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Executives

Jim Pluntze – CFO

Brooks Borcherding – President and CEO

Analysts

Alex Kurtz – Merriman & Company [ph]

NaviSite, Inc. (NAVI) F1Q2011 Earnings Call Transcript December 8, 2010 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the fiscal year 2011 first quarter NaviSite earnings conference call. My name is Dick, and I will be your operator for today. (Operator instructions)

I would now turn the conference over to the Chief Financial Officer, Mr. Jim Pluntze. You may proceed.

Jim Pluntze

Thank you. Good afternoon and welcome to NaviSite's first quarter fiscal year 2011 earnings conference call. Today, Brooks Borcherding, NaviSite's President and Chief Executive Officer, will begin by discussing our key accomplishments over the past quarter. I'll then review our financial results and business highlights for the first quarter, which ended October 31, 2010. I'll then conclude with our outlook for revenue and adjusted EBITDA for our second quarter of fiscal year 2011 before turning the call back over to Brooks for closing comments.

First, I'll read the required Safe Harbor statements. Please be aware that the information we're about to discuss includes forward-looking statements for the purposes of the Safe Harbor provisions of 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 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 adjusted EBITDA and cash gross margin performance for the first quarter of fiscal year 2011. Please note that adjusted EBITDA and cash gross margin are not recognized measures for financial statement presentation under United States Generally Accepted Accounting Principles, U.S. GAAP. The company believes that the non-GAAP measures, such as EBITDA, adjusted EBITDA, and cash gross margin provide investors with useful supplemental measures of the company's actual and expected operating and financial performance.

EBITDA, adjusted EBITDA, and cash gross margin do not have any standard definition and therefore may not be comparable to similar measures presented by other reporting companies. Management uses these measures to assist in evaluating the company's actual and expected operating and financial performance. These non-GAAP results should not be evaluated in isolation from or as a substitute for the company's financial results prepared in accordance with U.S. GAAP.

Tables reconciling the company's reported net loss to adjusted EBITDA and gross margin to cash gross margin are included in the condensed, consolidated financial statements in NaviSite's first quarter financial results press release.

In addition, in regards to the unsolicited offer made by Atlantic Investors LLC, a special committee of our Board of Directors unanimously rejected the offer on August 6, 2010. O On October 20, 2010, an amended 13D was filed mentioning that on October 19, 2010 subject to the terms of the confidentiality agreement, Atlantic submitted a revised offer with no additional details. The committee has indicated in a press release that it continues to consider strategic alternatives available to NaviSite, including maintaining NaviSite as a standalone public company.

NaviSite does not intend to disclose developments with respect to any consideration of strategic alternative unless and until the committee and the Board of Directors have approved a specific course of action. We will not be able to make any further comments relating to this topic on the call today.

Now, I’d like to turn the call back over to Brooks Borcherding, NaviSite's President and Chief Executive Officer.

Brooks Borcherding

Thank you, Jim, and just to commend you on the excellent job you do on the safe harbor. And I want to welcome everyone to today's call. Well Q1 was an exciting quarter for NaviSite, as it represents our first full quarter with our new managed cloud services offering. And I’m pleased with our performance.

Let me start with the headline results, and then provide specific details around our cloud progress. Total revenue for Q1 was $33.4 million, representing a 9% year-over-year increase and 2% increase versus prior quarter. Adjusted EBITDA for Q1 was $7.7 million, representing a 20% increase year-over-year and 7% increase versus prior quarter. And we also delivered another solid bookings quarter at $600,000, representing 49% increase year-over-year, and a 7% increase versus prior quarter.

We continue to successfully manage churn at 1.2% per month for the quarter, representing what we believe to be best in class performance.

In Q1, we experienced particular success with our new innovative enterprise class cloud offering, which we brought to market in June. Cloud represented a significant portion of our success in the quarter as we closed 13 new cloud contracts with immediate bookings of $50,000. In addition we recognized $27,000 of incremental bookings for our 4 initial cloud customers, reflecting their consumption of cloud resources above and beyond the originally booked right to use fees.

