operating performance amid both the soft economic climate as well to increase our growth objectives for the next quarter and for the next fiscal year.

As we’ve previously announced we have consolidated our sales effort under Brooks Borcherding, Brooks joined us in April as the Chief Revenue Officer, and Senior Vice President of Sales, and is responsible for driving our sales strategy and accelerating the top line growth for the company.

Brooks joined NaviSite from Cisco Systems where he was responsible for strategy, planning, business development, and sales operations for the enterprise east division, responsible for driving revenue from large enterprise customers that will be a key attribute for NaviSite. Brooks is leading our sales and account management organization to better position our resources to address our expanding market opportunity.

We are experiencing a new wave of opportunity emerging from the enterprise market and we are leveraging our significant experience with application management, its knowledge base, set of tools and protocols, to address the demand by enterprise customers for cloud based services.

This service which we are calling our app structure cloud service is a clear differentiator for NaviSite and our goal to meet our enterprise customers’ demand for services based on virtualization with its associated benefits. We have several significant customers already using app structure and are in discussions with several very large prospects as well as a number of strategic vendor relationships to enhance and expand this very offering.

Somewhat unique to the market the NaviSite app structure platform has been designed to accommodate the varying needs and price points of application tiers rather then a one size fits all offering. Furthermore and quite unique our automation layer extends to these application related services making it easier for enterprise customers to automatically scale and provide better services for their end users.

The convergence of this innovative approach to cloud based fabric supported by our extensive application experience is anticipated to be an important competitive differentiator for NaviSite going forward.

I’d like now to move on to discuss some of the issues that we’ve mentioned in the past about the potential divestiture of certain collocation assets. We mentioned this in our last earnings call. Our strategic intent is to increase focus on our managed hosting application management and enterprise cloud solutions as well as importantly to de-lever our balance sheet.

Since the last earnings call we have formally engaged the Bank Street group to initiate a process to solicit interest in these collocation assets and we expect this process to start within the next week or so. We anticipate that we should be able to provide an update on our activities here within the next 60 to 90 days.

In addition I’m sure you’re all aware, but I’d like to update you specifically on the NASDAQ hearing that we held on April 23, 2009 where we presented our plan to NASDAQ, the NASDAQ listing qualification panel, to regain compliance for the continued listing in the NASDAQ capital market. The panel did grant us after a month deliberation continued listing subject to the condition that on or before August 24, 2009 we demonstrate evidence of stockholders equity of at least $2.5 million or compliance with one of the alternative criteria for continued listing.

We are planning to regain compliance through execution of the strategic plan on the potential divestiture of collocation assets as I mentioned which will allow us to reduce our overall debt burden and increase focus on the core managed hosting application management and enterprise cloud solutions.

Before closing, and before providing guidance, I would like to mention that NaviSite did not renew the lease on our data center, our collocation only data center, in Los Angeles. Despite attempts during the last two years to renew this lease, the landlord insisted on a rent increase at a significant multiple and we could not agree to a price that would allow us to continue to run that business profitably.

We reached an agreement however in which we transferred our customers back to the landlord and we let our lease expire. This will have an impact on our Q4 numbers. The lost recurring revenue from this exit is going to be about $1 million for the quarter specifically and the lost gross margin for the quarter of about $300,000.

And based on that and looking ahead we project recurring revenue for the fourth quarter of fiscal year 2009 to be between $34.4 million and $35.4 million which reflects the reduction in recurring revenue from our lease expiration in that Los Angeles data center. We project total revenue to be between $36 million and $37 million. EBITDA excluding impairment costs, stock-based comp, severance, and costs related to discontinued operations as well as non-operational charges is projected to be between $8.5 million and $9 million for the fourth quarter of fiscal year 2009.

I would like to say that going forward we are reevaluating our guidance policy and may provide annual guidance at the next earnings call or eliminate guidance all together following suit of other companies in the hosting space.

On behalf of NaviSite I would like to thank you for your attendance and now I would like to open it up for questions from our listeners.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of James Breen - Thomas Weisel Partners

James Breen - Thomas Weisel Partners

Just a couple of quick questions, first one there’s that nice bump up in EBITDA margins this quarter wondering if that’s going to be a good run rate going forward and if you’ve seen pretty much the majority of the professional services business stabilize now.

Arthur Becker

I think that we’ll see same quarter comps stabilize now after the fourth quarter because pro services really declined dramatically beginning Q1 of this fiscal year so we think that pro services business will no longer be impairing results after this fourth quarter.

James Pluntze

I think you can sort of derive that professional services number by looking at the revenue guidance and subtracting out the hosting guidance and you can see where we’re thinking pro services is going to be in terms of its guidance for the fourth quarter. And as far as EBITDA guidance we are sort of guiding in the same range which I would think would indicate to you that we are comfortable that that is a range we can continue to maintain.

And we also saw some incremental G&A expenses this quarter so had we not seen the bad debt expense or increased legal expenses for the quarter we might have seen a little bit higher EBITDA for this quarter even.

James Breen - Thomas Weisel Partners

And then if you could maybe talk a little bit about CapEx going forward, where it could be and how it might break out.

James Pluntze

CapEx is related to our, the success of our bookings so as bookings would increase we would expect to see a need for CapEx. I think we’re cognizant that we don’t want to spend too much on CapEx. We want to make sure that its something where our customers are benefiting, we’re benefiting so I would think that the range that we have been in, sort of the $2.5 million or so to $3 million a quarter is kind of the range we would expect to continue to be in.

James Breen - Thomas Weisel Partners

Any update on America’s Job Exchange.

Arthur Becker

Yes, we decided to respond to questions on that rather then make an announcement. James why don’t you just give them a quick summary on that.

James Pluntze

As you know we’ve disclosed this as a discontinued operations for, now its in the second year and we are holding that out for sale. We’re continuing to take offers on that and the business itself continues to move forward and I think revenue has been growing reasonably well. I think you can see that we’re reporting its essentially EBITDA and cash flow neutral so its not taking away profitability from our business.

So we’re hopeful that we’ll find the right home for it at some point in the future but until then, we’ll maintain our investment in order to continue its revenue growth but also watch the profitability and cash flow to make sure that it doesn’t detract from our overall business.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Arthur Becker

Thank you all of you who did attend and we’ll speak to you after the end of our fiscal year. Thank you very much.

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Source: NaviSite, Inc. F3Q09 (Qtr End 04/30/09) Earnings Call Transcript
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