Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

NaviSite Inc. (NASDAQ:NAVI)

F2Q08 (Qtr End 01/31/2008) Earnings Call

March 4, 2008 5:00 pm ET

Executives

Jim Pluntze - CFO

Arthur Becker - CEO

Analysts

Sri Anantha - Oppenheimer & Co.

Colby Synesael - Merriman Curhan Ford & Co.

James Breen - Thomas Weisel Partners

Jonathan Atkin - RBC Capital Markets

Andy Schroepfer

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2008 NaviSite Earnings Call. My name is Karen and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call Mr. Jim Pluntze, Chief Financial Officer. Please proceed.

Jim Pluntze

Thank you. Good afternoon and welcome to NaviSite's earnings conference call for the second quarter of fiscal year 2008 that ended January 2008. Arthur Becker, NaviSite's Chief Executive Officer is also with me today to discuss our financial results, key business highlights as well as to provide an outlook for the remainder of fiscal year 2008.

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

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

We'll also discuss NaviSite's EBITDA performance for the second quarter of fiscal year 2008. Please note that EBITDA is not a recognized measure for financial statement presentation under US Generally Accepted Accounting Principle, US GAAP. The company believes that the non-GAAP measure of EBITDA provides investors with 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 costs, costs related to the discontinued operation of America's Job Exchange and other non-operational charges from a non-GAAP measure.

EBITDA does not have any standard definition and therefore maybe 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 the 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 second quarter fiscal year 2008 earnings press release.

With that I would like to turn the call over to Arthur Becker, NaviSite’s Chief Executive Officer. Arthur?

Arthur Becker

Thank you Jim and good afternoon everyone. Today we are pleased to report and discuss our second quarter fiscal 2008 results. I would like to start by sharing some key financial and business results for the quarter, review business and operating highlights and later provide guidance for the next quarter and the full fiscal year 2008.

In the second quarter of fiscal 2008, NaviSite continues growth momentum as a leading provider of application services and hosting solutions. Revenue for the quarter reached $38.9 million from $30.2 million for the same period last year recording a 29% year-over-year growth. Sequentially second quarter revenue was 8% higher than the $36.1 million revenue recorded in the first quarter of fiscal 2008.

We also reported a 65% growth in the EBITDA with $8.6 million of EBITDA as adjusted in the second quarter of fiscal year 2008 compared to $5.2 million of EBITDA recorded in the same period last year. This represents a record EBITDA performance with a 24% sequential increase over the $6.9 million of EBITDA reported in the first quarter of fiscal year 2008.

We also booked a record $1.1 million of incremental monthly recurring revenue, MRR we refer to it as during the second quarter, this represents a growth of 36% over the same period last year and 63% over the first quarter of fiscal year 2008. It is important to note that approximately 42% of the new MRR bookings this quarter originated in application services and about 58% came in from our enterprise hosting business.

This reflects the increasing emphasis that we have placed on our application service capabilities and these bookings are 106% higher than our Q1 application services MRR bookings and 223% higher than our MRR bookings for application services in Q2 '07.

Of the total MRR bookings this quarter 63% came from new customers and 37% came from existing customers. The MRR bookings from new customers are up 165% last quarter and 11% in the second quarter in fiscal year 2007. The MRR bookings from our existing customers are down slightly 1% from last quarter and up a 119% over the second quarter of fiscal year 2007.

As we have discussed previously we have implemented a number of changes in our sales and account management organization to provide a greater focus on growing our installed base of customers while sharpening our ability to close larger transactions with new global customers with our direct field sales organization.

The ARPU per month, the average revenue per customer per month for the new customers booked during the quarter was approximately $6,200 compared to an existing base ARPU per month of approximately $7,400, but significantly higher than the $3,800 recorded in the first quarter of fiscal year 2008. The increase in ARPU this quarter over last quarter reflects the booking of two large deals over $50,000 of MRR compared to none booked in the previous quarter.

These two transactions reflect our strategy to target larger opportunities and those that require our application expertise. The total contract value booked during the quarter was $37.4 million, a record. It's another record for us in Q2 and up 58% from the $23.7 million booked in the first quarter of fiscal year 2008.

Last year the TCV for the same period was $36.8 million. TCV from our application services business, which includes both monthly recurring revenue based applications management and non-MRR based professional services was approximately $17.8 million. And TCV from our MRR based enterprise hosting business was $19.6 million.

We are pleased that within the strong booking quarter that the TCV from our application services business of $17.8 million was up significantly from last quarter's bookings of $9.8 million and up from the $9.7 million in our second quarter of fiscal year 2007.

Of the $17.8 million of application services bookings, the recurring revenue component was $11.9 million this quarter as compared to $5.9 million last quarter and $2.6 million during the second quarter of 2007. The non-recurring component which is generally professional services was $5.9 million in the second quarter compared to $3.8 million in the quarter before and $7.2 million the quarter a year ago.

It's important to note that while we are successfully executing our strategy to increase the monthly recurring revenue component of our application services practice. The near term revenue growth will be moderately impacted as the revenue from these hosting contracts is typically recognized over 36 months compared to the six months term that typifies our professional services engagements.

