Ness Technologies, Inc. Q3 2009 Earnings Call Transcript

Nov. 3.09 | About: Ness Technologies, (NSTC)

Ness Technologies, Inc. (NASDAQ:NSTC)

Q3 2009 Earnings Call Transcript

November 3, 2009 10:00 am ET

Executives

Drew Wright -- SVP, IR

Sachi Gerlitz -- President and CEO

Ofer Segev -- EVP and CFO

Analysts

Avishai Kantor -- Cowen & Company

Manish Hemrajani -- Oppenheimer

Jose [ph] -- Oscar Gruss

Operator

Good morning. My name is Felicia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Ness Technologies third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator instructions)

I would now like to turn the call over to Mr. Drew Wright, Senior Vice President, Investor Relations for Ness. Mr. Wright, you may begin.

Drew Wright

Thank you Felicia. Good morning and welcome to the Ness Technologies third quarter 2009 earnings call. In today’s call, we will review our results for the quarter ended September 30th, 2009.

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

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

Some of the factors that could cause future results to materially differ from recent results of those projected in forward-looking statements are the risk factors described in Ness’ annual report on Form 10-K filed with the Securities and Exchange Commission on March 16th, 2009. Ness is under no obligation and expressly disclaims any obligation to update or alter its forward-looking statements whether as a result of such changes, new information, subsequent events or otherwise.

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

Leading our call today are Sachi Gerlitz, President and CEO; and Ofer Segev, Executive Vice President and CFO. Sachi, please go ahead.

Sachi Gerlitz

Good morning. Thanks for joining us on the call today. We are continuing to weather the tough economy, as slow economic recovery in Europe led to lower revenue for the quarter, and our typical second half topline boost may not materialize this year. Overall, we are continuing to see pipeline growth and we talked about last quarter, and we are starting to close new deals again, some of them respectably large. Sales cycles are still longer than normal of course.

We continue to focus on cost management and particularly streamlining certain parts of our business, which were most affected by the recession, such as Europe and Asia-Pacific. Our cost management in third quarter is working to our advantage now, and more importantly, we believe we are taking the steps needed to kick start growth in 2010.

Ofer, would you take us through the numbers, please?

Ofer Segev

Thanks Sachi. Good morning everyone. First, a reminder, as we go through our GAAP results, I will refer to non-GAAP results as well. To help understand the underlying performance of Ness, we calculate non-GAAP P&L metrics that exclude one-time gains, one-time expenses and recurring non-cash items.

Today’s earnings press release contains a non-GAAP reconciliation table that details these amounts. The only items excluded from the third quarter of ’09 are stock-based compensation and amortization of intangibles.

Revenues for the third quarter were $133 million, down 19% year-over-year and currency headwinds of $9.3 million and on slower sales in our System Integration and Software Distribution segment, and down 4% sequentially. We expected sequentially higher revenues increase in Q3 and the shortfall was due largely to the fact of the bottoming out of the recession in Europe is taking longer than we anticipated.

Backlog at the end of the quarter was $655 million, down 4% sequentially in dollar terms of 6% in constant currency, and down year-over-year 14% in dollar terms or 11% in constant currency. Backlog for the coming 12 months was 55% of total backlog at September 30th, within our normal range of 55% to 60%.

Revenues by customer geographical region for the quarter were Europe, North America and Israel at 32% each, and the rest of the world 5%. Gross profits for the quarter were $36 million or 27.1% of revenue, up from 26.3% in the third quarter of ’08 and flat sequentially. Operating income for the quarter was $2.1 million. On a non-GAAP basis, operating income was $5.1 million, or 3.9% of revenues, down 58% compared to $12.8 million or 7.4% of revenues in Q3 of last year and flat sequentially.

Non-GAAP EBITDA for the quarter was $7.9 million or 6% of revenues, down 48% for $15.2 million or 9.1% of revenues in the third quarter of ’08 and flat sequentially. Financial expenses were $400,000 in the quarter, down from $1.2 million in Q3 of last year, due to lower interest rates on our long-term debt and the small beneficial effect from exchange rate fluctuations. Our effective tax rate for the quarter was 50%, temporarily well above our normal range. The main reason for the high tax rate was losses in some jurisdictions in Q3, which could not be offset against income in other tax jurisdictions.

