International Business Machines Corp (IBM) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and than you for standing by.

Welcome to the Kenexa Third Quarter Conference Call. (Operator Instructions).

I would now like to turn the conference over to Mr. Don Volk, Chief Financial Officer.

Thank you, Millicent.

Today, we will review Kenexa's third quarter 2005 results, which were released this afternoon.

And we'll then provide guidance for the next quarter and the full year.

Finally, we will open up the forum to audience questions.

Before we begin, let me remind you that this presentation may contain forward looking statements that are subject to risks and uncertainties associated with the company's business.

These statements may concern, among other things, guidance as to future revenues and earnings, operations, transactions, prospects, intellectual property and the development of product.

Additional information that may affect the company's business and financial prospects, as well as factors that would cause Kenexa's actual performance to vary from our current expectations is available in the company's filings with the Securities and Exchange Commission.

Also, I would like to remind you that today's call may not be reproduced in any form without the express written consent of Kenexa.

We may also refer to certain non-GAAP financial measures on this call.

I will later discuss the reconciliation of adjusted numbers to GAT numbers, and a reconciliation schedule showing the GAAP versus non-GAAP financial measures is currently available on our company website, with the press release issued earlier today.

Our website is located at www.kenexa.com.

I will now turn the call over to our Chairman and Chief Executive Officer, Rudy Karsan.

Thanks, Don.

And than you for joining us on the call, as we review our third quarter results.

We were quite pleased with the company's performance during the third quarter.

Not only were our revenue and earnings better than the guidance we provided last quarter, but we also ended the quarter with a rock solid balance sheet, and we had a very strong cash flow quarter.

The talent management solutions, or TMS market continues to gain momentum, and Kenexa is emerging as one of the clear market leaders.

As Don will discuss later, the combination of our strong third quarter results and a positive outlook, has caused us to raise our expectations for the remainder of the year.

From a numbers perspective, our third quarter total revenue came in at $17.2 million, a 45% increase from the year ago period.

The largest and most strategic component to our revenue is subscription revenue, which at $13.4 million, grew 43% on a year-over-year basis, and 10% on a quarter-over-quarter basis.

This represents the third consecutive quarter our subscription revenue has grown at 10% on a sequential basis, and it was the highest year-over-year growth in the past six quarters.

The momentum of our business can be further seen by the fact that our deferred revenue grew just under 100% year-over-year to $11 million at the end of the quarter.

From a profitability perspective, we generated income from operations of $2.6 million or a margin of 15%.

Our operating profit, once again, grew well over 100% on a year-over-year basis, and we were able to generate another record operating margin in spite of the fact that we've observed significant incremental public company expenses over the past two quarters.

A recurrent theme you will hear from us is our focus on operational excellence, and it is our intention to continue driving profitability as we scale the business.

This focus, combined with the recurring revenue model, provides us with very attractive cash flow capabilities.

We had a very strong cash flow in the September quarter, and in the first nine months of the year, we have generated $11.4 million in cash from operations.

This represents growth of roughly 140% on a year-over-year basis.

The sensible (ph) financial results continues to be driven by the three key factors we highlighted last quarter.

One, the talent management market is experiencing growing awareness and demand; two, Kenexa has emerged as a clear leader in what is a fragmented market; and three, we are the only true solutions provider delivering an unmatched combination of software, services, outsourcing and content.

With respect to the market, the majority of major corporations have invested in ERP applications to automate their back offices, and many others have invested in human resource management systems from vendors such as PeopleSoft.

While a traditional HR system will let a company know how many employees they have, what type of benefits they may have, and what their payroll figure is, it does not help companies deal with talent management issue at hand, namely, how do I find the most qualified employees faster and cheaper, and then make those employees as productive as possible?

We believe a reason our financial results have been growing in strength is the TMS market is growing in awareness, and buyers are taking a more strategic approach.

And the reason for this is a significant ROI that our solutions can drive.

An example is, consider the significant benefits of a national financial holding company, with $12.6 billion in assets, and 435 banking locations, has enjoyed in part due to our solutions.

Ten months after implementing Kenexa's online assessment, which evaluates candidates' skill sets, capabilities and career path potential, the organization has been able to decrease branch sales turnover by more than 60%, teller turnover by 25%, and call center turnover by 25%.

This has a dramatic bottom line impact, due to decreased hiring costs to replace workers, training costs to get new workers up to speed, and potentially severance costs, as the companies need to release workers that don't work out.