So, while the TCV from this group is growing significantly, increasing the TCV coming from the MRR component will cause our revenue in this business line to ramp more slowly than we had originally forecasted. We will continue to shift the focus of our sales group towards the sale of application services, which leverages our broad portfolio of deep domain expertise in packaged applications.

In the second quarter, NaviSite signed MRR contracts with the 112 new customers compared to 72 new MRR customers during the same period last year and 70 new MRR customers in Q1 of fiscal year 2008. The average term as MRR contracts booked this quarter was about 28 months unchanged from that in the first quarter of fiscal year 2008 and down from 34 months in the same last year, when we signed one very large customer to a 60-month contract.

I'd like to now just take a minute to discuss a few of the deals that we closed this quarter. For the first, the company called Service-now.com is a subscription-based on-demand IT service management company, became our first customer for managed hosting, using both dedicated and the virtualized platform that also enclosed software-as-a-service, what we call SaaS enablement services.

Another customer, the Sacramento Municipal Utility District, the sixth largest public owned utility in the country, turned to NaviSite as a customer for managed hosting solutions as well as new application development services. LinkedIn, a well known and quite popular online network of more than 20 million experienced professionals signed up for application management and professional services to host and implement Oracle eBusiness Suite to support their financial operations.

Another new customer, one of the largest heavy civil construction companies in the US chose Navisite for a full suite of services that includes solutions and managed hosting, application management as well as professional services.

In addition in the transaction that came through our strategic channel efforts, one of the largest technology manufacturers in the US chose Navisite to deliver managed services to their large networks of US-based VARs, valued-added resellers, in an effort to generate stronger and more recurrent relationships with their partners.

Lastly, the strategic partnership with Sun that we announced last year continues to expand and we continued to see more leads and closed deals from this relationship.

Navisite also renewed contracts with several customers, including New York State Department of Labor for application development management services for America's One-Stop Operating System, a unique web-based job matching case management reporting system. We renewed a transaction with Norwalk Hospital, a private nonprofit, acute care hospital for PeopleSoft application management support, the Weather Services International, a leading provider of weather information and business solutions for our collocation infrastructure services and Arizona Web Services, a web hosting reseller and design services firm for dedicated hosting solutions.

Moving on to our product and delivery front, we continue to gain traction on the use of virtualization as part of our delivery platform. We currently remain agnostic from a technology perspective responding to the needs of specific customers and circumstances which best fit implementations.

That said, we have gained sufficient scale to attract the attention of the major hardware and software vendors in this area and we will continually leverage these relationships.

By virtualizing our technology fabric we're able to expand our offerings, become faster and more efficient our ongoing operations and reduce our overall cost of delivery. A few examples of uses of our virtualization include dynamic allocation, server consolidation, business continuity and disaster recovery.

Additionally, we continue to see an increasing number of opportunities and subsequently closed deals for ISVs that are looking to utilize our virtualization platform for the development and testing of their SaaS strategy as well as beta environments for the clients.

We have already seen two of these short-term deployments turning to longer-term and larger contracts in Q2. We have gained customer attention and new contracts with some of our new applications development capabilities with Web 2.0 and service oriented software, service oriented architecture as well as services and solutions to help companies with their PCI compliance initiatives.

On the marketing front, NaviSite recently launched our new website to increase our online marketing programs and our emphasis on organic and page search will continue to increase our opportunistic use of online media and the life cycle based customer contact strategy using interactive events and relationship marketing to attract, grow, and retain our customer base.

Turning now to our acquisition integration activity; during the second quarter, we completed what we estimate to be about 90% of the system and personnel related integration of the company that we acquired during the first quarter of '08. We are pleased with the synergistic EBITDA gains that we have achieved with our acquisitions and are encouraged by the talented sales and service delivery personnel that have now become significant contributors to the NaviSite family.

It is also worth noting that about 25% of our application services deals this quarter was sold to customers using Lawson and Kronos application services, services that came from our acquisition of netASPx.

As mentioned, during the first quarter call, we do plan to keep the Alabanza and Jupiter Hosting brands, those companies that we acquired in the first quarter to maintain their premium market position in the SMB and entertainment segments respectively, but we'll fully fold in the netASPx brand into NaviSite.

I would like to now just turn to something about our UK subsidiary. We've seen significant demand for collocation to managed services there in our London office. One of our now largest customers was recently installed in our newest data center space located just outside of London in Watford. The fact that this customer was booked in Q4 FY '07 and installed very late actually in January of '08 does cause us to reconsider certain assumptions of our financial model and to lengthen the implementation periods for some of these larger transactions.

In this case, we had originally anticipated this deal to install in early Q2, but due to certain construction delays, it did not install until late in January resulting at about what we estimate about a million of dollars of revenue that was deferred into the second -- it recognized about a million dollars less in Q2 than we had originally forecasted.

In view of the fact that we've seen such strong demand in the UK and continued to see such strong demand, we have secured an option for at least up to 70,000 square feet in a new data center also located just outside of London. This deal, the nature of the transaction will be similar in structure to the data center we just leased in Watford. We've already started selling this space and expect to close our first deal this month. We've also seen our pipeline for both collocation and managed services grow significantly in that London market.

Although we plan to book new business in the coming quarters, we do not anticipate seeing any revenue from this activity until the completion of the data center in Q2 or Q3 of fiscal year '09. It's important to note that the structure of this transaction will not require NaviSite to increase its capital expenditures prior or even after booking any business in this data center.