Quarterly GAAP net income was $840,000. On a non-GAAP basis, net income was $3.3 million, down 65% compared to $9.4 million in Q3 of last year. Quarterly GAAP earnings per diluted share were $0.02. On a non-GAAP basis, diluted EPS was $0.09 compared to $0.24 in the third quarter of ’08.

Our balance sheet is healthy. At the end of September, cash and cash equivalents and short-term deposit was $71 million, up from $59 million at the end of December. We had about $13 million of short-term debt and about $81 million of long-term debt, of which about $23 million is due in the next 12 months. Most of the long-term debt is 4 to 5 year long, taken during the last two years to fund acquisitions, with weighted average interest rate of about 5%. We remain in our comfort zone regarding liquidity.

Trade receivables were $138 million versus $200 million at year-end, while unbilled receivables were $42 million, down $3 million from year-end. Unbilled receivables as a percentage of total trade receivables were 23%, down slightly from 25% in third quarter of ’08. Days sales outstanding at quarter-end was 73 days, down from 80 days at June 30th, remaining a range despite the tough environment, thanks to solid collections.

Remember that in calculating DSOs, we exclude VAT and software vendor pass through from our trade receivables since these amounts don’t represent revenues for Ness. Our goal is to maintain DSOs in the range of 70 to 80 days. We delivered solid operating cash flow of $16.1 million in the third quarter. Our year-to-date operating cash flow of $34.5 million are the highest we have ever had in the first nine months of the year. Out total headcount at September 30th was flattish at about 7,780 employees, while our headcount in India increased for the second quarter in a row.

In terms of operating segments, our Software Product Engineering segment continued to generate strong operating margins, delivering 14.1% in the quarter, up from 12.2% a year ago. Revenues were flat sequentially and down about 2% year-over-year, largely because of the rate reductions we experienced in Q2, contributing to a smooth quarter in Q3. Operating margins were slightly lower than prior quarters, mainly due to these rate reductions. For the rest of the year, we expect Software Product Engineering operating margins to be in the range of 14% to 15%, with revenue growth resuming in 2010.

Our System Integration and Application Development segment continued to be impacted significantly in the third quarter by the economic slowdown. The segment delivered a non-GAAP operating margin of 4%, flat sequentially with a year-over-year constant currency revenue decline of 14% and a sequential revenue decline of 4%. In this segment, our revenues and earnings recovery much more slowly in Europe than we expected due to the extended economic slowdown there.

Our Software Distribution segment turned in a non-GAAP operating loss of 6.8%, below our expectations for the seasonally weak third quarter. Revenues in the segment dropped 40% year-over-year, and by 7% sequentially, partly due to the divestitures of our Israeli SAP licenses and distribution operation last August 2008 and partly due to economic conditions.

So, to summarize, our revenues were weaker in Q3 than we anticipated, while our non-GAAP operating margin net income and EPS were in line with our expectations, and operating cash flows were very strong.

Back to you, Sachi.

Sachi Gerlitz

Thanks Ofer. Let’s take a look at the business, and I will tell you how things are looking for each of our three operating segments. As Ofer mentioned, our Software Product Engineering segment did well on margins in Q3. The trend that we had mentioned before of construction in smaller labs and increase in larger labs continued, with the net effect being more of less flat billable headcount during the quarter.

As we expected, the pricing pressure experienced during the first two quarters has stopped, but it impacted this segment’s revenue growth in Q3. Our delivery operation in India remained very efficient. Employee’s attrition rate in India are still below historical levels, due to the economy, though they are peaking up a little and wage inflation is still low. During Q3, we launched a Special Economic Zone or SEZ facility in Bangalore to help moderate our Indian tech support future yields. We operate over 50 software products labs in India and Eastern Europe.

