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Ness Technologies Inc. (NASDAQ:NSTC)

Q2 2008 Earnings Call

July 29, 2008 8:30 am ET

Executives

Issachar Gerlitz - President, Chief Executive Officer and Director

Ofer Segev - Chief Financial Officer & Executive Vice President

Drew Wright - Investor Relations

Analysts

Moshe Katri - Cowen & Company

Matthew Mccormack - FBR Capital Markets

Mark Marostica - Piper Jaffray

Manesh Tamarijine - Oppenheimer & Co

Devang Kothari - JMP Securities

James Friedman - Susquehanna

Operator

Welcome to the Ness Technologies second quarter earnings call. (Operator Instructions) I would now like to turn the call over to Drew Wright, Senior Vice President, Investor Relations.

Drew Wright

Thanks for joining us for the Ness Technologies second quarter 2008 earnings call. During the call we’ll discuss the company’s results for the quarter ended June 30, 2008. I’ll start with a Safe Harbor statement. Except for historical matters discussed herein, the matters discussed on today’s conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are often preceded by words such as believes, expects, may, anticipates, plans, intends, assume, 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’s 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’s annual report on Form 10-K filed with the Securities and Exchange Commission on March 17, 2008. Ness is under no obligation to and expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of such changes, new information of subsequent events of otherwise.

The audio for 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.

Our call today will be led by Mr. Issachar Gerlitz, President and CEO and by Mr. Ofer Segev, Executive Vice President and CFO. Issachar please begin.

Issachar Gerlitz

We had a very good quarter. We executed well on our strategy and set several new records. We met our second quarter expectation and we even delivered some up-tick in what is normally a seasonally weak quarter.

Revenue for the quarter were $170.6 million, an all-time record up 36% year-over-year with a strong growth across the board and especially strong growth in Ness Europe. Quarterly GAAP net income was $8.1 million a second quarter record, up 94% year-over-year or $0.21 per diluted share. Backlog at the end of the quarter was a record of $799 million up 23% year-over-year.

Let’s take a look at the business; we feel good about it and about our ability to deliver top-line growth in earnings. As you know we focused on three service offerings; system integration which we offer around the rest of the world; software and product development, which we offer from India and Central Eastern Europe; and software distribution. We will start with the system integration and application development.

This includes most of Ness Europe and Ness Israel and all of TSG plus a small part of Ness North America and some of our other segments. System integration represented 74% of our revenue in the second quarter. Our strongest revenue growth occurred in our Ness Europe segment which in addition to the system integration for customers across Europe provides new shore software product development for Western Europe and the U.S. customer from delivery centers in Central and Eastern Europe.

Segments revenue for the quarter were $44.9 million, up 85% year-over-year, with an operating margin of 10% versus 7.1% last year. Year-over-year Q2 organic growth for Ness Europe excluding foreign exchange effects was at 10%, above our long-term segment organic growth expectation of around 15%. About 90% of our Ness Europe revenue is from Central Eastern Europe where the economy is remaining strong and where we are likely to expand our penetration within existing and adjacent geographies including through acquisitions.

Backlog in Ness Europe grew 81% year-over-year. We had over 20 wins across Europe during Q2 including four multimillion-dollar deals. I’ll mention one now; a $7.7 million SAP enterprise implementation for BAT, the Bratislava Heating Company in Slovakia. SAP system integration continues to be a growth engine for us in Europe, so does our recently acquired management consulting business in Hungary which we are now beginning to leverage in the Czech Republic and Slovakia as well.

We had a great quarter in our Ness Israel segment, which is responsible for our commercial and civilian businesses in Israeli IT services market including both system integration and software distribution. Despite normal Q2 of seasonal pressure in Israel from the high number of holidays we are able to achieve revenue of $52 million up 6% year-over-year with an operating margin of 9.5% compared to the operating margin of 5.2% in the prior year.

As you can see our strategy of focusing on higher margin business in Israel continues to payoff. Wins during this second quarter included a $6.5 million engagement at the Israeli airport authority and $3 million project for the Israeli electric company and numerous other deals. Next up is our Technology and System Group segment or TSG, which developed software solution for the Homeland Security and Defense Sector around the world. TSG delivered $14.3 million of revenue up 8% year-over-year in a seasonally weak Q2.