Combined, this represents total quarterly cloud bookings of $77,000 of monthly recurring revenue or 13% of our overall quarterly bookings. And as we experienced with our initial cloud customers, we expect the actual revenues related to these new cloud bookings to grow substantially, as customers embraced our managed cloud services for their business. Going forward, we plan to continue reporting the true up to the bookings each quarter to capture the incremental cloud revenues based on actual billings to more accurately reflect the direct contribution of cloud to our results.

And looking ahead, we expect to lead the revolution in IT managed services through the innovation we are bringing to market with our enterprise class managed cloud services. We’re positioning our cloud platform both as a compelling stand-alone infrastructure as a service offering, as well as an enabler of our core enterprise hosting and application management solutions.

Cloud opportunities already represent more than 14% of our total pipeline and continues to grow in an accelerating pace. NaviSite is quickly establishing a leadership position in the enterprise cloud market, which represent significant long-term growth potential for our business. Jim will provide more details on our financial performance later in the call. But I would like to take this opportunity to highlight a few of our cloud success stories from Q1.

First Marblehead, a leading provider of private student loans for lenders, credit unions and schools, selected NaviSite’s cloud enabled managed application offering for their Oracle EBS environment. First Marble had selected NaviSite over other cloud providers based on our comprehensive enterprise class security framework, and ability to accommodate their specific requirements as they moved their mission-critical applications to the cloud.

Keen [ph], and IT services firm, headquartered in the US, with more than 12,000 professionals worldwide chose NaviSite for its customer training and demonstration applications. They also plan to host their customers SAP application environments on the NaviSite platform. Keen selected NaviSite’s cloud offering for the flexibility and cost effectiveness of our solution, as well as the ability to offer their clients fast deployments of new environments.

iSentry, a UK-based provider of intelligent products for secure messaging, identity management and verification, digital signing and digital encryption choose the NaviCloud platform specifically for its regulatory compliance and security [ph], which is paramount for their business with US financial companies. iSentry's Digital Content Exchange offered in the US through Wolters Kluwer Financial Services, is used by tens of thousands of mortgage professionals everyday in the US as part of their mortgage workflow.

Another UK company, Exponential-e, a leading network services company, that designs custom LAN solution is using our cloud platform to provide one of their financial services customer with a private hybrid cloud solution. NaviSite was selected based on our technical excellence, flexibility, and ability to meet the tight timelines for the project.

Also one of the world’s leading battery companies selected NaviSite to host its Epicor ERP application. NaviSite will deliver a hybrid solution with the production application running on a traditional hosting environment, complemented by disaster recovery on the cloud. This is a great example of how leading enterprise companies are adopting hybrid solutions to better meet their business needs.

Springfield Clinic [ph], a long-standing customer of our PeopleSoft managed application services signed a 60 month early renewal and upgrade contract to take advantage of the flexibility of the NaviCloud platform, and are migrating their HR and financial modules to the cloud.

Springfield Clinic and all of our customers enjoy the financial and time-saving benefits of having their future upgrades included as part of our unique offering. And finally I’m thrilled to announce that one of the world’s largest insurance carriers has moved forward with the formal cloud trial of our NaviCloud platform, as their platform for all tests and development environments. We look forward to the successful completion of the trial and the opportunity to progress our partnership in the coming quarters.

These customer references are early proof points that we have made the right investments in our cloud infrastructure, and brought to market a truly innovative and differentiated solution to specifically address the needs of enterprise customers. A great example of our continuing innovation is represented by our most recent enhancements to our cloud offering, including role-based access control, dynamic resource instrumentation, and airlock which provides automation to import virtual machine images into the NaviCloud environment.

These enhancements offer compelling new capabilities for enterprises to better leverage our cloud solution for their specific business needs as a truly seamless extension of their in-house IT capabilities. NaviSite is uniquely poised with our applications management heritage, enterprise hosting expertise, and secure enterprise class services to deploy and manage these mission critical enterprise applications as they migrate to the cloud.

Our focus now is to execute on the conversion of the cloud pipeline, increase our market coverage through new indirect channels and accelerate our innovation to ensure we continue to distance ourselves from other cloud providers targeting the enterprise cloud space. And one final comment on our cloud development.