Summarizing, NaviSite has maintained its growth momentum in the second quarter of 2008, delivering 29% year-over-year growth in revenue, 65% of year-over-year EBITDA growth and 36% growth in year-over-year monthly recurring bookings.

We've achieved our highest ever bookings numbers as well as our best ever EBITDA performance during the quarter. We've completed the majority of our integration activities related to our recent acquisitions and I am pleased with the level of sales activity being generated by our application services and hosting solution business line building a healthy backlog of business to continue to accelerate our growth rate.

At this point I would like to turn the call back over to Jim our Chief Financial Officer for a detailed overview of our financial performance for the quarter. Jim?

Jim Pluntze

Thanks Arthur. As we previously mentioned revenue for the second quarter of fiscal year 2008 was $38.9 million up 8% sequentially and up 29% over the second quarter of fiscal year 2007. About 86% of our revenue this quarter came from recurring type revenues and 14% of our revenue this quarter came from non-recurring revenues generally professional services, which is down from the 16% in the first quarter of fiscal year 2008.

Income from operations was $1.3 million in the second quarter of fiscal year 2008 as compared to a loss from operations of $0.4 million in the second quarter of fiscal year 2007 and income from operations of $0.3 million for the first quarter of fiscal year 2008. NaviSite generated gross profit of approximately $12 million or 31% of revenue for the second quarter of fiscal year 2008 as compared to $9.7 million or 32% of revenue for the same fiscal quarter of 2007 and $11.1 million or 31% of revenue for the first quarter of fiscal year 2008.

Our cash gross margin which excludes non-cash charges of depreciation, amortization and non-cash stock compensation was 46% for the second quarter of fiscal year 2008 up from the 44% we reported in the first quarter of fiscal year 2008 and up from 43% in the second quarter of fiscal year 2007.

Operating expenses as a percentage of revenue were 27% in the second quarter of fiscal year 2008 down from 33% in the same fiscal quarter of 2007 and down from 30% in the first quarter of fiscal year 2008. The decline as a percentage of revenue is primarily related to G&A and reflects the scalability of these expenses as we grow our revenue.

NaviSite recorded $8.6 million of adjusted EBITDA excluded; impairment costs, stock base compensation, costs related to the discontinued operations of America's Job Exchange and other non-operational charges for the second quarter; representing a 65% increase over the $5.3 million of EBITDA reported in the second quarter of fiscal year 2007 and a sequential increase of 24%.

The company reported a loss from continuing operations of $1.9 million for the second quarter of fiscal year 2008 down from $4.1 million reported in the first quarter of fiscal year 2008. On a per share basis the company reported a net loss attributable to common shareholders including the cost related to discontinued operations of America's Job Exchange, as compared to a net loss of $0.13 in the second quarter of fiscal year 2007 and down from the loss per share of $0.14 reported in the first quarter of fiscal year 2008.

Customer churns, from base accounts defined as the loss of customer or a reduction in a customer's monthly revenue run rate excluding our major accounts was approximately 0.8% per month for the second quarter compared to 1% per month for the second quarter of fiscal year 2007 and 1.4% per month for the first quarter of fiscal year 2008.

Note that churn this quarter does include any churn that we might have seen from the Alabanza data center move. Churn from all accounts including our major accounts was 1.5% this quarter. We have traditionally only discussed churn of our base accounts feeling that's a meaningful discussion about the impact of our churn of business. But going forward, we plan on discussing churn from our total accounts, to give investors a complete picture of any revenue reductions that churn might be causing in our business.

Company's DSO or days sales outstanding increased to 41 days in the second quarter of fiscal year 2008, down from 38 days reported in the second quarter of fiscal year 2007 and up from the 38 days reported in the first quarter of fiscal year 2008. The increase is mainly due to revenue growth and to the integration of the accounts receivables from our recent acquisitions.

We do not believe that this change reflects any change in credit quality of our receivables and we do expect our DSO to remain in the 39 to 40 day level going forward. We are continuing to carefully screen all of our new accounts and are conscious what the impact of a slowing economy might have on AR and are focused on ensuring that our DSO remains in a proper range.

The company's cash balance at the end of the quarter decreased to $4.9 million from $5.5 million at the end of the pervious quarter. The reduction is mainly due to the increase in DSO as I mentioned and the payment during the quarter of some of the integration charges related to our Q1 acquisitions.

We borrowed $5 million of our $10 million revolving credit line during the quarter to fund the deposit for the option on the new data center that Arthur discussed in the UK, and which will be returned once the lease for the new center has been signed.

Excluding this deposit, which is recorded as the use of cash from operating activities, we generated approximately $3.8 million of cash from operating activities during the second quarter, which is up significantly from the $113,000 generated in Q1 of fiscal year '08.

During the quarter we invested about $2.8 million in capital expenditures in the quarter, consistent with the $2.89 million invested in the first quarter of fiscal year 2008. Of the capital equipment spend this quarter, about 75% was used for customer installations with the remaining amount used for internal purposes and data centre expansion, primarily in our San Francisco and San Jose data centers.