We signed five new multimillion dollar SPL deals in Q3, three with the new clients and two with affiliates of current clients. Three of the new deals was sold via our consistent team, in which with blessings of existing labs customers, we sell through to their customers and partners. During Q3, we launched a new SPL service campaign related to Agile, a super-efficient programming, the technology [ph] used in many of our labs. This campaign resulted in 85 new target account and we will be working those leads in the coming months. In addition, we are just about to launch our first major SPL sell initiative in Europe.

Our System Integration and Application Development segment experienced more topline pressure in Q3 than we expected. Here too, the effects of Q2 rate reduction for the full third quarter was a factor, but the bigger issue is that the bottoming out of the recession in Europe is taking a long time.

Our financial services vertical is continuing to see pipeline recovery in the US and in Israel, while it remains a challenge in the CEE region. Our defense and homeland security business has good pipeline activity in Q3 and is delivering margin well above the corporate average. The utilities and public sector is improving in CEE and in Israel, with some nice swings in Q3 and good pipeline activity. The recession affected mostly the industrial sector, which showed no improvement in Q3, and the healthcare sector was flat.

Let’s go through the details starting with Europe. Despite the continuing tough economy, we started to grow backlog again in Europe. We had two very nice wins in the quarter, which we hope to announce shortly. One was a (inaudible) municipality for $7.5 million and one was Arcadia [ph] Bank for $5 million as well as several smaller wins. In Slovakia, we are making progress in the large public sector deals, which we have mentioned last time. You will read about one of them soon, a $16 million deal for land registry system for the Slovak government. This deal by the way, it is one which we expect to expand there furthermore.

We also won a $6 million deal with a large electrical power company and other large public sector deals are advancing in the pipeline as well. In Hungary, we had a nice multimillion dollar win with Pannon, a leading Hungarian mobile operator for a strategic three-year CRM solution. In Israel, our commercial and to win a business was also a little light in revenue. The public vertical is showing relative strength. In the quarter, we had a very nice win at the Israel Electric Corporation for the implementation, deployment and taxing of enhancement and extension to a very large integrated at the DC spend. And Israel’s National Water Company, Mekorot selected us a multimillion dollar SAP implementation.

We also closed an important extension to our multi-year contract engagement to Tel Aviv Academic College. In our defense and homeland security vertical, revenues slowed a little in Q3, largely due to the timing of contract award, while operating margins remained very strong. We had several wins during the quarter, and completed several successful field trials of customers’ deliverable, but most importantly, we saw a lot of growth in our pipeline and we bid on a record number in the dollar volume of opportunities.

We also completed negotiation on some new deals, but we are saving time to count, the September 30th backlog. In North America, we won a number of new deals, including some key win backs deals, which were originally awarded to competitors, then re-awarded to us. We continue to build out North American sales team to enable topline growth again. As you know, our System Integration segment, it’s all about scalability. One application of this slow growth or even contraction is a small business unit, it can become a drag on the company results. And it’s even worse once the economic situation is more demanding.

We have a few cases like this, especially when we have a small geographic footprint and we have won relatively large and complex projects. In the current environment, we believe that such projects are best served via our best-of-breed global delivery model, rather than relying only on local resources. Therefore, we have decided to restructure these small operations and related projects. We have already started this process, and we expect to complete the restructuring in the fourth quarter.

Moving on, our third segment, Software Distribution is still struggling with a slower demand for enterprise software licenses. A part of our NessPRO market is in Italy and Spain where the recession is still in full force. Total Software Distribution revenue for the quarter was about three quarters of normal. The expense cut that we took earlier in the year are helping, but the Q3 revenue shortfall in this segment still led to underperformance. We had some large license deals in the pipeline, which we have said now for several quarters. Based on what we have seen, we think that some of them will close in Q4 on normally stronger quarter for this vertical.

Finally, a few other Q3 accomplishments. One key achievement was the door lifting of our Tel Aviv Stock Exchange in mid-September, and the subsequent issue of the inclusion of Ness into the Tel Aviv 100 Stock Index. The door lifting reinforce our visibility and stature in Israeli marketplace, and we believe it will make our share acceptable to a range of new investors and funds, including index funds, which tracked the Tel Aviv 100. We have already seen an increase in our aggregate trading volume, increasing liquidities for institutional investors.

