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Ness Technologies, Inc. (NASDAQ:NSTC)

Q1 2008 Earnings Call

May 5, 2008 8:30 am ET

Executives

Drew Wright – Investor Relations

Issachar Gerlitz – President, Chief Executive Officer & Director

Ofer Segev – Chief Financial Officer & Executive Vice President

Analysts

Mark Marostica – Piper Jaffray

Moshe Katri – Cowen & Company

Matthew McCormack – Friedman, Billings, Ramsey & Co.

Shaul Eyal – Oppenheimer & Co.

Analyst for Ehud Eisenstein – Oscar Gruss & Son

Devang Kothari – JMP Securities

Operator

At this time I’d like to welcome everyone to the Ness Technologies first quarter earnings call. (Operator Instructions) Thank you Mr. Wright, you may begin your conference.

Drew Wright

Good morning and thank you for joining us today for the Ness Technologies first quarter 2008 earnings call. During the call we’ll be discussing the company’s results for the quarter ended March 31, 2008. I’ll start with our usual 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, anticipate, plans, intends, assumes, will or similar expressions. Forward-looking statements are based on management’s current expectations and beliefs about future events 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 uncertainties 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 or those projected in forward-looking statements are the risk factors described in Ness’ annual report on Form 10K filed with the Securities & Exchange Commission on March 17, 2008. Ness is under no obligation to and express disclaims any obligation to update or alter its forward-looking statements whether as a result of such changes, new information, subsequent events of otherwise. The audio from today’s call is being webcast live on the Internet. A reply of the call will be available online at the Ness Technologies’ corporate website www.Ness.com under investor relations.

On today’s call you’ll hear from Mr. Issachar Gerlitz, President and Chief Executive Officer and Mr. Ofer Segev, Executive Vice President and Chief Financial Officer. Over to you Issachar.

Issachar Gerlitz

Hi everybody and thanks dialing in. Our prepared remarks today will be shorter than usual as our first quarter was very much in line with our and the markets expectations. Revenue for the quarter were $159.7 million, a first quarter record up 27% year-over-year based on solid growth across all our segments and helped by the weakness of the US dollars. Quarterly net income was $6.9 million also a first quarter record up 21% year-over-year or $0.18 per diluted share. Backlog at the end of the quarter was a record of $791 million up 25% year-over-year as a result of continued strong bookings during the quarter especially in the independent software vendor and high tech homeland security and defense and utilities vertical.

I don’t need to elaborate about the microeconomic business challenges in 2008. The weakness of the US dollar has created a challenging environment for everyone including us. It’s enough to say that if the dollar has remained at the Q1 07 level it would have contributed almost $2 million additional to our EBIT. Ofer will discuss the effects of the foreign exchange on our business later in the call. Nevertheless, our business remains strong, we are adjusting to the challenging environment and we feel good about our ability to deliver good organic top line growth and meet our earnings projections.

As you might recall, our business is focused on three service offerings: system integration, which we offer around the world; software product development which we offer from India and Eastern Europe; and software distribution. Let’s start off with system integration and application development which includes Ness Europe, Ness Israel and TSG and which represents 76% of our revenues in the first quarter. Our strongest revenue growth occurred in our Ness Europe segment which in addition to system integration and software consulting services for customers across Europe provides near shore software product development for western European and Europe customers from delivery centers in central and eastern Europe. Segment revenues for the quarter were $40.2 million up 76% year-over-year with an operating margin of 11.2% year-over-year organic growth for Ness Europe excluding foreign exchange effects was 24% somewhat higher than our long term segment organic growth expectation of around 15%.

We had many wins across Europe during Q1 growing segment backlog by over 70% year-over-year. Those deals included four multimillion dollar deals in Slovakia, Romania, in Hungary, in the utilities, financial services and public sectors. A number of other wins in western and eastern Europe in a variety of verticals. Another key driver was our growing European SAP proxies which accounted for three of the larger deals.