And we're not resting in our laurels.

We continue to introduce new technology to the marketplace.

During the quarter, we progressed two new high value add applications, bStrategic and Kenexa Infinity Survey System. bStrategic is an application that takes analytical capabilities to the next level, allowing customers to access and integrate varying sources of data that are stored in multiple systems within an organization.

With Kenexa bStrategic, work force data is unified and easily accessed, allowing customers to tailor key performance indicators to their strategic work force goals.

Kenexa Infinity Survey System is a standalone solution developed in response to the growing trend of our large global clients who need to quickly and cost effectively self-administer ongoing pulse surveys to supplement their employee engagement programs.

During the quarter, our business continued to have an equal contribution from the talent acquisition and performance management side.

In particular, we added Smurfit-Stone, Cabela's and FedEx Kinko's on the talent acquisition side, and Bay (ph) and Zimmerman, 7-Eleven and Kroger on the performance management side.

Technology is only half the discussion.

Customers are interested in business results and ways to improve their business processes.

As talent management is becoming viewed as a more strategic priority, we see customers that are interested in a comprehensive strategic solution that covers more than just software.

Customers want to invest in a partner with prepackaged best practices content in the talent acquisition and performance management areas.

They want a partner with a long-term proven track record in the deploying talent management solutions.

Some customers would also like to leverage the ability to outsource certain functions or the entire talent management function, while they dedicate their focus and resources on their core competencies.

To this point during the third quarter, HRO Today Magazine evaluated the top 13 outsourcers who are engaged in areas of full service RPO, and Kenexa is ranked number one on the list.

There is simply no comparison between Kenexa's combination of domain expertise, technology solutions and service capabilities with vendors that only deliver a software solution.

Let me give you a real world example of the breadth and depth of our value proposition in action.

A restaurant operator was able to realize a $5.00 per hour sales difference between employees who scored high versus low on the Kenexa selector assessment.

This equates to over $7,000 in incremental revenue per year, per employee, for a large company; and the driver behind this is improved intelligence and processes in assessing which candidates are best fit for the job.

Not only was Kenexa the technology engine being used by the restaurant operator, but we also consulted with this customer to improve the overall work flow process related to how hiring decisions are made.

In addition, our consultants worked with the customer to actually develop the specific tests and interviewing techniques that were best suited for that customer to evaluate talent.

A unique and powerful value proposition drives two important factors to our business, higher renewal rates and follow-on business.

Our customer satisfaction is very high, which helps drive annual renewal rates in the 90% range.

This is a critical aspect to the long-term cash flow capability of our business model.

On the follow-on sales front, we continue to generate a material portion of our bookings from our existing clients each and every quarter, where we are able to leverage the best of our solution suite and roll out existing solutions to additional geographies and business units.

Again, this quarter, roughly half of the increase you saw in our revenue came from the growth in existing accounts.

For example, during the quarter, we closed a very interesting follow-on deal with Tyco, a Fortune 50 company.

Only a couple of quarters ago, we signed an agreement with this customer for employee engagement and courier feedback surveys.

However, during the third quarter, we came back and signed another agreement with Tyco to automate the service process for senior management.

Tyco will use these surveys for a variety of reasons ranging from strategic planning to stock compliance, as they continue to practice great corporate governance, which would include surveying employees on management policies and execution.

In summary, the third quarter was very strong across all key metrics.

Top and bottom line results exceeded our expectations, and our balance sheet and cash flow metrics were also very strong.

The talent management market is growing in awareness and demand, and our unique total solution value proposition is helping us gain market share and solidify our position as a market leader.

Now, I will turn it over to Don.

Thanks, Rudy.

I will reiterate your beginning comment that we are very pleased with the company's performance in the third quarter, which was highlighted by rapid growth and record revenue and profitability.

I would like to provide more details on our third quarter results and financial guidance for the fourth quarter, beginning with the P&L.

Total revenue for the third quarter was $17.2 million, an increase of 45% over last year, and 8% sequentially.

On a year-to-date basis, our total revenue has grown 43%, an acceleration from the 35% growth we experienced in the comparable year ago period.

Subscription revenue is the majority of our revenue, and it is the strategic component of our business that encompasses our technology solutions which are delivered via an on-demand model.

During the third quarter, our subscription revenue was $13.4 million, representing 78% of our total revenue, and growth of 43% on a year-over-year basis, and 10% sequentially.