We will soon be adding significant incremental capacity to our cloud to meet growing customer demand. This expansion includes additional capacity in Andover, activation of our San Jose cloud node [ph] in January, and construction of our UK cloud node, which we expect to have online by early spring.

At this point, we will turn the call over to Jim to review our financial results. Jim.

Jim Pluntze

Thank you, Brooks. During the call today, I will be providing some additional details about NaviSite's first quarter fiscal year 2011 financial results, which ended on October 31, 2010, and then provide an update on NaviSite's second quarter fiscal year 2011 guidance.

The first-quarter results represent another solid quarter across-the-board from an execution standpoint. Our performance this quarter was primarily driven by the growth of recurring revenue due to the implementation and revenue generated from some of our recent large customer wins. The revenue growth enabled us to meet the high end of our revenue guidance range, and exceed the high end of our adjusted EBITDA guidance range.

As reported in our press release earlier today, total revenue for the first quarter ended on October 31, 2010 was 33.4 million, which was at the upper end of our guidance range of 32.9 million to 33.4 million, and represented a year-over-year increase of 9% and a sequential increase of 2%. Recurring hosting revenue was 32.9 million for the first quarter compared to 29.6 million in the first quarter fiscal year 2010, and compared to 32.4 million in the prior quarter, an increase of 11% over the prior year and a sequential increase of 2%.

Recurring hosting revenue accounted for about 99% of our revenue in the first quarter. During the first quarter, we recorded bookings of approximately 600,000 of new monthly revenue, about 500,000 in monthly recurring revenue, MRR, and 97,000 in a long-term delivery contract to a long-term hosting customer for a total of 600,000. This compares to 553,000 booked in the fourth quarter of fiscal year 2010, and about 396,000 booked in the first quarter of fiscal year 2010.

In the first quarter, 37% of our recurring revenue bookings came from new customers, and 63% came from the existing installed base, representing an approximate monthly recurring revenue booking per new customer of about 13,100 and a monthly recurring revenue per existing customer of about 4200. Overall, average revenue per customer or ARPU is approximately 8630 at the end of the first quarter compared to our overall ARPU of approximately 8600 at the end of the fourth quarter fiscal year 2010.

Average contract length of the bookings in the first quarter was 18 months as compared to the 21 months for contracts booked in the fourth quarter of fiscal year 2010. The sequential decrease was mainly due to the fact that we are no longer requiring term contracts for our cloud customers.

As mentioned previously, customer churn, which we define as the revenue loss of a customer or reduction in a customer's monthly revenue run rate remained stable at approximately 1.2% per month during the first quarter compared to 1.1% per month in the first quarter of fiscal year 2010, but down from the 1.3% per month reported in the same period last year. We are pleased by our churn results and remain committed in our efforts to maintain the low churn rate in fiscal year 2011.

Gross margin increased to 38% during the first quarter compared to 37% in the first quarter of fiscal year 2010, and 37% recorded in the fourth quarter.

Gross margin excluding depreciation, amortization and non-cash stock compensation or cash gross margin was 52%, the same as the first quarter of 2010, but up from the 51% reported in the fourth quarter of fiscal year 2010. The increase in cash gross margin was mainly due to the flow through impact of the increased revenue during the quarter.

Income from operations for the first quarter was $0.9 million compared to $1.2 million reported during the first quarter of fiscal year 2010, and $1.4 million reported in the fourth quarter of fiscal year 2010. Excluding costs relating to the departure of our former CEO during the quarter, income from operations for the first quarter would have been $1.6 million.

Adjusted EBITDA of $7.7 million was up significantly during the first quarter, and was above our guidance range of 7.3 million to 7.6 million. This represents a year-over-year increase of 20% and the sequential increase of 7%. The growth in adjusted EBITDA was also mainly due to the benefit from the growth in recurring revenue reported during the quarter.