We also recorded about $14.7 million of new capital leases related to the new Watford, UK data centre and the 10 year lease that we signed. While we do not own these assets, the correct accounting treatments is to record the assets as capital leases and this was added to our assets in capital leases this quarter. As a side note, as we mentioned, the entire amount of the space leased in Watford has already been contracted and the customer took delivery of this space in late January.

Our data centre capacity was approximately 57% utilized at the end of the second quarter of fiscal year 2008. And finally consistent with our expectations, we excluded an approximate net loss of $237,000 from adjusted EBITDA related to the discontinued operations of Americas Job Exchange.

With that said I will turn the call back over to you Arthur.

Arthur Becker

Thank you, Jim. Now I would like to take this opportunity to summarize and wrap up our second quarter earnings and business highlights for the quarter. Revenue and EBITDA are accelerating and bookings reached a record level for both MRR and TCV. Our organic revenue growth remained strong as I have pointed out to investors.

Our bookings and churn rates for our quarter can provide a view into our implied organic revenue growth in subsequent quarters. For this second quarter, given the MRR bookings of $1.1 million or approximately $367,000 per month, less the churn of 1.5% per month on a recurring revenue base of $11 million or about $165,000 per month, so the subtraction of the churn from the actual bookings generates about $165,000 of organic business implying about a 5% per quarter revenue growth rate going forward.

Changes implemented in our sales organization are showing signs of traction. The channel and strategic partnerships are growing and expected to accelerate in the coming quarters. The account management approach to our installed base of customers has been transformed into quarter bearing selling organization.

And the Application Solutions Group is making real inroads increasing the MMR for our application services practice. We've effectively integrated our recent acquisitions achieving the expected synergistic gains and beginning the process of selling NaviSite solutions to the customer base of the acquired companies.

We've also made some significant progress with a number of new technologies to increase the efficiency of our platform. We are close to the final stages of implementation of BladeLogic for all of our data centers in the US and UK, which should provide a change in management event histories for every device that we manage. We're close to testing a new software that will allow us to remotely reboot any device in all of our 16 data centers. And we are expecting our new coating engine, a big machine to be ready next quarter to provide uniform real-time coating for our sales personnel and our growing list of channel partners.

Before moving on to guidance, I wanted to also briefly update you on our progress with the America's Job Exchange. Despite the seasonal slow months during the holidays, the job portal site attracted more than 1.25 million monthly visits and maintained an average of approximately 700,000 job postings in the second quarter. The site has undergone a thorough facelift to create a more compelling user experience and to maximize ad inventory.

As we've discussed last quarter a task year has been approved for the revenue model and to that end, we've recently launched the paid job postings service to help individual businesses buy and post online using e-commerce capabilities. We've been able to demonstrate the ability to attract high volume consumer traffic as well as provide job content and in the coming months, we remain focused on introducing and selling paid services to build the revenue base, improve the business model to drive the business valuation.

Now, looking ahead, we project revenue for the third quarter of fiscal year 2008 to be between $41 million and $42 million. EBITDA excluding impairments, stock-based compensation, costs related to the discontinued operations of America's Job Exchange and non-operational charges, for the third quarter of fiscal year 2008 is projected to be between $9.0 million and $9.5 million.

For the full year of fiscal 2008, NaviSite expects revenue in the range of a $160 and $165 million and adjusted EBITDA between $35.0 million and $38.0 million. The change in revenue and EBITDA guidance reflects two primary factors.

The refocusing of our application services sales personnel to sell monthly recurring services has significantly increased the total contract value of bookings in the past two quarters. But the recurring revenue bookings will not generate as much revenue in the second half of the fiscal year compared to professional services due to the fact that the revenue will be recognized for 36 months from these contracts as opposed to the average six months terms of the professional service engagements.

And two, we're recognizing that as we close larger and larger transactions and more of them that the deals are not only larger but also more complex and some of these implementations are taking longer to install and turn into revenue and this guidance reflects the projected longer implementation cycle for these transactions.

Having said this, we continue to see a strong market for our services, do not see any slowdown due to any macroeconomic pressures. Our sales pipeline is very robust and we're looking forward to an accelerating growth rate with respect to bookings, revenue, EBITDA and cash flow.

Now, I'd like to take this time to open up the phone lines to questions from our listeners so I'll turn the call back over to the operator. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Sri Anantha. Please proceed.

Sri Anantha - Oppenheimer & Co.

Yeah, good afternoon, thanks.

Arthur Becker

Hey Sri.

Sri Anantha - Oppenheimer & Co.

Hey, couple of questions, I know you mentioned about the large caller contract in London, Europe took longer than expected. Is that now fully online?

Arthur Becker

Yes, it's fully online. Although the revenue we recognized, not only in January but in the quarter, is not fully embodied in the numbers. In other words, they will be more in Q3 than in Q2.

Sri Anantha - Oppenheimer & Co.

Got it. The second one is, I know you previously talked about the acquisition customers, or generally have low ARPU. But you expect that ARPU to grow as you're increasing the cross-sell additional services which NaviSite has been offering. Could you talk about where you are in that process and to what extent customers have been taking additional services from your folks?