Another significant milestone was our recent joining of the United Nations Global Compact, a UN initiative that quotes for companies to voluntarily align their operation and strategies with 10 universally acceptable principles in the area of human rights, labor environment and IT core option. As the company already resulted to social responsibility and environmental issues, NessPRO immediately accepted to the UN Global Compact.

On the market front, Ness was ranked 54 on the 2009 InformationWeek 500, and annual ranking of the 500 multi-innovative users or business technology in the world. And this was also ranked in the top 100, Software Magazine's Software 500 for the world’s largest software and services providers, a third year it has been for honored. And just last week, Ness was included in the FinTech 100, an annual international listing of the top 100 global application and service providers to the financial services industry. We were ranked 45th, advancing from last year’s 47th position.

Finally, looking forward, we have scheduled our Annual Investor and Analyst Day for Friday, November 20th at the NASDAQ marketplace here in New York. We have a powerful lineup of Ness’ executive from SPL Europe in Israel, and as we speaking about differentiation and globalization as well, plus we have customers get speakers representing several geographic regions, Ness’ business units differentiated Ness re-selling the proposition and industry vertical. Please contact Drew if you are interested in attending.

Ofer, would you present our financial guidance, please?

Ofer Segev

Thanks Sachi. Baking in our Q3 revenue shortfall and the corresponding anticipated topline pressure in Q4, both largely attributable to the delayed economic recovery in Europe, we are lowering our revenue guidance for the year to the range to the range of $540 million to $550 million. As Sachi mentioned, we intend to restructure certain small operations and related projects in Q4. We expect a restructuring charge of $7 million to $9 million in the quarter. Therefore, we are lowering our full-year non-GAAP diluted net earnings guidance to between $0.36 to $0.40, and our full-year GAAP EPS guidance including the anticipated restructuring charges to a loss of between $0.08 to $0.14.

The major factor that could cause us to swing to the high end or the low end of our guidance ranges is the timing of closing certain large licensing deals in escrow, which could impact Q4 either way.

To you, Sachi.

Sachi Gerlitz

Thanks Ofer. It has been tough for three or four quarters, and we are working very hard now to go beyond the cost efficiencies that has helped us to remain profitable to the topline growth that we and you want to see. The biggest question mark remains the timing of the economic recovery in Europe. We are working hard to further differentiate ourselves in the marketplace, making steady progress in the globalization of our offering, processes and delivery capabilities, and continuing to enhance our already strong domain expertise.

I will talk more about those points at the Analyst Day. Thanks to our over 7,800 employees in 18 countries for all your hard work and commitment, and thanks to our shareholders for your continuing support.

That concludes our prepared remarks. Felicia, let’s take questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Moshe Katri with Cowen & Company.

Avishai Kantor -- Cowen & Company

Hi, it’s Avishai Kantor for Moshe.

Sachi Gerlitz

Good morning Avishai.

Avishai Kantor -- Cowen & Company

Hi. Two or three questions, I guess the first question basically, are the slower-than-expected revenues in Europe coming from cancelled deals, delayed funding for deals that were awarded, slower conversion from the pipeline to actual contracts, I mean what exactly is the – which one of those basically?

Ofer Segev

I would say that the first contribution to the slower revenue in Europe is a slow conversion of opportunities to bookings and from bookings to revenue. We saw for the first time after a few quarters where the booking in Europe increased, which is a very good sign, but still the conversion to revenue is slower.

Avishai Kantor -- Cowen & Company

Understand. And any specific verticals are more affected?

Ofer Segev

Say that again, verticals?

Avishai Kantor -- Cowen & Company

Which specific verticals basically are the most affected by that slower conversion rate?