Net loss, attributable to common shareholders for the first quarter was $2.2 million or a loss of $0.06 per share compared to a loss of $3.3 million or a loss of $0.09 per share in the first quarter of fiscal year 2010. Excluding the impact of the one-time cost associated with the departure of our former CEO, net loss attributable to common shareholders would have been approximately $1.5 million or a loss of $0.04 per share.

Now, turning to the balance sheet, the company's cash balance at the end of the first quarter was $6.6 million, compared to $4.6 million at the end of the fourth quarter of fiscal year 2010, reflecting strong cash generated from operations and a decline in spending on capital equipment during the quarter.

DSO for the first quarter was 30 days, compared to 35 days during the fourth quarter of fiscal year 2010, and 39 days during the same period the prior year. We are very pleased with the improvement we have made in DSO during the quarter.

Cash generated from operating activities for the first quarter of fiscal year 2011 was $6.5 million, reflecting a 42% increase compared to the $4.6 million generated in the first quarter of fiscal year 2010, and representing an 83% increase over the 3.6 million generated in the fourth quarter of fiscal year 2010. The increase in operating cash flow was mainly due to the reduction in DSO made during the quarter.

As we expected, our spend on capital equipment declined in the first quarter with cash spending on capital equipment purchases at $3.5 million, as opposed to $5 million reported in the prior quarter. This lower spend reflects the return to Capex tied more closely to our bookings of new revenue following the data centre upgrades and cloud spend that we saw in Q3 and Q4 of last year.

Our debt balance remained the same as the prior quarter. At the end of the quarter we had approximately 4 million outstanding on our revolver, with 5 million available and an overall senior debt balance of $53 million. I remain comfortable that the company has liquidity needed to achieve our business objectives during fiscal year 2011 due to our continuing ability to generate positive operating cash flow, combined with reduced capital expenditures.

Now turning to our outlook, in terms of guidance for the second quarter of fiscal year 2011, which ends January 31, 2010, we expect the revenue to be within the range of $33.5 million and $34 million, and adjusted EBITDA to be within the range of $7.7 million to $8 million.

Now, I'll turn the call back to Brooks for closing comments. Mr. Brooks.

Brooks Borcherding

Thank you, Jim. As you all may recall, fiscal year 2010 was a year of significant transformation for NaviSite, a year in which we sharpened our focus on the enterprise market, divested non-core assets, delevered our balance sheet, upgraded our core infrastructure, and brought to market our superior cloud offering.

In the first quarter of fiscal year 2011, NaviSite delivered solid results across all metrics as we exhibited our ability to execute on our strategy. As we continue to build momentum as illustrated by our early cloud successes and rapidly expanding cloud pipeline, our focus is now turning to one of acceleration, as we look to increase the velocity of our new bookings going forward, while continuing to successfully manage churn and deliver exceptional service.

We are on the right path and excited about the future for NaviSite. And with that, I would like to close our prepared remarks and open the call to questions. Operator.

Question-and-Answer Session

Operator

(Operator instructions) And our first question will be coming from the line of Alex Kurtz from Merriman & Company. You may proceed.

Alex Kurtz – Merriman & Company

Hi, guys. Thanks for taking the questions. I have got a bunch here. So I will try to go through it pretty quickly here. Jim, if we were to normalize the G&A number, it sounds like there was some additional severance cost in there, is that right?

Jim Pluntze

Yes. Well, there were some severance costs and there were also cost relating to the assignment of our New Year office [ph] to our former CEO, which accelerated some leasehold improvement, depreciation, so the combined impact was about $700,000.

Alex Kurtz – Merriman & Company

Okay. About $700,000. Okay, great. It looks like your stock based comp sort of kicked up a little bit from last quarter, is that right?

Jim Pluntze

Yes, there was also some accelerated stock compensation due to the same event.

Alex Kurtz – Merriman & Company

Where do we think that should normalize then, $600,000 to $700,000 a quarter or so?

Jim Pluntze

Yes, I think that is probably approximately a reasonable number.

Alex Kurtz – Merriman & Company

Okay. And if I – just filling up the pieces here, how many new customers have you guys signed in the quarter.