Arthur Becker

Yeah, it depends on the customer base. The smaller customers, one of the companies, Alabanza, we acquired a very large population of very small customers. Very small in our mind is under a 1000 a month. There, we are procreating a product pipeline, or actually a product roadmap, to sell things like spam filtering and some synching with blackberries and other mail service related products. I don't expect that to be a large cross-sell opportunity for NaviSite. It's more of a platform-based capability in any event.

The medium-sized customer is really where we see things. Having the opportunity in particular, I think, would be the acquisitions we made of Net Aspects. Those customers have all already made the decision to outsource enterprise applications of Lawson or business intelligence products like Kronos.

So we are actively involved in those customers. I don't think we have a specific count. But I've anecdotally heard that there are a number of things that are going on with customers, a number of dialogues selling them messaging and disaster recovery and other kinds of services that we sell to our typical customer base.

Sri Anantha - Oppenheimer & Co.

And last I know, Arthur,… you know everybody is concerned about quality of customer base. I just wanted to know, how strictly do you monitor the credit requirement for your customers, and has there been any change? I know you guys report a pretty good turn in numbers here. So I assume there hasn't been any change there, but just wanted to hear how good of a quality credit check? Do you guys keep track of it?

Arthur Becker

Well I think I should really pass it over to Jim because if he is not doing it, I'm not.

Jim Pluntze

Yes. So I think we certainly, we've been through a downturn before in the 2003 time period. We understand what happened and we are conscious of what we need to do to monitor customers. We've weekly reviews of all significant accounts and we do credit checks of all new customers. So we are doing what we can to make sure that the customers that we bring on are going to pass, and keeping our DSO low is definitely a focus of our group.

Sri Anantha - Oppenheimer & Co.

Got it. One housekeeping question, Jim, what were your total ending customers?

Jim Pluntze

I calculate about 1420.

Sri Anantha - Oppenheimer & Co.

1420. Thanks guys. Thanks a lot.

Operator

And your next question comes from the line of Colby Synesael. Please proceed.

Colby Synesael - Merriman Curhan Ford & Co.

Thank you. I have a few questions. One just really quickly, if you could talk about how much revenue you received from the acquisitions this quarter? I think last quarter you told us this is about $6 million?

And then I have two broader questions, one on the sale cycle, maybe to get a better understanding what's going on in some of these new, larger customers that you are bring on, if you can talk about what the average sale cycle was from signing the contract to installing. More historically, first, maybe some of these new, larger contracts that we've signing, and talk about how much of that really impacted the fact that you slightly missed your revenue guidance for this quarter?

And then just the last question will have to do with your capital structure. Your accounts payable did go up this quarter. You don't have that much cash, what is the plan in terms of trying to improve that, or do you feel like you need to improve that? And can you explain a little bit again about how the data center in London is going to be paid for? Thank you

Arthur Becker

Thanks Colby. Jim- you want to talk about the revenue composition, then I can address the --

Jim Pluntze

Yeah. What we said last quarter about the acquisition revenue, is that the last quarter we're going to talk about composition of revenue for acquisitions. I think we did tell you last quarter that all we'll talk about this quarter is that. We had the full quarter of all of our acquisitions as well as our organic growth. That can be the answer to that question.

I can address also the growth in AP and, which I recall hearing, we did see a growth in AP that was somewhat an artifact of bill paying in the company- we pay bills on Thursday's and Friday's, our quarter ended. So, AP does go up sometimes at the end of the quarter, just because of the artifact of when it happens during the week. I don't think there is anything strictly unusual.

We don't have a lot of cash. We do have a revolver and we have $5 million available on that revolver. $5 million is drawn for the data center that we are in the process of leasing, it will be returned upon the signing of the lease. So, I think we feel like we're based on the growth in cash flow, the growth in our EBITDA on the business, we're feeling that we're capitalized to the extent we need.

Arthur Becker

Yeah, as you pointed out, just to add, we are close to signing another 10,000 feet of the lease option of 70,000 and concurrent with that we are close to closing our first customer. It should happen this month. So the $5 million that should have been paid as an option should be returned to us, our cash balances should go up a little bit anyway.

And that leads me into the discussion you had about, I think, the UK data centre as well as the customers. The larger customers definitely take longer to close. They are more complex, there is usually more competition, they require more sign ups from the internal enterprise, the organization, and they go through more itterations in terms of refining what the actual architecture of the solution is.

In terms of term, I don’t think we really have been at this long enough to really give you a better sense of it. But it's clear that these are six month transactions from identification to closing and they are probably four to six months before we start seeing revenue from them. Now that's not always the case, but it frequently is the case and it's particularly the case with application services where there is a deployment that's necessary prior to the hosting, or the application being hosted, and generating revenue.

So that's one of the things we are seeing in our revenue forecast, we are taking into account looking at not the closing of deals, because we think our bookings number is in good shape and we internally think our pipeline is in good shape. It's really once you have the deal, how long do you see until you see the money. The UK data centre deal for example we closed in June, we didn't start recognizing any revenue and even the revenue we recognized is probably 30% of it in the month of January.

So it's seven to eight months before we saw dollar one and that's probably a million dollar miss in the second quarter right there. So our quarter would have been a million higher had we put that customer in when we had originally thought. I think that's about it.

Colby Synesael - Merriman Curhan Ford & Company

Last question is I don't understand how you're paying for the new data center in the UK?