On a year-to-date basis, our subscription revenue has grown 37%, and the quarterly year over year growth rate has increased in both of the past two quarters.

Over the past year, many software companies have seen flat to slowing demand.

However, as our results show, we are actually seeing growing demand for our total solutions.

The remaining $3.9 million of total revenue came from other and professional services, representing an increase of 51% over last year, and a slight sequential decrease.

The majority of the revenue from this line item comes from discreet professional services.

In addition, as we discussed last year, we occasionally close a perpetual deal, and the other line is where it falls.

To reiterate, perpetual deals are an exception, and they are only a consideration if, number one, we are penetrating a new vertical; two, it is a long-term existing subscription based client that is making a separate purchase of a product; and number three, we are able to charge what we view as a premium or an attractive price for that product.

During the third quarter, we signed one perpetual deal for roughly $400,000.

We will continue to focus on our subscription based on-demand business model, but we don't want to lose market share because of refusing to accommodate how certain customers may wish to do business, if we can do so in a way that is advantageous for both the customer and for Kenexa.

On a geographic basis, our revenue continues to be dominated by the U.S. in over 90% of our total revenue.

However, we are stepping up our investments in the EMEA, and we recently acquired a company in Canada to jumpstart our efforts north of the border.

This acquisition, as expected, added between $100,000 and $150,000 to our total revenue in the quarter, in line without comments on our last conference call.

Our clients typically purchase multi-year subscriptions, which provide us with a predictable, recurring revenue stream.

From a retention perspective, our focus on customer satisfaction and delivering business results continues to drive renewal rates in the 90% range.

Looking at customer concentration, no customers accounted for more than 10% of our quarterly revenue, and our top five customers represented less than 25% of our third quarter revenue.

During the quarter, we added over 10 preferred partners, of which Rudy highlighted several by name earlier.

And for the first nine months of the year, we have added over 30 preferred partners, which are customers who spend more than $50,000 with us annually.

Our average annual revenue from our top 80 customers, what we refer to as P3, continues to be in the $550,000 range, which is up from $392,000 at the end of 2004.

This shows the growing adoption of our solutions within our customer base, the success we are having cross-selling our solutions and customers increasingly viewing talent management as a strategic investment.

The average length of our subscription deals in the quarter was approximately two years, in line with prior experience.

Turning to costs and profitability.

Gross margin was 71%, in line with the prior quarter, and our expectations of being within the low '70s on a quarterly basis, similar to the range we have been in in the past year or so.

On the operating expense side, sales and marketing came in at $4.2 million, or 25% of revenue, consistent with the prior quarter, and a reduction from 27% in the year ago quarter.

We continue to invest in sales and marketing to pursue new clients and expand relationships with existing ones.

However, we are continuing to gain economies of scale, due to the recurring nature of our on-demand business and revenue model.

We currently have 66 people in sales and marketing, with roughly 75% carrying a quota.

G&A expenses were approximately $4 million, or 23% of revenue, compared to 22% in the prior quarter, and 21% in the year ago quarter.

The increasing G&A was a result of an increasing public company costs, bonuses due to over-performance relative to internal targets and increases in headcount.

We expect G&A will increase modestly in absolute dollars during the fourth quarter of '05, due to ongoing public company costs, as well as incremental increases in rent that we discussed last quarter, which is needed as we expanded to more office space to support the growth of our business.

Research and development came in at $1 million or 6% of revenue, in line with the prior quarter, and below the 9% level in the prior year's quarter.

We increased our R&D headcount by 35, and we continued to invest in broadening and deepening our solution suite.

We expect R&D to increase modestly as a percentage of sales, as we absorb this additional headcount, which was added primarily at the end of the quarter.

However, we have a highly efficient R&D organization as a result of our significant offshore presence, and we believe the efficiency of our ISO certified and highly qualified R&D process is a key competitive advantage.

Turning to profitability.

We generated income from operations of $2.6 million for the third quarter, which represented over 175% improvement on a year-over-year basis.

And we also maintained an all time high operating margin of 15% in the second quarter for the second quarter in a row.

Our pro forma income from operations, which excludes stock based compensation expense, was $2.7 million.

Based on 17.9 million shares outstanding for the quarter, we generated pro forma diluted EPS of $0.15 a share, better than our guidance of $0.13 per share.

A reconciliation of GAAP to non-GAAP pro forma income from operations can be found in our press release and 8-K documents.

Turning to the balance sheet.