On top of the normal holiday seasonality for this Israeli based offering TSG experienced significant foreign pressure on earnings despite which it turned in an operating margin of 6.3%. Backlog in this segment grew 21% year-over-year. We won a variety of new deals during the quarter and at the end of the quarter we kicked off the $30 million command in control system deal that we have announced in May.

Our second service offering in software product development represents 14% of our revenue in the second quarter. We provide software product development in R&D services from India and Central and Eastern Europe to high tech companies and other companies in U.S. and Western Europe that rely on software products to create their revenue. Our offering is called software product labs or SPL. The bulk of our SPL revenue are provided by our Ness North America segment.

The performance of Ness North America in the quarter was much improved from Q1 with a revenue of $30.6 million up 16% year-over-year and the combined operating margin of 6.6%. Q2 organic growth in our SPL business specifically was 23% year-over-year with an operating margin of 7.7%. In India we grew billable headcount in Q2 by 150 employees bringing a fair tough billable headcount growth to 350 people, roughly inline with target.

Attrition remains within our normal range as did wage inflation. Backlog in this segment grew 63% year-over-year. We currently operate over 50 software product labs for clients.

During Q2 we signed a new software product lab for an established award winning internet retailer. We initiated a software product lab for our Acresso, formerly MicroVision, the maker of FlexNet and Install Sheet product line were awarded a large expense of another SPL customer for eCommerce payment solution provider and we won new addition at four other existing labs Prognostic, Cobalt, Workspace and Quintel.

We’ve began to market our SPL offering more actively in Europe and we are starting to develop a good sales pipeline. In fact, we also just won a new lab for our Kosice Development Center. In addition, we’re likely to start one or two new SPL development centers in Central and Eastern Europe this year to support the strong demand for those services either by green fielding and/or small acquisitions.

As you know Ness North America also provides some system integration and application development service in the U.S. These onside component of the business now about 20% to 25% of Ness North America revenue continues to improve its margin by focusing more on project work and choosing not to renew low margins, non-strategic staff implementation businesses. To that point we shared above 35 to 40 such positions in Q2.

In this part of our Ness North America business we won new deals during Q2 like Boehringer Ingelheim, Wiley and others. Our third service offering is software distribution, a part of which is included in our other segment and a part of which first within Israel. Software distribution represents 12% of our revenue in the second quarter. Our other segment delivered Q2 revenue of $28.8 million up a 126% year-over-year with an operating margin of 7.6%.

NessPro which serves enterprise software licenses of third party software vendors to corporate clients outside of Israel continues to perform well in Q2. NessPro Italy did particularly well and this SAP complementary product we introduced recently are getting a lot of interest in Europe as well as in Israel.

Ness IBS, which provides software development and system integration, services to the financial services and healthcare vertical is seeing some lengthening of sales cycle in its U.S. based financial services business, representing about 4% of the total revenue, although it hasn’t had any project cancellation. By the way actively marketing our unique intellectual property Financial Data Enterprise or FDE in Europe and in Asia now and we are seeing good signs of future.

Ness Asia-Pacific, our system integration and business in Asia-Pacific did alright in Q2. Revenue growth in this business unit remains low, but margin has improved a lot and we added four new customers in this quarter. We continue to eliminate or not to renew low margins, non-strategic staff supplementation business shutting another 15 people. Our headcount increased to 7840 in the second quarter, net of almost 120 reductions in our staff implementation businesses in APAC and in the UAE and in non billable employees in India. Our percentage of billable employee remained about 87%.

Last quarter when we spoke, I mentioned that we would continue to look for opportunities to unlock shareholder value over time. As we announced on July 10, we’ve signed a definitive agreement to sell our SAP sales and distribution division in Israel to SAP AG. Under the terms of the agreement SAP will acquire from us selected assets related to the distribution support and maintenance of SAP Technology and Solutions. We’ll continue to work with SAP as a strategic partner and value-added reseller and as a system integrator for Israel and other geographies.