Sachi Gerlitz

I would say that two verticals are most affected. Financial services, there were people that little bit slower in starting up a new project and into a large extent the public sector, which was planning to launch some of the new deals in Q2 to Q3 time frame, and it’s moved to Q3 to Q4 time frame. So, some of the booking will take place only in Q4. This, I would say, is a major reason for shifting the revenue from Q3 to Q4 time frame to 2010. The good news is that we have seen these deals come in, and as I said in my prepared remarks, some of these deals have already been booked, and we will be able to announce them in the next, say, few days or week.

Avishai Kantor -- Cowen & Company

Okay. Are those deals from existing customers, from new customers?

Sachi Gerlitz

Both.

Avishai Kantor -- Cowen & Company

From both. And what’s the mix between, I mean, can you break down the mix of those deals between existing and new customers?

Ofer Segev

It’s very difficult to answer the question, because, let’s say, for Slovak government, if you look at the government as one entity, and you would say it’s an existing customer, but agencies go to different mechanism to purchase, and therefore, I would say some of it is new customers.

Avishai Kantor -- Cowen & Company

Okay. And my last question for (inaudible), can you elaborate on any hiring plans, again sort of remaining of the year specifically in India?

Sachi Gerlitz

We can’t say because we watch our bench very carefully. We hire only as we get the booking coming in. We really don’t hire in anticipation. We do see some pickup in India over the last, I would say, I think this quarter, we grew in India a little bit and we probably will grow moderately in India in Q4 also. But in the rest of the world, it’s really taking it one project at a time and then we hire the people.

Avishai Kantor -- Cowen & Company

So, should we assume basically moderate growth in India and flattish in the rest of the world for Q4?

Sachi Gerlitz

Yes.

Avishai Kantor -- Cowen & Company

Okay. What’s the headcount in India?

Sachi Gerlitz

One second. 2,800 people in India.

Avishai Kantor -- Cowen & Company

Great. Thank you very much.

Sachi Gerlitz

Okay. Thank you Avishai.

Operator

(Operator instructions) Your next question comes from the line of Manish Hemrajani from Oppenheimer.

Sachi Gerlitz

Good morning Manish. Well, actually good evening.

Manish Hemrajani – Oppenheimer

Good morning. Can you hear me?

Sachi Gerlitz

Yes.

Manish Hemrajani – Oppenheimer

Can you comment on the pipeline geographically, and what the status with the healthcare vertical, does it still remain depressed as you indicated last quarter?

Sachi Gerlitz

We have seen in last quarter some construction in our healthcare vertical, mainly due to rate cuts. And what we have seen this quarter that rate cuts did not continue. We are in a stable, pricing environment, and therefore, I would say it’s kind of a flattish in Q3. We are expecting growth coming to this vertical from some public deals in Europe that have been delayed and probably would be on the verge between Q4 and to 2010.

Manish Hemrajani – Oppenheimer

Also, can you comment on the pipeline geographically, where you are seeing deals coming in from?

Sachi Gerlitz

We have a very solid pipeline on the different vertical where we hope to see very nice conversion going forward. In the Central and Eastern Europe, our strongest pipeline is coming from the Czech Republic, mainly in the public vertical, but some also from financial services. In Slovakia, the strongest pipeline is coming from the public and the utility vertical. In Israel, the pipeline is strong on the public vertical as well. And I think we feel probably where we are.

Manish Hemrajani – Oppenheimer

Okay. On the headcount, if I am correct, you shrunk by about 20 heads this quarter from last quarter. Where do you see this shrinkage, what weakens and where are you adding people?

Sachi Gerlitz

We are adding people in India and we are contracting in, actually the rest of the world.

Manish Hemrajani – Oppenheimer

Okay. So, everywhere except India, you are basically cutting heads?

Sachi Gerlitz

Yes.

Manish Hemrajani – Oppenheimer

If I look at your full-year guidance, it implies pretty much a flat sequential growth in Q4, a little uptick but generally flat, how should we view this? I mean, are you seeing Europe pretty much non-existent or are you being conservative here on Q4?