Arthur Becker

It's a lease that's why, so we lease it, you pay it monthly.

Colby Synesael - Merriman Curhan Ford & Company

Okay, and what about the cost, is there a cost?

Jim Pluntze

It's more like a facility, like a digital realty kind of facility, where it sort of comes pre-built.

Arthur Becker

They are building it out for us

Colby Synesael - Merriman Curhan Ford & Company

Okay. So, from a CapEx standpoint, there is not much required to get that ready to go?

Arthur Becker

That's right, very little. Probably zero I guess.

Colby Synesael - Merriman Curhan Ford & Company

And you said that you're going to start seeing revenue from that in fiscal second quarter or third quarter '09?

Arthur Becker

Well, to the extent that we close bookings, close deals for that data center, to the extent that we do we won't see the revenue until Q2. So, it's going to be six to seven months out before we'll generate revenue, not too dissimilar from what we saw at the most recent UK data center where we closed it in June and started seeing revenue in January.

Colby Synesael - Merriman Curhan Ford & Company

And forgive me if you said this. Did you say, you already closed on that, so you're already starting to pay for that today?

Arthur Becker

No. Which one are you talking about the first one or the second?

Colby Synesael - Merriman Curhan Ford & Company

The second one.

Arthur Becker

The second one we've only put money out in option. We haven't started leasing, we are about to close our first 10,000 feet of lease. It won't kick in in terms of expense until we occupy it and that occupation should be co-terminus with the sales of the first customer's business. We are trying to time it well.

Colby Synesael - Merriman Curhan Ford & Company

Okay. Thank you very much

Arthur Becker

Thank you, Colby. Any other questions.

Operator

And your next question comes from the line of James Breen with Thomas Weisel Partners. Please proceed.

James Breen - Thomas Weisel Partners

Thanks guys. Sort of a question on the revised guidance. Where do you see the difference coming between your previous guidance on the revenue side 1.70, 1.80 versus the 1.60, 1.65. It seems as though your bookings were very strong this quarter, churns down, your customer account is up. So, just looking at it in a broad view it seems like the business is going well, yet the guidance is coming down. Is it more timing in terms of the contracts that have to do with the one-in build-out? thanks

Arthur Becker

No, I think it’s really about, it’s two things. It’s about taking the experience of what we just did with the UK data center and seeing it in the deals we're closing- the larger deals that we closed in Q1 and the larger deals that would -- not the larger deals we closed in First quarter, but the larger deals we've just closed in Q2 and just seeing they are not going to be installed within the normal assumptions we've made for our model. So they are going to be longer or at least we have to prepare for them to take longer to generate revenue. The other element is really about pro services. If you look at the pro-services business. What was the number of the TCV for the second quarter. Jim. do you have it on hand?

Jim Pluntze

Yes. $17.8 million from the application solutions, $5.9 million from pro services specifically.

Arthur Becker

So, $5.9 million and what we're really seeing there Jim is that the pro services engagements and the bookings are shifting from professional services engagements to hosting engagements. Now the TCV of those contracts is growing significantly in our applications hosting business. It’s a very high ramp, so it’s really proving our model but the time that it takes to generate revenue from those contracts is over 36 months rather than six months.

So for example $2 million of total contract value in professional services engagement will start seeing $320,000 a month probably the next month for six months whereas with the monthly recurring revenue contract we'll start seeing $60,000 a month for the next six months so the difference between the revenue for the next six months in a pro services engagement is $2 million on one hand and maybe $360,000 on the other hand

James Breen - Thomas Weisel Partners

So what’s causing this shift in terms of the revenue being allocated to hosting versus professional services?

Arthur Becker

It is not allocated. It's what you're winning. It's a conscious effort on our part to lay around to the professional services sales personnel. The target of selling hosting services, application hosting- we think that is the stickiest, best deepest kind of relationship that we can generate with the customer. It has the near- and short-term impact of lowering the revenue you see from professional services.

But to be candid we really never want to be in a professional services business and I have always wanted to keep that number under 15%. It grew to 17% last quarter. I think our target now was 17% a quarter before and it's 14% last quarter. And we will continue to see it move between 10% and 15% of our revenue rather than growing towards 20% of our revenue.

James Breen - Thomas Weisel Partners

So is it fair to say that your changing guidance is less about sort of the fundamentals of business and more about how you guys can project your business going forward and you have a better hand on that now given?

Arthur Becker

Yeah, I think it's absolutely that. I mean our business has, in our experience it's never been as strong as it is, not only in terms of the revenue growth, in terms of the churn, in terms of the pipelines. But consciously one of the impacts we didn't see was when you start empowering your sales people to sell hosting and you didn't send them to sell it with more commissions for selling hosting than professional services. It's remarkable how quickly they react and that's great news for the business, but it has a near-term impact of lowering the revenue growth.

James Breen - Thomas Weisel Partners

Great, thank you very much.

Arthur Becker

Thanks Jim. Operator?

Operator

And your next question comes from the line of Jonathan Atkin with RBC Capital Markets. Please proceed.

Jonathan Atkin - RBC Capital Markets

I have a couple of questions. One, on the guidance- can you give us a flavor with all the adjustments for longer implementation time then in the shift from professional services to more of a monthly recurring stream. The year end run rate that you expected to see originally at the end of fiscal (inaudible) versus your live guidance, how does that compare now versus before?