Cash and investments were $39.1 million at September 30, 2005, an increase from $24.8 million at the end of the prior quarter.

This increasing cash was driven by slightly over $7 million in proceeds that came in from the IPO, and regenerated cash from operations of $8.4 million.

In addition to solid net income, a significant driver of cash from operations was very strong collections.

Accounts receivable declined by $500,000 from the end of the prior quarter, even as our business showed strong growth.

While we expected to catch up on cash collections per our commentary last quarter, we actually collected more cash this quarter than we expected.

We also saw our payables tick up by $1.5 million, due to the timing of payments.

Finally, a key driver of our cash flow was deferred revenue, which grew 27% sequentially and 97% on a year-over-year basis, primarily due to strong bookings in the quarter, but also because we received cash up front for some service business.

As we mentioned last call, quarterly cash flow will continue to bounce around as a result of the timing of payments and collections that are hard to predict.

We had some collections slip last quarter, while collections were ahead of plan during the current quarter.

If you look at our results on a year-to-date basis, to smooth out timing volatilities on these line items, we are running in the neighborhood of a $4 million in cash from operations quarterly run rate.

I would like now to turn to our outlook for the fourth quarter of 2005.

We expect the following; revenue to be $17.2 to $17.8 million, subscription revenue to be $13.6 to $14 million, pro forma income from operations to be $2.6 to $2.8 million.

Assuming our 6% tax rate and 17.9 million shares outstanding, we expect our pro form diluted earnings per share to be $0.15 to $0.16.

In summary, we were pleased with our third quarter results.

We finished the quarter in very solid shape, and we have increased our expectations for the remainder of the year, based on the momentum we see in talent management markets and in our business in particular.

Operator, we would now like to take questions.

Please begin the Q and A session.

Thank you. (Operator Instructions) Our first question will come from Peter Goldmacher, SG Cowen.

Hi guys.

Two quick questions.

The first is, can you help us to understand how the invoicing cycle is working?

Are you able to extend the duration that you're able to bill for?

And secondly, can you give us a little bit of an update on the competitive landscape?

Thank you.

I'll take the first one, Peter.

The increase in deferred was primarily driven by good new business flow.

And we also had some service business where we collected cash up front.

From a high level perspective, our payment terms were not materially different than what we have seen in the past.

The only time we can collect annual cash up front is when it makes good business sense, and we aren't going to take a major discount to do so, and we continue to do that selectively.

But we feel good about our cash flow model, and we are doing business on good terms.

And from a competitive position, Peter, the marketplace has not changed dramatically.

It is still a highly fragmented market.

We know we're one of the larger players and the clear leader there.

One other player, mainly Taleo, became public, I think about a month or a month and a half ago.

So we welcome them into the public forum.

In general, we are expecting the highly fragmented market to start to consolidate over the next few years.

Thanks, guys.

Our next question comes from Richard Davis, with Needham and Company.

Thanks very much.

It's actually Jon Maietta for Richard.

Rudy, I was wondering if you could give us a sense of kind of revenue contribution by industry vertical.

Was there anyone vertical where you saw the most number of wins?

Not really, Jon.

What we really saw was our continued expansion in the verticals that we're currently in, namely pharmaceutical, retail, hospitality.

Those segments have continued to remain strong.

Manufacturing has continued to grow.

We haven't seen any real expansion in the public school market that we mentioned, the education market that we talked about last time.

We haven't seen significant growth in that yet.

I am sorry if I missed it but I was wondering if you could give us a sense as to what the total headcount was at the end of the quarter?

The total headcount at the end of the quarter was 659.

Okay, great.

Thank you very much.

(Operator Instructions) And we'll go now to Matthew Weiss, with Maxim Group.

Hey, guys.

Congrats on the quarter.

You guys are having obvious success upselling into your existing customer base, and that's reflected positively in your average annual revenue from your top 80 customers.

I was wondering if you could let me know how many of these 80 are purchasing more than one of our 10 plus solutions.

I believe, previously, it was around 23 out of those 80.

Has that climbed up significantly?

Well, it was 27 at the end of the second quarter, and the number has now reached 30 by the end of the third quarter.

Is now 30, okay great.

Also, I wanted you to maybe talk a little bit about your plans to sort of scale your R&D operations, offshore development efforts.

Is there any new data center in the works in India, outside of India, sort of what's going on over there?

Currently, we stand, I think Don mentioned, we added 35 heads in the R&D in India.