Jim Pluntze

So, I think we had about – now let me – why don’t you ask the other question, I will say the answer to that in a second.

Alex Kurtz – Merriman & Company

Okay. I guess to you Brooks on the year-over-year growth in the bookings has been impressive, but the sort of the implied growth rate based on the MRR is sort of been around 7% for the last couple of quarters. You know, so when do we think we will start to see an acceleration in sort of the implied growth rate, or I guess another way to think about it is with all this pipeline out in the cloud, do you expect to start to see a step function in bookings going into January and April?

Brooks Borcherding

Well, Alex, first of all thank you for recognizing the year-over-year performance in our bookings, and certainly we hope that that is indicative of the positive execution of our strategy. And I understand the implied growth rate as you are looking at the 2% in the quarter, and the 2% in the guidance. Certainly the upside for us is going to be based off of the conversion of cloud and acceleration of the consumption of those cloud-based services.

So, as you saw, they already had a significant contribution to our first quarter with 13% plus impact on our bookings. And we did see the contributions, well to the first four customers somewhat significant incremental booking number that was coming from them. So assuming that type of trajectory proceeds that would be upside opportunity for us to maintain kind of the basis of our booking through our core lines of business, the enterprise hosting, application management, and accelerate the cloud-based bookings.

Also what we are seeing with the increase in brand recognition based on the success we are having in cloud, and certainly that is breathing some new life into the pipelines of our traditional lines of business, and then even on top of that we are cloud enabling those, and bringing them out as more dynamic offers in the market. So we are hoping that between those several initiatives that is what will drive the acceleration in our bookings that I referenced in my closing remarks.

Alex Kurtz – Merriman & Company

I guess another way to ask you Brooks is looking at the pipeline and knowing when certain yields are supposed to close, are you expecting to see that acceleration in the next quarter or you are expecting that sort of exiting the fiscal year.

Brooks Borcherding

Well, we have already guided for the coming quarter and we don’t provide that guidance for bookings. But we have given you the trajectory of cloud, and that is a variable, cloud is a variable that has many short-term upside opportunities for us Alex, and beyond just the opportunity for new customers and new bookings, and the second impact, meaning the ability for customers to add additional services as we have already started to see. The third is the faster time to revenue recognition for us for cloud based services, instead of having to have physical hardware deployed and consumed; they can essentially provision those immediately.

So, those are all factors that can lead to the upside in those bookings, and I understand that your question is really driving to when can we look to get into view [ph] of more double-digit or high double-digit, high teens type of growth and those are the dependencies that we are focused on, and the real priority of our business is accelerating those bookings, and driving our successful cloud.

Alex Kurtz – Merriman & Company

Got it. I appreciate that. And Jim, do you have the answer on that?

Jim Pluntze

Yes, 14 new customers in the quarter. 14 new names.

Alex Kurtz – Merriman & Company

So, what is the – you added a bit of pretty good clip last year, I think you had 33 exiting Q4, what is the dip down for?

Jim Pluntze

Well, I mean, I think in the end what we’re looking at is obviously new customers are important to the business, but overall bookings as you are pointing out is the driver for revenue going forward. So, you know, does it matter each quarter how many new customers? I think what matters is the nominal number and how fast we can drive our revenue growth.

Brooks Borcherding

Yes. I do think Alex you are also starting to see that the results of the enterprise focus of our business is it does represent significantly new cross sell, up sell opportunity within the larger accounts as we bring them onboard and they become more comfortable with quality of the primary service that we deliver. So we hope to see that as we continue to land more new large enterprise accounts that we will continue to drive that behavior.

Alex Kurtz – Merriman & Company

All right, guys, thanks and congrats on the good EBITDA number this quarter.

Brooks Borcherding

Thank you.

Operator

(Operator instructions) At this time, I’m showing no further questions in queue. I would like to turn the call back over to the CEO, Mr. Brooks Borcherding, for closing remarks.

Brooks Borcherding

Thank you, and thank you everyone again for your interest in NaviSite. It is certainly an exciting time for us, and I look forward to continuing to have your participation and engagement on the call. So thank you again, and operator that brings us to an end.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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