And then on the revision that you gave just now kind of the follow onto the last question, How much of the change in revenue guidance due to long implementation times versus the shifting of the professional services sales team, if it is roughly 50:50 in terms of the impact or is it more weighted towards one phenomenon versus the other?

Arthur Becker

That's a good question. We don't break out pro services, Jonathan, but the pro services piece and the pro services revenue for the business from our original forecast is down measurably for the year. And I think that probably most of the revenue change is coming from pro services. And you can see that to the extent that their revenue guidance is down materially more than the EBITDA guidance is down, and that is because the gross margins from professional services are so much more modest than the application hosting. Jim, do want to expand on that?

Jim Pluntze

No, I think that's, I would sort of say it is [17:30] split, if I was to sort give a guess. But it all depends on what your starting position was. So it depends on where your model adjusted from but given our internal model I think it's probably the split that we gave.

Arthur Becker

Yeah. I think the principle EBITDA was to see the pro services were not going to be what they were by intention. And remember when we gave guidance, it was June before we bought that aspects and it was really a month after we had given the quarter of selling application hosting to our professional services team.

So, now we've seen that really grow in traction. I mean the numbers are remarkable, what we closed as a percentage of the overall hosting revenue and the percent of the overall application services, we're really seeing tractions there. I mean it's quite exciting for us and we feel like we're right for five minutes.

But it has the appropriate reduction of pro services bookings which is okay, that's fine with us, but it does have the near-term impact. And I think that 70/30 is probably a pretty good gesture.

Jonathan Atkin - RBC Capital Markets

Again, the kind of the year end run rate question, I don't know if there is a way to answer that?

Arthur Becker

Well, let's se, I mean, I think I can do the math. What do we have in for EBITDA right now Jim?

Jim Pluntze

Are you talking about revenue or EBITDA?

Arthur Becker

Well, just let's say -- which one do you want, Jonathan, you want revenue or EBITDA?

Jonathan Atkin - RBC Capital Markets

EBITDA.

Arthur Becker

Yeah, EBITDA, so we did nine, we did 86. We did, what, 69 last quarter?

Jim Pluntze

69 correct.

Arthur Becker

16.5, so if we just take the -- let's just say, for the fun of it, the mid point of guidance is 37 or 36.5, so we need to do 20 million, right? Is that right?

Jonathan Atkin - RBC Capital Markets

Yeah.

Arthur Becker

In the second quarter, we are guiding at 9 to 9.5, so you're looking at 10 million to 11 million if we hit the midpoint of the guidance for EBITDA run rate for Q4. Is that right math, Jim I think it is?

Jim Pluntze

I think that's in the range of what we are thinking, correct.

Jonathan Atkin - RBC Capital Markets

And then can you comment on the pricing that you're seeing for your various services on both new businesses as well as renewable?

Arthur Becker

I don't think we are seeing, a lot of our pricing is so not commoditized. We've seen some pricing at the shared hosting business of Alabanza be mark-to-market. So we've seen some lower pricing going forward with the shared hosting customers. Now those shared hosting customers together are less than 3% of our revenue. So, you can reduce it by 20% and you won't see more than a 40 or 50 basis points change in churn.

But other than that, we don't see a meaningful price changes in the co-location business, the hosting business, or in the application services business.

Jonathan Atkin - RBC Capital Markets

And then, if you look at your incremental revenues as a company, is the mix of incremental revenues in the UK meaningfully different than the mix you would be finding in the US?

Arthur Becker

Yeah, it is because the UK revenue has been, first of all it's very modest. So even with the pound being so strong against the dollar, I think it is less than 5% of revenue, maybe it's 4% of revenue, Jim?

Jim Pluntze

It's 5% of revenue, it had been 6% last year, but modest.

Arthur Becker

So it's growth is significant, we won a big customer and that customer was co-location, so the mix between co-lo and managed services has changed but still it's only in that little anecdote of the market, 7% to 8% of our revenue.

Jonathan Atkin - RBC Capital Markets

Thanks very much.

Arthur Becker

Okay.

Operator

And the next question comes from the line of [Andy Schroepfer]. Please proceed.

Andy Schroepfer

Hi guys.

Arthur Becker

Hi, Andy. Speak up a little if you can.

Andy Schroepfer

I will do. I have a bunch of tactical questions I can ask, Jim, and I will get into those in a second. But bigger picture, with leasing 70,000 more square feet of space in London, that's going to have a business impact to me positively on EBITDA. But you also have a shared hosting business which, you pointed out, there is benefit to the business. You have a 3% of revenues. So it's insignificant in some context and it's significant in others. My question is what are you trying to accomplish with some of these moves, like why deal with some of the headaches in the shared hosting business and why try to take the big extra step and I heard nothing about the CDN part of your business in the quarter. Are you sure you are talking about the focus on the business on the application management which is going great?

Arthur Becker

Yeah, it is going well. It is going great.

Andy Schroepfer

So I was just trying to understand, what are these side bars doing in the construct of what you believe the business is going to be a couple of years down the road?