So we're pretty well maxed out on our physical location in our existing space.

We acquired additional space in Q3.

We've got the land grant in the Vizag in the state of Andhra Pradesh which will probably not come in line until probably mid or late '07, because it's going to take time for construction.

And we're looking to expand outside of India, maybe Malaysia, to give us additional language capability, CCJK, namely Chinese, Chinese, Japanese and Korean.

So we're negotiating currently with the government of Malaysia to get some help in terms of expanding into the country.

One quick question on the balance sheet, the deferreds obviously came in strong.

You mentioned last quarter that they came in significantly ahead of your expectations.

I was wondering where they came in this quarter relative to your expectations?

Well, they came in significantly ahead of our expectations still.

We were expecting 9.3, and we came in at 11.

So, you were expecting 9.3.

Okay.

Great.

Thank you, guys.

And our next question comes from Patrick Walravens with JMP Securities.

First of all, Don, this is for you.

As we model out '06, and forgive me if you've answered this already, what tax rate should we assume?

We're currently evaluating our '06 numbers, and we will have some NOL carryover going into '06.

But I think that you should -- and we'll give some more clear guidance on our next call as to what our tax rate will be into next year.

But I think you should keep your tax rates where they are for the time being.

Okay.

I want to avoid having a negative surprise for people here.

So if we think it's going to go up, I'd rather be in the right ballpark now, rather than having to take it down later.

We're evaluating where it's going to be at this point, so I don't want to be premature in giving you when it's going to go up.

How about for '07, because we have that as well?

Can we assume by then it's going to start to normalize?

Sometime yes, I would expect that.

And then, Rudy, I guess, two for you.

Can you just describe for us -- I get this question a lot -- what is a really well profiled opportunity for Kenexa, versus one where it might not be as well profiled, and maybe it's something that a Taleo or Recruitmax or someone else like that might have a higher chance at beating you in.

What are the types of situations where you guys stack up the best?

We stack up the best in situations where the organization is looking for a strategic partner.

We stack up the best when all aspects of our organization are in play.

Our solutions, our services, our content, all lines up to give the client the maximum advantage in the talent management space.

So examples would be, say, a company like K-Mart would use our applicant tracking system, together with our Selector product and our Prove It! product wrapped into one solution, in order to allow them to do the best possible job of hiring the people in the fastest and the most efficient manner.

Those are the kinds of situations where we tend to excel in and win quite a bit.

Okay, that's great.

Can you just comment on what you're seeing from the economy overall and what you're seeing from enterprises' willingness to spend overall?

One concern investors have is that eventually sort of the energy inflation kinds of things that are starting to tighten up consumer spending are going to roll over into the enterprise, and we're just wondering if you're seeing that at all yet?

I'm paranoid by nature.

So are we seeing it?

Are we on the watch out for it?

Yes, we are.

Do we think it's going to start hitting us?

Well, next quarter's guidance, we haven't really indicated it's going to start hitting us yet.

We haven't really heard it a lot from customers yet, but if the drag continues, and we're into next year, and oil prices go up by another 30, 40%, and interest rates climb by 100 basis points, and inflation starts to creep up, I would say we're going to start seeing a little bit of it fallout into us.

Last question.

As you grow, you're going to need to continue tracking sales talent.

How easy is that to find, and where do you get it?

We can kind of eat our own dog food, so to speak, as the saying goes.

We tend to use our own tools in hiring salespeople.

We tend to find that the most successful salespeople are more of a consultative nature rather than what one would consider a hard core salesperson.

We find them in three general areas.

One is within our own staff.

We tend to run -- and in fact, we're in the process of doing one right now -- is running our selector assessment against our existing service staff to see anyone can transition into the sales environment.

The second area where we tend to find the individuals are the domain specialists.

They are individuals who have a good, solid understanding of our domain space, and want to make the transition into sales.

And then the third is the usual suspect, which is a combination of competitors and industries that are alongside industries, like CRM and the like.

Thanks very much.

And at this time, gentleman, we have no further questions standing by on our question roster.

I'd like to turn the conference back to our speakers for any additional or closing comments.

Thank you Millicent.

Let me conclude by saying once again, on behalf of Kenexa, thank you for joining the call.

And we've had a heck of a quarter.

And we thank all of you for your support.

And we'll talk to you, I guess, in a quarter from now.

Thank you for your participation on today's conference call.

You may disconnect at this time.