Also, we had a good quarter in our Ness Israel segment which is responsible for our commercial business in the Israeli IT services market including both system integration and application development and software distribution. As you recall from our Q4 earnings call we have been implementing the strategy of focusing on higher margin businesses. Thus we spun out our low margin non-strategic Israeli staff implementation business early in the first quarter subtracting about $24 million on the line of revenues from the segment and almost 500 people. We are constantly looking for opportunities to create shareholder value as we did in this case through this spin out of this low margin business. Of course, we’ll continue to look for another opportunity to unlock shareholder value over time. This strategy is paying off. Even after this spin out quarterly revenues were a strong $51.3 million up 1% year-over-year while operating margin was a first quarter record of 9.1% up from 6.1% in Q1 07 normalizing for the spin out of the staff implementation business and excluding foreign exchange effects year-over-year organic growth in Ness Israel was 2.4%.

Wins during the first quarter included two large deals mentioned in our last earnings call, a $10 million contract extension from the Israeli Court of Administration for enhancement and support of the paperless next generation Court system previously built for them and a $7 million contract from the Ministry of Construction and Housing to develop, operate and maintain a new system for managing housing assistance programs. Then, in various other wins some large some smaller.

Next is our technology and systems group segment known as TSG which develops software solutions for the homeland security and defense sector. TSG performed on plan with quarterly revenues of $16.5 million up 17% year-over-year and a solid up urging margin of 13.4%. Wins during this quarter included a $30 million contract to provide our integrated command and control system and build a national command and control center for a foreign country. This is another manifestation of our strategy to globalize Ness and a significant expansion of our intelligence system contract we announced at the end of 2006 for a different foreign country. And of course, we secured several new contracts in Israel as well.

Our second service offering is software product development which represents 14% of our revenue in the first quarter. As you know we provide software product development and R&D services from India and Eastern Europe to high tech companies and other companies that rely on software products to create their revenues. We call this software product lab or SPL. Our strategy to expand software product lab in to global offerings is bearing fruit as witnessed by two important milestones. First, we just exceeded 2,000 billable employees worldwide in our SPL business. Second, for the large multinational software product Ness contract I mentioned in our Q3 earnings call in November valued at just short of $30 million we have just celebrated the 100 employee mark in the eastern European lab we are building for the client and the [inaudible] mark in the more recently initiated lab in Indian. As you recall we won the deal because we were able to provide outsource software product development from our offshore centers in Indian and from our near shore centers in eastern Europe as well as technical expertise from our Israeli operations. The client, by the way, is [Nostics] the leading mapping software company.

The back of our SPL revenues are provided in our Ness North America segment. The performance of Ness North America in the quarter was a mixed bag. We continued to win and establish our leadership in the states but we also increased our investment and focus on utilization in India. The result was a temporary lower than desired operating margin of 4%. In India we grew billable headcount in Q1 by 200 employees as expected. Attrition remains within our normal range [inaudible] the wage inflation. For Q1 net North American revenues were $27.1 million up 4% year-over-year. Organic growth in the SPL portion of North America was 13%. Backlog in the segment grew over 75% year-over-year. We currently operate over 50 software products for clients. In addition to the backlog our sales pipeline for this line of business remains very strong.

We had a good quarter in our offshore software product development sales pipeline including an $18 million offshore contract for a leading western European company in the travel business. The sizeable increase in our [Nostics] contract and significant front [inaudible] increases for several other existing customers once again demonstrated customer satisfaction with our unique SPL offering. Net North America also provided some system integration and application development services in the US. This is something that we have discussed before. The onsite component of this business which was a drag on the segment operating margin in the fourth quarter has improved its margin significantly by willowing out some low margin non-strategic staff implementation business and tuning up its business which reduced the US headcount by about 50 people.