We have nearly 10 of our SAP academy training centers and we continue to support SAP and its customers in the market. The transaction is expected to close in the third quarter of 2008. The sale of this division enables us to increase the strength of our relationship with SAP outside of Israel.

One of our strategic goals is to increase our SAP related system integration business. Today we are the largest SAP implementer in Israel and we are growing our SAP practice rapidly in other geographies as well. As part of our strategic trust to turn that into a truly global company, we have decided to create business units that will focus in strategic global partner relationship.

These units will be responsible for intellectual asset mobility in further leveraging our global reach with partners like SAP and others. Intellectual asset mobility means, sharing expertise, knowledge, processes and intellectual property between this and that unit in geographies.

Effective September 1, I’ve appointed Shachar Efal, the President of Ness Israel as the President of a new Global Partnerships and Center of Excellence Group. Shachar has done a great job over the years as President of Ness Israel and I thank him for his achievement. I look forward to the important contribution he’ll make in this new strategic role.

Effective the same date, I had appointed Effi Kotek, the President of Ness Israel. Effi has been with Ness since inception and has had a number of Senior Management positions in the company. Most recently, Effi has been the second in command to the President of North Ness Israel. I’m confident that Effi will continue the good work began by Shachar, providing high quality services to the Israeli IT services market, maintaining and further strengthening this financial performance of Ness Israel and maintaining our leadership position in Israel. I wish Effi much success in his new role.

Marketing activity was strong this quarter, notable items included. We had a large and very successful business conference for Israeli customers in Tel Aviv on May 20. Our guest of honor was former US Vice President Mr. Al Gore with over 2000 representatives. We won Microsoft Industry Awards, Best Solution Competition in Slovakia for 2008 for web based E-Government System we built for the city of [Kossity].

At the National Association of Broadcasters, NAB show in Las Vegas we show cased our media business framework as well as net content office, which manages contract rights and royalties. We were selected as the Oracle partners of the year for 2007 for our Singapore headquarter APAC business and we were ranked as the number one Israeli IT services providers by BBI.

Now to the numbers; Ofer, would you run through our financial results please.

Ofer Segev

Good morning everyone. Total revenues for the quarter were a record $170.6 million, up 36% compared to $125.8 million in the second quarter of 2007. Organic year-over-year revenue growth for Q2 was 25% in developments and 11% excluding currency fluctuations. Revenue by customer’s geographic region for the quarter were Israel 35%, Europe 34%, North America 36% and the rest of the world 4%.

Our top 20 customers accounted for approximately 32% of revenues during the quarter. We have more than 500 active customers worldwide and no customer accounted for more than 5% of revenues in the quarter. Revenues from existing customers in the quarter remained steady at over 85%.

Gross profit for the quarter was $62.6 million or 30.8% of revenue compared to $36.1 million or 28.7% of revenues in the second quarter of last year. Operating income for the quarter was a record $11.2 million or 6.6% of revenues up 107% compared to $5.4 million or 4.3% of revenues in Q2 last year. EBITDA for the quarter was $16.2 million or 9.5% of revenues up 89% from $8.6 million or 6.8% of revenues in the second quarter of ‘07.

The continued weakness of the U.S. dollar versus the Shekel, the Euro and other relevant European currencies has an effect on our results in the second quarter. It inflated our reported revenue and it turned our operating income a little and the net result was lower operating margin. We now expect that our operating margin for the year will be around 8%.

We had financial expenses of $1 million in the quarter compared to $100,000 in the second quarter of last year. These financial expenses are primarily due to interest expenses on the long-term loan we took for final positions. We have over $70 million remaining on our credit facility.

Our tax rate in quarter was approximately 21%. GAAP net income for the quarter was $8.1 million or $0.21 per diluted share compared to $0.11 in the second quarter of ’07. On a non-GAAP basis excluding stock based compensation expenses and amortization of intangible assets, net of taxes, net income was $9.7 million or $0.25 per diluted share compared to $5.1 million or $0.13 in the second quarter of ’07.

At the end of the quarter cash and cash equivalent, restricted cash and short-term deposits was $64.7 million compared to $46.1 million at the end of the year. Trade receivables were $196.5 million compared to $181.6 million at March 31, while unbilled receivables, short and long-term were $57.1 million up $1.1 million sequentially. Unbilled receivables as a percentage of total trade receivables were 23% at the end of the quarter down year-over-year from 28% at the end of the second quarter of ‘07.

Day Sales Outstanding as of June 30 was 84 days, compared to 85 days a year ago and 84 days at the end of the first quarter. Remember that in calculating DSO we exclude VAT and software vendor pass through from our trade receivables. Since these amounts don’t represent revenue for Ness we continue to focus on improving our DSO going forward. We target DSO to be between 70 to 80 days.

We had a record second quarter for operating cash flow bringing in $30 million in what was traditionally a weak cash flow quarter for us. We will continue to push for positive operating cash flows every quarter and except for normal increases in our working capital as we go, operating cash flow should credit net income much better than in the past.

I would like to remind you about the seasonality. We have just completed Q2 which is a seasonally weak quarter for our operations based business, Ness Israel and TSG while Ness Israel overtakes this national dispute in part to a strong Q2 software product here in Israel. In Q3 we should expect some seasonal weakness in Ness Europe from the summer vacation season and in Q4 you can expect quite strong performance by our software product distribution business.

As Segev mentioned a few minutes ago we recently signed a deal with SAP to sell them our SAP sales and distribution division in Israel. This division in sales enterprise licenses for SAP products to customers in Israel represents about 2.5% of our total revenue. SAP would pay us $19 million euros approximately $13 million of which -- around $20 million will be paid upon closing of the deal which is suppose to be this quarter, Q3 and up to $6 million euros or approximately $9 million we will be paid in commission on sales achieved by the division we sold which will represent most of the operating income that would have been generated by the business unit over the next 18 months, through the original end date of the distribution agreement.

The transaction is expected to close in third quarter of 2008. By the way the sale does not affect our SAP related system integration work which represents 11% to 13% of our total revenue and is growing nicely.

I would like to talk about guidance. We are reiterating our 2008 full year GAAP diluted EPS that is of $1.00 to $1.05 per share and increasing our revenue guidance to $670 million to $695 million for the year.

The recently announced sale to SAP of our Israeli SAP sales and distribution division did not negatively impact guidance, as we anticipate that the future reduction in revenue and earnings will be offset by other factors including stronger than expected revenue growth. These factors, as well as foreign exchange effect, account for the increase in revenue guidance.

In addition, we expect to recognize a gain of $0.18 to $0.23 per diluted share in the third quarter from the initial portion of the SAP reconsideration. Just to be clear this $0.18 to $0.23 is not included in our GAAP guidance of $1.00 to $1.05 for the year.

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

Issachar Gerlitz

Thanks Ofer. We are proud of the excellent quarter we delivered, the fourth in a row and we plan to keep working hard for our share holders in the quarter and the years to come. Thank you to our over 7800 employees in 18 countries for making Ness what it is today and for the drive and dedication that will take us to an even better future. That’s concludes our prepared remarks. Patrick let’s take questions.

Question-and-Answer Session

Operator

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

Moshe Katri – Cowen & Company

I am just trying to get some clarification regarding the impact of FX. Obviously it did help revenues, maybe can you quantify that, but then it did impact margins, can you quantify that as well and then in the same respect obviously it will impact ‘08’s operating margin levels. You said now you’re looking for 8%, so what was the impact for the year all together? Thanks.

Ofer Segev

If you look at our sales and expenses denomination in currencies, about 70% of our sales are in non-dollar currency and 90% of our expenses are in non-dollar currency. When you do the math it inflates the revenue much more or inflates the revenue very similar to the way it inflates expenses in dollar term and the result is that we feel the same operating income, but the revenues are much higher so the margin is actually lower. So it’s about 60 basis points. So as we said at the beginning of the year we expect it to be 8.5 to 8.7 we currently believe it’s going to be around 8.

Moshe Katri – Cowen & Company

Understood and then Ness Israel continues to show very impressive improvements in margins and this is something that you guys spoke about since you came on board; how far can you push EBIT margins in Ness Israel and then also Ness Europe showed very impressive improvements in margins; what sort of targets do you have on both?

Issachar Gerlitz

I think in Israel, the target is to be relative today and I don’t think we can improve from where we are today. In Ness Europe we should do a little bit better; we said that 10 to 12 and again it depends on the quarter of course. You have to remember everything we sell is in an annual basis and not quarterly base and so you should expect Q3 lower than it is today, because Q3 is always the summer vacation in Europe and Q4 much stronger, much stronger again, overall for the full year that will be between 10 to 12.

Moshe Katri – Cowen & Company

Okay and then finally you’ve disclosed operating cash flow, what was free cash flow for the quarter and then do you have a target for free cash flows for 2008?

Ofer Segev

One second, I will give you the number. The free cash flow was around $10 million this quarter. For the first six months excluding the payment to the settlement arbitration the free cash flow for the six month was about $19 million. We expect probably in the next six month to probably be the same.

Operator

Your next question comes from the line of Matt Mccormack from FBR Capital Markets.

Matthew Mccormack – FBR Capital Markets

In terms of the strength in Europe, could you just give a little bit more detail on what types of vertical you’re seeing there that’s strengthening and also I know you said 90% Eastern Europe, but how is Western Europe doing as well?

Issachar Gerlitz

In Europe, about 90% of our revenue are coming from Central and Eastern Europe, where the main vertical that we are operating in our utilities, the financial services and a little bit of government. We see very good growth in those verticals and are internally creating the structure to support those vertical and focus more on those verticals. A good support on the financial services came from the acquisition of FMC last year in Hungary, as it now starts to payoff by providing regional activities also in the Czech Republic and Slovakia.

Regarding Western Europe most of our revenue in Western Europe comes from software distribution, where we saw a strengthening in Italy and we have good hope that this direction will continue going forward in Q3 and Q4.

Matthew Mccormack – FBR Capital Markets

Okay, in terms of the transaction with SAP obviously there is a benefit from you selling that, but what are the, I guess intangible benefits meaning you had exclusivity in terms of the license in Israel. So, does that open up any other opportunities that some clients didn’t want to work with you because of your relationship with SAP on the integration side. So, what kind of opportunities do you see that change providing?

Issachar Gerlitz

You hit the nail on its head, that’s totally correct. I believe it predominantly opened for us two types of opportunities; the first is in Israel. In Israel we are the largest SAP implementer in system integration partner, we are the largest by far and we were limited by some of the customers that did not want to have the vendor for the license and the implementer coming from the same company. This of course now is not the case and this enables us to increase our market share in these implementation services. So, this is one of the opportunities.

Another opportunity, we are enhancing our relationship with SAP and we expect through different ways by strengthening the relationship with SAP on one hand side, by realigning ourselves and enabling asset mobility. That’s exactly Shachar’s new job, to even have stronger SAP revenue in other territories and predominantly in Eastern Europe.

Matthew Mccormack – FBR Capital Markets

Okay and then my last question on the SPL offering; obviously strong backlog growth of 60%; its sounds like you’ve got some new wins, not necessarily in the software vertical. I guess could you just talk about that backlog growth and is that coming from new wins or are you expecting significant expansion with the current labs that you already have in place?

Issachar Gerlitz

I think that it’s both. We already saw some nice expansion from current labs that we do have and the nice wins that we have had at the beginning of the year and throughout the year are starting to ramp up and turning the backlog into revenues. This offering is especially important at this time as we are competing on R&D budget and not on IT budget, that are less acceptable to the macro economical effect here in the United States, and in Western Europe.

So, we see very good demand and we believe that this value to propositions, which is not limited to this only but so many average customers that relay on software development as core competence to create their revenue will continue to grow. We believe that this is a very important part of our engine for growth.

Operator

Your next question comes from the line of Mark Marostica from Piper Jaffray.

Mark Marostica - Piper Jaffray

Can you give us a sense of what your targets are for headcount by the end of the year and in particular India?

Issachar Gerlitz

I don’t think that we have a target with a total headcount, because of too many moving parts. As we shared some positions in some geographies for reducing our less profitable, the fundamental business and increasing in other places, but as I said before our targets in India for the year were increasing the billable by about 800 people in the first two quarters. In the first half of the year we have increased to 350. I assume that we will continue at this phase. Maybe we will be a little bit short of this 800, maybe we’ll do a little bit better, but this is a ballpark.

Mark Marostica - Piper Jaffray

And then regarding the lengthening of sales cycles, could you again comment on where you’re seeing those sales cycles lengthen. I think you said you haven’t received any word of any cancellations, but anymore color on how long sales cycles are starting to look from where they were and where you’re seeing the sale cycles elongated?

Issachar Gerlitz

Let me put it this way. It is related mainly to our U.S. customers, mainly on the financial services. As we’ve said and I said before, we have not had any cancellation of contract, but we see sometimes half a quarter delay in decision making, sometimes a quarter delays in decision making for those financial services customers and mainly offer our IBS offering.

Mark Marostica - Piper Jaffray

Okay Issachar, you also mentioned throughout the quarter shed a few positions in Q2. I was wondering as you kind of look to the balance of the year, first of all where you see the opportunity to shed positions in order to control expenses appropriately and then if you could quantify for us how many more positions you think you’ll actually cut out of the business.

Issachar Gerlitz

I would say not to come with a quantative number of positions but we would assume in order to maintain and expand our margin it would be in our operation in Ness U.S. and in our operation in Asia Pacific and to some extent in Israel.

Mark Marostica - Piper Jaffray

And then the last question, relates just to the tax rate; I am just wondering in your guidance, what implied tax rate you have incorporated? Thank you.

Issachar Gerlitz

There is no change from -- they remain there between 20 to 22.

Operator

(Operator Instructions) Your next question comes form the line of Manesh Tamarijine form Oppenheimer.

Manesh Tamarijine - Oppenheimer & Co.

TSG margins were down significantly this quarter; can you provide us with some detail on the decline, is it mainly due to the Shekel or was there strong impact from the ramp of the large deals signed this year?

Ofer Segev

TSG is the unit that suffers the most from the continuing of the Shekel. Actually, in dollar rates of Q4, six months ago, their margin would have been 11% this quarter, so 50% of the sales of this unit is dollar, a few dollar or dollar linked and close to 100% of the expenses are in Shekel, so that was the most. We don’t see anything significantly changing in the business that’s caused this whole currency fluctuation.

Manesh Tamarijine - Oppenheimer & Co.

And what the level of the Shekel are you assuming for your forward guidance?

Ofer Segev

We currently are working to-date.

Manesh Tamarijine - Oppenheimer & Co.

What’s today, okay?

Ofer Segev

I don’t know, about 3.4 or something.

Manesh Tamarijine - Oppenheimer & Co.

On the SPO front, could you provide us with the breakup of clients between India and Eastern Europe?

Ofer Segev

I think we have one major in India and six in Eastern Europe and actually one is both. NavTeq is the deal that has over 100 people in Slovakia and over 100 in Mumbai.

Manesh Tamarijine - Oppenheimer & Co.

Issachar on the M&A pipeline you’ve mentioned the past of doing a sizable acquisition in India and some smaller once in Eastern Europe, any progress on that front?

Issachar Gerlitz

Each time we say that we are close to doing something the seller increases the price, so I need to be a bit cautious about it, but there is a pipeline and we hope to conclude some acquisition in the near-term, let me put it this way and of course when we do we’ll let everybody know, but obviously I cannot talk more about it.

Manesh Tamarijine - Oppenheimer & Co.

Fair enough. One last question; I know you don’t provide quarterly guidance but given your strong Q2 despite seasonality, could you provide us with some color going forward directionally?

Issachar Gerlitz

We said it’s going to be the same and you have to remember the dollar is really pressing us and beside the dollar effect, a pretty strong head win, we still manage to come on the guidance, but I would not praise the guidance, the dollar is really a tricky game for us, which is very difficult to control and we currently feel that we can make our numbers at the current rate, but if it continues to weaken there is some limit to how much we can be more efficient in the business so, I’d rather stay where we are today.

Operator

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

Devang Kothari - JMP Securities

Quick question on backlog; Q2 is seasonally weak for you in terms of backlog growth. It looks like this quarter we saw a little bit more of a weakness; could you give us some commentary on that?

Issachar Gerlitz

I would say three things; backlog growth was good but in light of the economy, I think that we are a little bit more conservative in our booking to backlog. So, this is one thing that we need to take into account. Secondly, some of the SAP maintenance backlog was dropped out of the backlog due to the intending sales, so the real growth is higher than you see.

Devang Kothari - JMP Securities

Okay and what was the impact there? How much did you drop off?

Issachar Gerlitz

We do not disclose this number.

Devang Kothari - JMP Securities

Okay.

Issachar Gerlitz

And there thirdly and probably most importantly, we’ve resolved some of the delivery issue, that we have experienced in the past and we are converting backlog to revenue better in Q2 than we have done recently. So, backlog situation is better than you perceive.

Devang Kothari - JMP Securities

Okay and moving onto Ness North America, could you give us a feel for what margins look like for the Onsite Business and then the offshore Software Labs Business; if you could delineate between the two?

Issachar Gerlitz

Yes, I think we said it on the call, but just to reiterate that, the offshore component will be 7.7, the SBA unit; this 7.7, which is close to doubled from Q1, is fairly way below where it needs to be. Our long-term target is 15% and the short-term is close to double-digits but at least we see a nice improvement mainly in India and the second part of the fewer onsite contracting is around five to six and again the long-term one or for the next year it should be double-digit and again this improved a lot from Q1 and isn’t more from Q4.

Devang Kothari - JMP Securities

Okay. Is your goal to ’08 generating double-digit operating margins in that segment in Ness North America?

Issachar Gerlitz

I think in Q4 we’ll probably be close to it, but still single digits.

Devang Kothari - JMP Securities

And then you had a change in leadership in the software labs business, could you comment on the short-term and the long-term plans for leadership in that segment?

Issachar Gerlitz

In the short-term we have Holly Ripley-Boyd, our Chief Marketing Officer taking command of the SPL business and the longer term plans, we’ll let you know. We believe that we can represent some of the changes that the company is going through turning from entrepreneurship type of operations to a more structured professional management and I think that longer-term this is good for the company and good for the business.

Devang Kothari - JMP Securities

A healthy backlog growth in that business; the challenge has been I guess in the past hiring to that backlog and giving capacity. It sounds like the labor environment is easing a little bit in India from what we are hearing; how are you finding it? Are you finding it easier to hire folks in that group?

Issachar Gerlitz

The true in the matter is that we have not seen any relaxation on the environment in India but I think that through Q2 we have done quite a good progress in our operation in India and we feel very comfortable about our capability to grow and meet the revenue targets and turning booking into revenue. Of course, we are talking about a fast growing situation and as we grow the target and the obstacle become higher and we need to adapt to this all the time, but at this point in time, we are at a comfort zone with regard to operation in India.

Devang Kothari - JMP Securities

Okay, you don’t anticipate having to like as you had to do in Q1 having to hire some people to the bench prior to deployment and taking a margin hit there; do you anticipate that happening anytime again in the future? I mean anytime in the near-term I guess.

Issachar Gerlitz

We don’t expect this growth in the near term.

Operator

(Operator Instructions) Your next question comes from the line of James Friedman from Susquehanna.

James Friedman – Susquehanna

Hi, I just wanted ask; the company generate $19 million of free cash flow you said in the first half, it sounds like you have something similar projected for the second half. In terms of use of funds what is the board’s appetite at this point for a potential share repurchase? Thank you.

Issachar Gerlitz

I think that around the table of our board, the position has not changed. We believe that we need to use our resources and the free cash flow as well as the leverage, the results that we are taking to build the business for investment. We are looking into some acquisitions as I’ve hinted before as well as some investments as I also said in the call for EDCs or Extended Development Centers in Eastern Europe. We will open another Extended Development Center in Eastern Europe in the short-term that requires some investment. Just stay tuned for some acquisitions.

Operator

(Operator Instructions) and there are no further questions at this time. I would like to turn the call back over to Mr. Gerlitz.

Issachar Gerlitz

Thank you for joining us on today's call. We'll speak to you again when we report our next quarter results. That concludes today's call. Thank you and have a very good day.

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Source: Ness Technologies, Inc. Q2 2008 Earnings Call Transcript
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