Sachi Gerlitz

I think what we have learnt in the last, let’s go to three quarters, that we had to be very conservative on the pace of conversion from pipelines to bookings and revenue, and really looking at Q3 assuming looking at the headcount, assuming we will be at the same levels during the quarter, it did translate very closely to same revenues and plus or minus the vacation stories, and then the upside could come from NessPRO. In Q4, this business delivers clearly a big effect on revenues, but mostly affect on the bottom line. And so, we do expect some end-of-the-year deals in Europe, and that we will have an effect on revenue, those are not so much in the helping them defrost with them all, somehow as usually in Q4. This is the way we look at it now. And I guess you want to be this time more conservative than anything else.

Manish Hemrajani – Oppenheimer

Okay. Thank you very much.

Sachi Gerlitz

Thanks Manish.

Operator

(Operator instructions) Your next question comes from the line of Ziv Tal from Oscar Gruss.

Jose -- Oscar Gruss

Hi, this is Jose [ph] on behalf of Ziv Tal. I guess, one of the process for TSG next year in 2010, especially given the competitive landscape and competition from local companies?

Sachi Gerlitz

Can you repeat the first part of your question?

Jose -- Oscar Gruss

Yes, I am sorry. What are the prospects for TSG limits in 2010?

Sachi Gerlitz

Our defense and homeland security verticals set from TSG business unit, and the goal for 2009 was to have more than 50% of its revenue outside Israel. And I believe that we will meet or exceed this goal this year, and the trends will continue to grow, as if we look at the pipeline and the deals that are awarded to the defense and homeland security vertical, the trend will continue to grow. We are facing a competition from international players and are searching some competition from industry leaders coming from Israel, but so far, I think that our booking and winning ratio are totally in line with our expectations, and the value proposition that we have mostly based on the IPs that we have developed and the fact that we have seen trial or live experience by the Ministry of Defense in Israel is helping us a lot in selling our services outside of Israel. Frankly, we are selling our services in over 11 countries outside Israel.

Jose -- Oscar Gruss

So, thanks. And let me enter into Eastern Europe, meaning, what countries were hurt more or less by the recession? Hungary, Romania, you mentioned a lot about Slovakia, and what start programs you plan on take to advance in those areas?

Sachi Gerlitz

I would say that all four countries, the Czech Republic, Slovakia, Hungary, and Romania were affected by the recession. I think that the large effect that we had was in Romania. Second to that, I would say it was Slovakia, but in Slovakia, we see a very nice recovery. With the recent wins in Q3 and anticipation for good pipeline in Q4. The Czech Republic was lagging. We hope full recovery in Q3, and we see recovery in the bookings in Q3, but some of these projects are slow to start. We have issued in the Czech Republic because of the election being delayed for another year. So, it tumbles the government projects that were about to be issued, is being delayed a little bit. And we hope this would be recovered. Hungary is suffering very much from the recession, but I think that we are very smooth operation, not only being able to maintain the profitability that we expected from our Hungarian operation, but also we need new deals from new verticals, getting into the telecom vertical, it was new for Ness, but definitely new for Ness Hungary and this is a good example of where our strategy is working to create more differentiation and competitive advantage where we can enter new vertical, because of experience and knowhow that exists in Ness, and we can bring it to another country.

Jose -- Oscar Gruss

Thank you. Just one last question. You mentioned, someone asked before, that as far as growth, India will be, you should say the growth in the rest of the world will be flat, is that referring to next quarter or also next year?

Sachi Gerlitz

The answer actually was what happened in Q3. So, we refer to – you have to remember in India, we have two operations. One is our SPL Software Engineering business, which we said going to be flattish and other is in the System Integration piece that’s coming from the US, and we refer to India business, we refer to all of it together, the number of employees. So, that’s why the confusion, probably in the SPL, we will see flat growth and growth in our delivery in the System Integration piece, which is mainly financial services to the US.

Jose -- Oscar Gruss

Okay. Great, thank you very much.

Sachi Gerlitz

Thank you.

Operator

There are no further questions at this time. I would like to turn the call back over to management for any closing remarks.

Sachi Gerlitz

Thank you Felicia. Thanks for joining us today. We will speak to you again when we report our Q4 results at the beginning of February. That concludes today’s call. Thank you and have a good day. Bye.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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