Our third service offering is software distribution a part of which is included in our other segments and a part of which falls within Ness Israel. Software distribution representing 10% of our revenues in the first quarter. The other segment includes several smaller operations, Ness Pro Global, Ness IPS and Ness Asia Specific. Segment revenue were $24.7 million up 105% year-over-year while operating margin was -1%. This planned loss is the result of three factors: seasonality in our software distribution business which is weakest in Q1; the impact of our amortization intangibles; and the investment we made in Q1 on our healthcare business as part of Ness IPS. Ness Pro Global which serves enterprise software licenses of third party software vendors to corporate clients including implementation, customization, and support services for those licenses came in on budget for its seasonally weak first quarter. The Ness Pro Global business continues to grow.

Ness IPS which provides software development and system integration services to the financial services and healthcare vertical had two nice wins during the quarter. A major western European bank selected our financial data enterprise product as its consolidated data management platform in a multiyear multimillion Euro agreement. This is the third international win for Ness IPS financial services this quarter. And, in our healthcare vertical we won our first multimillion dollar offshore engagement.

Ness APAC came in on target for the quarter and had normal wins to show. In line with our strategy we also eliminated a low margin non-strategic staff implementation unit from our APAC corporation during the quarter representing about 80 people. As part of our adjustment to the macroeconomic environment we reduced our global workforce by almost 480 employees net of new hires, exiting from low margin non-core businesses in Israel, the US and Asia Pacific. At the same time we increased or percentage of billable employees sequential from 86.9% to 87.4%.

Marketing and branding efforts in the first quarter included presentation in the [inaudible] industry conferences. In addition, we continue to be recognized in industry ranking [inaudible]. Notable items included in March we were ranked as a top 10 best performing IT service provided on the 2008 Global Services 100 List, a listing of the world’s most innovative technology services provider. Last month we presented our defense and homeland security solution at [FIGAD] 2008, the international air and space fair in Santiago Chile. In February we were ranked as best global IT solution provider by the World Finance Magazine as a result of our increasing stature in financial services globally. In March we were sponsor and round table moderator of FIMA US 2008 conference in New York where we presented our financial data enterprise solution and other proprietary offerings for the financial services sector. In March we sponsored the [Znode] Research and Contracting Offshoreing R&D 2008 conference in Bangalore, the first large conference of software product development outsourcing professionals and customers.

Richard Thomas, EVP of Quintiles, one of our largest SPL customers gave the conference keynote address on the topic of software product R&D in India during which he described his satisfaction with Ness and our software product development methodology. He also stated that the initial engagement is now 18 months ahead of plan. In February Ness Czech was ranked by IBM as partner of the year and last week we were included in the IAOP Global Outsourcing 100 List of the best 20 companies offering product research, development and maintenance. The other major item of news is that the large business conference that we are holding for our Israeli customers in Tel Aviv on May 20th at which our guest of honor will be the former US Vice President Al Gore. Mr. Gore has made possible what looks like from the start an impossible task. His leadership, ingenuity and success in the campaign to bring global warming to the world’s attention are attributes we strive to bring to every client engagement. We expect over 2,000 attendees at the event.

Ofer will you take us through the review of our financial results please?

Ofer Segev

Good morning everyone and thanks for joining us. Total revenues for the quarter were a first quarter record $159.7 million up from $125.8 million in the first quarter of 2007 an increase of 27% year-over-year. Organic year-over-year revenue growth for Q1 was 21% in dollar sales and 10% excluding currency fluctuations. Revenues by geographic region for the quarter were Israel 38%, North America 26%, Europe 31% and the rest of the world 4%. Our top 20 customers accounted for approximately 31% of revenues during the quarter. We have more than 500 active customers worldwide and no one customer accounted for more than 5% of revenues within the quarter. Revenues from existing customers in the quarter remained steady at over 85%.

Gross profit for the quarter was $45.3 million or 28.4% of revenue compared to $36.1 million or 28.7% of revenues in the first quarter last year. Operating income for the quarter was $10 million or 6.3% of revenues up 49% compared to $6.7 million or 5.3% of revenues in the first quarter last year. EBITDA for the quarter was $15 million or 9.4% of revenues up 50% from $10 million or 8% of revenues in the first quarter of 07. The weakness in the US dollar versus the Shekel, the Euro and other European currencies had a significant effect on our results in the first quarter. On the one hand comparing average Q1 foreign currency exchange rates versus those in Q4 of 07 we recorded approximately $5.3 million of additional revenue in Q1 due to the re-measurement in to dollar of our non-dollar revenue. On the other hand the corresponding effect on the operating income line was a decrease in operating income of approximately $600,000. Therefore there was a hit to our operating margin from advanced currency movement, mostly the dollar versus the Shekel of 60 basis points. Although we were able to meet our earnings expectations if the dollar remains at the current level for the remainder of the year we expect a similar effect on operating margins each quarter.

We had financial expenses of $1.4 million in the quarter compared to financial income of $400,000 in the first quarter of last year. This financial expenses are largely due to interest expenses on the long term loans we took for 2007 acquisitions as well as for some expenses due to the dollar exchange rate. We have over $70 million remaining on our credit facilities. Our tax rate in the quarter was approximately 20%. Net income for the quarter was $6.9 million or $0.18 per diluted share up 20% compared to $0.15 in the first quarter of 07. On a non-GAAP basis excluding stock-based compensation expenses and amortization of intangible assets net of taxes net income was $8.8 million or $0.22 per diluted share up 29% compared to $0.17 in the first quarter of 07.

At the end of the quarter cash and cash equivalents with restricted cash and short term deposits was $70.3 million compared to $46.1 million at the end of 07. Trade receivables were $182.1 million down sequentially compared to $184.1 million at year end. While unbilled receivables sort and long term were $56.7 million up $5.5 million sequentially. Unbilled receivables as a percentage of total trade receivables was 24% in the quarter down year-over-year from 29% in the first quarter of 07. Days sales outstanding as of March 31st was 84 days compared to 94 days at the end of the first quarter last year and 80 days at the end of Q4. Remember that in calculating DSOs we exclude VAT and software vendor pass through from total accounts receivables. We continue to focus on improving our DSOs going forward. We target DSOs to be in the range of 70 to 80 days.

Clearly our focus on cash generation is working. Operating cash flows in the quarter were very strong in what is typically our weakest cash flow quarter. After paying the $9.5 million arbitration settlement during Q1 which we provided for in the fourth quarter, we still brought in positive operating cash flow of $1.9 million. Excluding the arbitration payment, operating cash flow would have been $11.4 million. Backlog at March 31st was a record $791 million, up $160 million or 25% compared to $631 million a year ago as a result of strong bookings in the ISP and high tech homeland security and defense and utilities vertical.

I close my part of the call with a word about guidance. We remain comfortable with our guidance of a full year diluted net earnings per share in the range of $1.00 to $1.05 despite the dollar weakness. On the other hand our top line will probably be considerably higher than previously guided due to the dollar re-measurement issue. We current expect full year revenue to be in the range of $660 million to $680 million. Remember that our guidance does not include any contribution to revenues for earnings per share from future acquisitions.

That concludes the financial overview. Issachar will say a few words before we take questions.

Issachar Gerlitz

We are pleased by the solid quarter we delivered and our goal is to continue and deliver solid quarters going forward. And, as always, a word of thanks to our 7,800 employees in 18 countries whose vision, focus and ongoing efforts have made Ness such a strong company. That concludes our prepared remarks. Let’s take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mark Marostica – Piper Jaffray.

Mark Marostica – Piper Jaffray

I wanted to ask Issachar, clearly you’ve done a nice job optimizing the cost basis and I’m curious whether that you see more opportunities to spin out or reduce some of your lower margin business or, if that effort is wrapped up at this point? And, if you have additional opportunities, if you could quantify that for us in terms of headcount or dollars you expect to still take out of the business?

Issachar Gerlitz

You know this kind of question is very difficult to address but I’ll give you a guidance that is basically from an operations point where we think that we did almost what is needed in order to optimize the business in tune the machine to the current environment. Of course, when the environment will change then the tune is needed. But, all in all from an operating point of view, I think that the major effort is behind us.

Mark Marostica – Piper Jaffray

In regards to North America in particular where you saw margin decline, could you give us a little bit more detail on exactly what’s driving year-over-year margin declines in North America and when you think those declines will stabilize? And, over what time period?

Issachar Gerlitz

When you’re talking about North America actually you’re talking about across two segments and I believe that you’re more referring to the part that is part of the SPL software product lab that is coming from offshoring from India. The other part from the onsite consulting is going to continue its improvement and we’re probably going to see continuous improvement in margin over there. But, let’s talk about the India part. One of the issues in our India operation was to close a gap of say open positions that we had talked in the past about of around 200 people. During Q1 we changed our recruiting policy and went for what we call pro-active hiring. The cost of almost 200 people of pro-active hiring that were on the bench until we train them and will ebb until we deploy them affected our margin in the quarter. This was by the end a successful exercise as we entered the quarter with an additional 200 more billable people that will of course effect the Q2 and going forward and therefore we see, we hope to see quite a change in the margin for Ness North America is from Q2 and onward in to the year.

Mark Marostica – Piper Jaffray

Relative to a few housekeeping items, I noticed stock comp jumped up in the quarter. Can you give us a sense for what’s going on with that line item and how we should model that going forward?

Ofer Segev

I think it’s probably going forward take the number from Q1 and probably the same number until we issue some more and then we’ll announce it. We hired some more people and we issued some more stock and that’s the current number.

Mark Marostica – Piper Jaffray

Then the tax rate Ofer, how should we model that going forward?

Ofer Segev

I think we said 20% to 22% early in the year. At the beginning of the year it’s a little bit lower mainly in our Ness Pro business which is higher tax rate because it’s in Europe, Q1 is always the weaker quarter of the year that’s what the tax rate effective is a little bit lower. So, 20% to 22% I think is the right number.

Operator

Your next question comes from the line of Moshe Katri – Cowen & Company.

Moshe Katri – Cowen & Company

Can you give us an update on the UK operation, what was it during the quarter in terms of the financial impact? Are we beyond breakeven at this point? And then, what are the plans about the UK for the remainder of the year?

Issachar Gerlitz

This quarter we have not mentioned the UK, it’s a good sign. It’s definitely in the black, it’s not in the red. Outside two issues affected our UK operations, the majority of the difficulty was on the expense side, I think we’re done with that and now it’s time to establish a good pipeline for business coming from the UK. Practically, it’s part of our SPL business and sales they are consolidated with our SPL business and this is off the agenda of issues to discuss.

Moshe Katri – Cowen & Company

In terms of looking at your EBIT margins for the quarter, you’re obviously in the process of ramping a pretty significant amount of new business that you’ve been winning during the past quarter or two, has that also impacted EBIT margins for the quarter?

Ofer Segev

It’s mainly if you look the biggest down was in Israel and that’s a process we’ve been starting from the date we joined about a year ago. We’re not bidding on business that doesn’t meet a certain margin level and that’s the result of it. Moving from 6% to 9% in Israel that’s a major, major improvement. And, the rest of the businesses it’s basically continuous improvement. You see Europe which is about 11%, again above their annual target of about 10% to 11%, so I think it’s the message for the last year. You’re talking about margin improvements, we’re starting to see some results.

Moshe Katri – Cowen & Company

What sort of EBIT margin are we targeting for 2008, can you remind us Ofer?

Ofer Segev

Again, I think last quarter we said we’re targeting something around 8.5% to 8.7% and that was before the dollar started to play with us. So, I guess you take the 8.7% minus 60 basis points it’s probably 8.1% to 8.2% this year.

Moshe Katri – Cowen & Company

Then, in the financial services vertical any changes in terms of sales cycles? Any climbs? Any project deferrals? And again, I’m talking about the general macroeconomic environment.

Issachar Gerlitz

We look very cautiously at the financial services sector as everybody has. We do not see any real impact to our business, actually we were able to win more customers this quarter than in one quarter ever before. We do not see slowdown but we monitor the situation very cautiously.

Moshe Katri – Cowen & Company

Then two last questions, I promise. What were free cash flows for the quarter? Then also in the same context is there anything that you can, can you give us any comments about the June quarter?

Ofer Segev

Q1 excluding, I don’t know if you want the count with arbitration but, if you exclude the arbitration, free cash flow that’s basically operating minus investment in equipment was about $8 million.

Moshe Katri – Cowen & Company

Then can you make any comments towards the June quarter?

Issachar Gerlitz

Moshe, let me give you an example about the arbitration fee because it’s been discussed so many times. If you remember, we provisioned $9 million in Q4. By the time we paid the money because of the conversion rate we recorded $9.5 million as the dollar weakened versus the Shekel, [inaudible] a very good manifestation of the issue that we are facing.

Moshe Katri – Cowen & Company

Then finally, do you have any comments about the June quarter? Any guidance in terms of revenue growth or anything about the bottom line?

Ofer Segev

Remember, we don’t give quarterly guidance now. I think what has been expressed in the model that we mentioned at the beginning of the year that Q2 would be slightly better than Q1 and still remains the same. Again, the revenue are affected mostly on top of what we said three months ago, the revenue are affected by the re-measurement to the dollar. So, it’s not real new business just new dollars. So, I think we still stand behind what we said about three months ago, there’s no real change to that.

Operator

Your next question comes from the line of Matthew McCormack – Friedman, Billings, Ramsey & Co.

Matthew McCormack – Friedman, Billings, Ramsey & Co.

In terms of the guidance, in terms of the fx impact, what were you contemplating in terms of the fx hit when you first established that when you reported the fourth quarter? And, what is it now?

Ofer Segev

If you look back at the process we went through we started the process of budgeting sometime around the October timeframe and everything was modeled based around the dollar at that time. Since October, November, the dollar took about a 10% beating. The biggest effect it has on us is in Israel where the mix of our revenue and expenses in Israeli currency is not like in Europe where most of the revenues and expenses are the same. In Israeli because we have, look at the total Israeli business, the total business in Shekel terms which includes the Ness Israel business, the TSG business and then our corporate overhead expenses which are also in Shekel we have more expenses in Shekel then revenue in Shekel and in Israel we have more revenues denominated in dollar than expenses in dollar. That’s why it hits us in Israel on the operating side by about $500 to $600,000 per quarter if it stays where it is today versus the Q4 average.

Matthew McCormack – Friedman, Billings, Ramsey & Co.

Then you had said you would expect it to be a 60 basis point hit. If I do my math correctly that’s about $4 million whereas you just kind of said it’s a half a million a year so could you rectify that?

Ofer Segev

Well, again the 60 basis versus what we planned to be. So you must remember revenues also go up so the whole formula changes. Nothing is constant, the revenue go up and because the earnings stay the same basically we said we need to get, by keeping the earnings the same but we cannot increase earnings, that’s how the calculation comes out in the end.

Matthew McCormack – Friedman, Billings, Ramsey & Co.

In terms of the margins of the segments I think you eluded to Europe is at the high end of your 10% to 11% target. Can you comment about the 9% Israeli margin and even the 13% TSG margin and how we should kind of model that going forward through the rest of the year.

Ofer Segev

In Israeli that’s probably the average target for the year which you have Q2 is seasonally the weakest quarter because of the holiday, so Q2 for Israel will be lower margin but Q3 and Q4 will be higher so on an average the 9%, 9% plus is probably where it will be on an annual basis. TSG I think similar to last year came in higher than the target which is around the 11% to 12% however, TSG is the segment that is the most affected from the dollar because 50% of its revenues are in or linked to dollar and close to 100% of the expenses are in Israeli currency. So the margin in TSG will be affected going forward. Most of the effect is in our TSG business.

Matthew McCormack – Friedman, Billings, Ramsey & Co.

Then in terms of the headcount reductions are there any kind of severance charges or were there in the first quarter that we should kind of possibly back out in order to normalize a margin?

Ofer Segev

Not really. It’s part of the normal course of business, nothing out of the usual.

Operator

Your next question comes from the line of Shaul Eyal – Oppenheimer & Co.

Shaul Eyal – Oppenheimer & Co.

Two quick questions, one for you Issachar, one for your Ofer. Issachar I know especially during 07 we spoke about it being some sort of a transitional clean out year. Is it fair to say now that this stage is absolutely behind you guys?

Issachar Gerlitz

I do hope that the numbers speak for themselves. I think that we promised to deliver good operating margin. I think we promised to bring good news. I think that almost in every measurement this was a record quarter, in many of the segments as well. We’re getting there. I don’t think that we are in any clean up mode anymore.

Shaul Eyal – Oppenheimer & Co.

Also, with respect to the currency, obviously everyone’s focusing this conference call on the US dollar and Shekel, what about the Rupee, how did it act this quarter?

Ofer Segev

The Rupee didn’t move that much this quarter and actually we decided to start hedge the Rupee just to mitigate any future ups and downs, take one risk out of the equation. So, no real effect on us.

Operator

Your next question comes from the line of Analyst for Ehud Eisenstein – Oscar Gruss & Son.

Analyst for Ehud Eisenstein – Oscar Gruss & Son

Two questions, one if you could talk a little bit about the Israeli competitive landscape and how it is progressing? And second, if you can comment on the margin for the $13 million deal you’ve announced?

Issachar Gerlitz

In Israel I think that there is no major change to the competitive landscape over the last year, at least since we are here. I think we are much more selective. This is really the story here and we let our competitors feed on low margin deals and we wish them good luck on that. The positive, we see some change in the Israeli market again relates to the dollar environment. The high tech sector that is being hurt due to the dollar situation and we see some slower decision making, I would call it, not much more than that. Regarding the new deal that we announced last week this is a normal margin deal for TSG and usually again, those are deals that are denominated in dollars. However, when we win deals that are [inaudible] we take care of the dollar situation in a way that it won’t affect us going forward. Now, this is [inaudible] deal, it’s not a one quarter deal so revenue will be over time.

Operator

Your next question comes from the line of Devang Kothari – JMP Securities.

Devang Kothari – JMP Securities

You might have addressed this earlier, I missed part of the call but current exchange rate between the Shekel and the dollar, is that what you’re baking in to your EPS guidance that you’ve just reiterated for 2008?

Ofer Segev

Yes.

Devang Kothari – JMP Securities

Then if I look back Ofer for the past couple of years we’ve seen kid of a decline in your operating margins in Q2. Should we expect a similar type of pattern in 2008?

Ofer Segev

No, I think this is again, mentioning what we said a quarter ago, this year is behaving differently than previous years. Basically, it’s going to go Q1, Q2, Q3 and Q4 sequentially improving every quarter.

Devang Kothari – JMP Securities

Okay. So we should expect improvement in Q2 and then improvement in Q3 and again in Q4.

Ofer Segev

Yes.

Devang Kothari – JMP Securities

Okay. Then the contract that you announced in to TSG group you said that was a two year term. Should we expect the $30 million to be recognized approximately 50% in 2008, 50% in 2009?

Ofer Segev

We have not yet baked the exact development of this project in to the different quarters. But, as usually in large quarters it’s skewed towards the end of the project so it will probably be the majority in 2009 and not in 2008. [Inaudible] ramping up resources and so on.

Devang Kothari – JMP Securities

Okay but the majority, could you give us some type of a ballpark feel for how much of that revenue would be recognized in 08? I know you might not have exact numbers but something so we get a order of magnitude?

Ofer Segev

You have to remember that this is not a surprise for us so it’s all baked in to our guidance.

Devang Kothari – JMP Securities

Then my last question is the software labs business I thought you said had a 13% organic growth rate this year?

Ofer Segev

Yes.

Devang Kothari – JMP Securities

So Ness North America only grew I think it’s 4% and I know you have the staff aug business locally and I’m trying to understand how big of a drag that was and if there was any other divestitures that were a big drag as well?

Ofer Segev

So the staff aug piece is being reduced overtime so actually revenues in this segment declined year-over-year as the offshoring grew.

Devang Kothari – JMP Securities

And you’re happy with the preferment of the software labs business?

Issachar Gerlitz

Well, we’ll be happy when we reach our 12% margin target so we’re not there yet but we feel very confident we’ll get there before the end of the year.

Operator

Your next question comes from the line of Moshe Katri – Cowen & Company.

Moshe Katri – Cowen & Company

Just a follow up, is there any change in visibility looking at the June quarter now versus the June quarter last year or versus any typical quarter?

Issachar Gerlitz

Numbers do not show any change in pattern. Like everybody else we’re very nervous whether the macroeconomic probable recession will affect us and so on and so forth. We do see people taking the time to make decisions but in terms of visibility and backlog and current contracts and meeting of obligation, we don’t see any change.

Moshe Katri – Cowen & Company

Then could you talk a little bit about the India operation? Specifically talk about your headcount growth objective for 2008 and maybe talk about wage inflation and attrition?

Ofer Segev

Sure. Let me start from the end. Attrition is at our normal level and we don’t see a major change in that. We believe that the overall slowness in the competitive landscape will help in that. We’ve just been through, or going through a salary raise which is typically in India during the second quarter so we believe that it’s well within the industry standard and expectation of everybody. We don’t see any major change due to the salary raise like every year. Regarding headcount, our major focus in Q1 was to improve utilization and turn people from the bench to become billable. We will continue this quarter and going forward with our efforts to add about 150 to 200 people per quarter net and meet overall 800 or so increase for the year.

Moshe Katri – Cowen & Company

Are you comfortable with the infrastructure that you have in India today, specifically recruiting and execution? Or, do you feel that you still have to fine tune it as you go along throughout the year?

Ofer Segev

We believe that we are at a situation where scale changes the type of organization. We went through one major change, that’s consolidating the infrastructure for India but moving from around 2,000 billable headcount to around 3,000 billable headcount required an organic, I would say a non-organic change to the organization. So, we need to develop the organization in India continuously and that is what we are doing and intend to continue to do during the year to achieve our goals.

Moshe Katri – Cowen & Company

Then finally, can you talk about your M&A pipeline? Are we going to be inquisitive this year as well? Or, are we kind of taking a pause right now and kind of digesting some of the acquisitions?

Issachar Gerlitz

We believe that acquisition is probably one of the best tools for us to have non linear growth in two areas, places where we want to exploit our leadership and get to a significant size and places where we would like to acquire competence in verticals or special expertise where we think we will become more competitive. We believe that the semi slowdown on the macroeconomics have a few implications. First, it brings lots of opportunities and one just needs to be more selective to pick the right company and that’s what we are doing. And secondly, to be very cautious about the price so I believe that we will continue to be inquisitive, I think this is the right strategy for Ness but we’ll be more cautious on the targets that we are taking and the prices we are paying.

Operator

There are no further questions so I’ll turn the call back over to the chair person for closing comments.

Issachar Gerlitz

Thank you for joining us on today’s earnings call. We look forward to speaking again when we report next quarter’s results. That concludes today’s call. Thank you and have a good day.

Operator

This concludes today’s conference call.

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Source: Ness Technologies, Inc. Q1 2008 Earnings Call Transcript
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