Arthur Becker

Sure. Well, the UK is just an interesting little market. It's a subset of Europe. It's nothing to do with the US and we happen to have a pretty good relationship over there with my partner and the chairman who has built a few hundred thousand feet of data center space. So you can rest assured that we won't be leasing any space unless we've sold it. Its just we have an option to do it and it and we will be timing the leasing of the space when we're able to sell the space. So we won't be spending out ahead of ourselves. And I think the important thing to note there, too, is we have the option to lease up to 70,000 feet and we clearly won't be taking that space down until we have the customers.

But the pipelines for us in the UK have been quite dramatic. There is big demand and it's not just for co-location but it's for managed services, which is as you know our sweet spot. Probably 40% of our revenue would be called pure managed services. And we think that’s consistent with our overall strategy and if we can leverage our ability to get space in a cost effective way and in a capital structure efficient way we will certainly go after that market.

Turning to shared hosting, that’s a tiny piece of our business. We bought a dedicated hosting platform Alabanza as you know. Most of the revenue from that company was dedicated hosting and the resellers reselling the Alabanza platform. So the shared hosting component just came along with it and to be frank we want to do the right thing for those shared hosting customers as well as for the platform for our resellers, but other than that, that’s our principal focus. We didn’t really have an objective of being in the shared hosting business itself.

In CDN I think we found there that they are very tough to scale. We've tried for some time, we still do a small business in CDN, but most of our CDN capability has really been about delivering applications on top of the CDN. So customizing a CDN for a large hardware vendor, which we've done on a global basis which is really our skill set rather than having large enough pipes to handle bursts from customers which seems to be one of the key competitive strengths of Akamai or was for limelight, before the litigation occurred. So we just didn’t really see that we had the scale and the ability to be a competitor there.

Andy Schroepfer

Good answer. I appreciate that you put some of your money to work and by the fact stock what we see has come up in bids since last quarter. So that was the context of asking the question and as things change valuation wise what is that you're trying to be as we try to gain some of that back collectively here? I would love to know --

Arthur Becker

I don’t know what that meant, Andy but it sounded like a rumination.

Andy Schroepfer

Well it was a compliment and thank you on behalf of the shareholders, that you are put up here, you are sharing the same pain.

Arthur Becker

Yeah, okay well I am glad I could share the pain that's fun.

Andy Schroepfer

On the stock compensation side can you break out the total that you gave out in the press release between COGS and F&M and G&A?

Arthur Becker

I don’t know Jim, do you have that number somewhere.

Jim Pluntze

I am sure I have it, probably better if I --

Arthur Becker

Yeah. Do it offline if you don't mind. I am sure it will be in the queue but we can give you that number.

Andy Schroepfer

I think it was a brilliant move to start giving out total churn companywide rather than excluding major accounts. Can you give any of the back quarters, either last or any of the prior quarters in terms of total churn?

Arthur Becker

We thought about doing that but we just felt like now we're starting to reveal things or trying to provide retroactive transparency, we just didn’t think that was appropriate.

Jim Pluntze

How about just a little bit.

Andy Schroepfer

What was the mitigating factor towards giving out the total churn previously just so we can know?

Arthur Becker

When our business is a little bit smaller and our larger customers were such a large piece of our revenue we just felt like churning from one of those customers would be a misleading information, because you could have a big churn in one number and a lower churn number than the next number. It just didn’t feel like we were giving reliable and dependable information to investors. And now that that's changed, the larger customers represent a smaller piece of our overall revenue. We just thought that it was easier to, it would be easier for investors to have an insight and see overall number.

Andy Schroepfer

Is it fair to then assume regardless of what happened in the past that there is, you are not expecting any meaningful churn going forward?

Arthur Becker

That's like a leading question. I don't think we can answer that.

Andy Schroepfer

It is a leading question and I am trying to assume that that's the case.

Arthur Becker

You have full transparency now and that will be our policy going forward. It wasn't meant to be not fully transparent in the past, that we just, but we didn't feel it would be meaningful to investors and now we've concluded that we think this is the right way to go forward.

Andy Schroepfer

Excellent. And then the last question I'll ask on the 10,000 square foot co-lo contract, what technically happened that caused that to not be able to be revenue generating or part or all of the --

Arthur Becker

The customer had difficult making up their minds between PDUs and bus bars.

Andy Schroepfer

Okay. Do you now know incremental questions to ask future customers of meaningful size space?

Arthur Becker

Bus bars or PDUs, right.

Andy Schroepfer

All right.

Arthur Becker

The COGS stock comp number was 636,000 CDs, subtract from our reported stock comp number, you'll get the remaining number for S&M and G&A.

Andy Schroepfer

Thanks guys. You did do a great job this quarter even from the stock-based compensation...

Arthur Becker

We were waiting for somebody to flatter us. We appreciate it being you, Andy.

Andy Schroepfer

I refuse to ever do that again at the start of a phone call, but you guys did put up a great bookings number. Congratulations. Thanks.

Arthur Becker

Thanks.

Operator

There are no additional questions at this time. I would now like to turn the presentation over to your host for closing remarks.

Arthur Becker

I think we are all set. Thank you all for attending. We appreciate it. Hope the afternoon call works for everybody as we will probably continue this going forward. Thank you very much. Bye.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: NaviSite Inc. F2Q08 (Qtr End 01/31/2008) Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts