International Business Machines Corp (IBM) 2006 Q3 法說會逐字稿

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  • Operator

  • Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Kenexa third quarter 2006 earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference is being recorded.

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

  • Don Volk - CFO

  • Today, we'll review Kenexa's third quarter 2006 results, which were announced after the market close this afternoon. We'll also provide guidance for the fourth quarter and preliminary guidance for the full year 2007. And then we will open up the forum for questions.

  • Before we begin, let me remind you 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 could 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 GAAP numbers and a reconciliation schedule showing that GAAP versus non-GAAP financial measures is currently available on our Company web site in 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.

  • Rudy Karsan - Chairman and CEO

  • Thank you for joining us on the call as we review our third quarter results which were highlighted by better than expected revenue growth and profitability. Market awareness for talent management solutions continues to grow, and we believe that Kenexa's unique business model and value proposition are driving our market share gains.

  • In addition, we expect that our pending acquisition of BrassRing expands our market opportunity and leadership position.

  • As a result of these factors, we're optimistic about our outlook as we approach the end of 2006 and look to 2007. Taking a look at the numbers, our third quarter total revenue came in at $28 million, an increases 63% year over year. The most important component to our business, subscription revenue, came in at $23.2 million, a 73% year over year increase, and a very strong 16% increase in a sequential basis.

  • The strength of our subscription revenue is being driven by strong bookings across most of our major product categories. From a profitability perspective, we generated non-GAAP operating income of $5.5 million or a margin of 19.6%. This represented another record quarterly operating profit and margin and it was 6% ahead of the high end of our previously issued guidance.

  • Our cash flow from operations excluding the tax benefit associated with FAS 123(R) was $9.2 million during the quarter. As Don will touch on later, we continue to expect very strong cash flow growth for the year, based on our growing profitability margins and strong execution of our on demand business model.

  • We believe that we are still in the early stages of a very large market opportunity. Customer interest in talent management solutions are strong and the overall awareness of the market, and Kenexa in particular, continues to grow.

  • As I mentioned on our call a few weeks ago, the number of inbound inquiries to Kenexa during a single week in August was at the same level of inquiry that was received in the entire second quarter of 2005. In addition, well over half our business comes from inbound inquiries as opposed to our outbound sales and marketing efforts.

  • There was no better event to see the strong interest levels in talent management solutions in Kenexa than at our inaugural user conference, which was a three-day event held in Chicago during the month of September. Kenexa customers such as Campbells Soup, PricewaterhouseCoopers, Caterpillar, Johnson & Johnson, Chevron, Starwood and The Limited Brands were among our customers that presented their success stories and best practices to our worldwide customer base and select prospects.

  • Companies of all sizes are increasingly realizing the potential benefits of talent management solutions, including reduced external recruiting costs, training costs and turnover, in addition to shrinking time in greater productivity.

  • For example, one of Kenexa's customers realized 23% more production for high scoring technicians compared to those scoring lower on Kenexa's testing technology. From a payback perspective, this meant over $2 million in incremental revenue during a 12-month time period. In addition to a strong ROI profile, we believe there are positive long-term demand drivers for talent management industry, such as aging of the workforce, declining tenure of employees, increased globalization and the ability of organization structures and pressures on the HR department to minimize costs. We believe these combined factors will continue to provide a favorable demand environment for Kenexa.

  • During the September quarter, we continue to see small and large customers turn to Kenexa as their talent management solutions provider. Across all of our solutions, we added over 30 preferred partner customers during the quarter, which was a record, and an increase from the over 20 level we cited in the prior quarter and the over 10 level we cited in the quarters immediately following our IPO in mid 2005.

  • On the talent acquisition side, we added customers such as Legal Seafood, American Heart Association, (indiscernible) Healthcare, Colonial Bank, County Bank and Gaylord Entertainment, while on the performance management side, we conducted business with customers such as Providence Healthcare, Sears, Alcova, Goliath DataSystems and Constellation Brands.

  • During the quarter, approximately 60% of our new sales were attributable to talent acquisition, while 40% were attributable to performance management, consistent with the prior quarter. The number of new customers we are winning is increasing and our attention rates continue to be very strong. We believe that this is because Kenexa's value proposition goes far beyond our state-of-the-art software solutions.

  • Kenexa is also differentiated by the breadth of our solutions across both talent acquisition and performance management and by our domain expertise, proprietary content and outsourcing capabilities.

  • During the third quarter, we added to our domain expertise the acquisition of Gantz Wiley. Founded in 1986 Gantz Wiley Research has been a pioneer in the survey research industry and was the first to publish work on how employee and customer opinions are linked to business metrics. The research was based on 20 years of experience and data from over 10,000 business units.

  • Gantz performs in line with our expectations during the quarter and the addition of their domain expertise has been a positive factor in sales cycles, where the customer is taking a very strategic perspective on their talent management selection process.

  • An example of one of Kenexa's survey customers is Sears Canada, a multichannel retailer with 37,000 associates and hundreds of locations across Canada as Sears Associates may be driving to many locations, including behind a cash register, visiting customer homes or driving a forklift truck. With a strong belief there is a direct correlation between engaged associates and customer loyalty in revenues, serving its associates has been an integral part of Sears Canada Corporate Initiatives for many years.

  • Sears Canada turned to Kenexa to redesign this survey in reporting capabilities as a result of our expertise in designing, administering and interpreting quantitative results for the measurement of psychological variables.

  • We believe Kenexa's value proposition and competitive position will be further strengthened by our pending acquisition of BrassRing. We expect the acquisition to close during the fourth quarter and initial feedback from customers, prospects another industry observers has been quite positive since we made the announcement several weeks ago.

  • To quickly reiterate the expected benefits of the BrassRing acquisition -- one, it expands our opportunity to the large end of the market. BrassRing brings significant capabilities and a proven track record in serving the town's acquisition needs of global 2000 organizations. Kenexa now effectively addresses the needs of any customer, from the smallest to the largest global organizations.

  • Two, expand our global infrastructure and product capabilities -- BrassRing has numerous international offices and is well positioned to serve global organizations as a result of their strong global product capabilities, including localization and multilingual support across 23 languages. As successful as Kenexa has been, we have been in a position where we have not been able to respond to our RFPs that involve global requirements. And we believe that this will no longer be the case.

  • Three, finally, we believe there is an excellent opportunity to sell our testing surveys and performance management applications to BrassRing's customer base that has already rolled out a recruiting solution. Similarly, Kenexa has many enterprise customers that have purchased our testing or service products. And the addition of BrassRing's global product capabilities means that we can now meet the needs of those customers looking to roll out a talent acquisition system on a single instance across their global workforce.

  • BrassRing also brings additional product depth in the areas employee onboarding and mobility and new applications in the areas of workforce planning.

  • In summary, our third quarter results were very strong. On top of our strong current momentum, we believe that the acquisition of BrassRing expands our market opportunity and further extends our market share leadership position.

  • I will now turn it over to Don to review the financials in more detail. Take it away, Don.

  • Don Volk - CFO

  • Thanks. I would reiterate your beginning comment that we are very pleased with the Company's performance in the third quarter, which was again highlighted by record revenue and profitability. Let me start with the details of our third quarter results and then I'll finish with guidance for the remainder of 2006 and our preliminary thoughts on calendar year 2007.

  • Beginning with the P&L, total revenue for the third quarter was $28 million, an increase of 63% over last year. For comparative purposes, it is worth noting approximately $800,000 of our total revenue came from the acquisition of Gantz Wiley, which was not anticipated at the time we provided our third quarter guidance. That said, even excluding the contribution from Gantz during the quarter, our total revenue still would have been $1.2 million about the high and of our previously issued guidance.

  • Subscription revenue is the majority of our revenue, and it is the strategic component of our business that encompasses our on demand technology solutions. During the third quarter, our subscription revenue was $23.2 million, representing 83% of our total revenue and growth of 73% on a year over year basis and 16% sequentially. The remaining $4.8 million of total revenue in the a September quarter came from other and professional services, which increased 25% over last year and was roughly flat with the prior quarter. The majority of the revenue from this line item typically comes from discrete professional services, though we occasionally have a perpetual license that'll go into this line. For the fourth consecutive quarter, however, we did not sign a perpetual deal.

  • On a geographic basis, our year-to-date revenue continues to be heavily skewed towards the U.S. at over 90% of total revenue. Our clients typically purchase multiyear subscriptions and the average length of those subscription deals remains at approximately two years.

  • Looking at customer concentration again, no customer accounted for more than 10% of our quarterly revenue and our top five customers represented less than 25% of our third quarter revenue. Our revenue continues to be highly visible as a result of the diversity of our revenue across many customer relationships, long-term contracts with renewal rates that continue to be in the 90%-plus range, and the growing number of new customers that we are adding to our overall customer base.

  • During the quarter, we added over 30 preferred partners, some of which Rudy discussed earlier. Our average annual revenue from our top 80 customers, what we refer to as PQ, was over $800,000 -- an increase from the $700,000 level in the prior quarter and a significant increase from the $550,000 at the end of 2005. Our demonstrated ability to scale customer relationships over time is one of the reasons we are optimistic that we will again be able to leverage from the acquisition of BrassRing. Which will bring us a Tier 1 customer base to sell to and service.

  • Turning to costs and profitability, we will be providing non-GAAP measures of each third quarter 2006 expense category, which excludes the stock-based compensation charges associated with the implementation of FAS 123(R) and amortization of intangibles associated with previous transactions. In order to provide comparisons to prior periods, which do not include such charges, all comparisons will be using the non-GAAP current period results.

  • Non-GAAP gross margin was 71% in the quarter, which compares to the 74% level in the prior quarter and 71% in the year ago quarter. On last quarter's call, we mentioned that it was likely our gross margins would move back to the lower 70s level, which is within our long-term target for gross margins. On the operating expense side, non-GAAP sales and marketing came in at $5.8 million or 21% of revenue, a reduction from 23% in the prior quarter and 25% in the year ago quarter.

  • The reduction in sales and marketing as a percentage of sales is being driven from economies of scale and the benefits of the on demand model as the revenue scales over time. We continue to invest in sales and marketing to pursue new clients and expand relationships with existing ones. And we are focused on continuing to optimize the productivity of our sales organization. We ended the quarter with 98 people in sales and marketing, consistent with the level at the end of the prior quarter.

  • I would remind investors that we grew the sales force by roughly 25% in the first quarter of the year and there will be another increase in our sales organization as a result of our pending acquisition of BrassRing.

  • Non-GAAP G&A expenses were approximately $5.5 million or 20% of revenue, below the 22% level in the prior quarter and the 22.7% a year ago. G&A expense as a percentage of revenue is down as a result of leverage from prior investments related to public company costs. Non-GAAP R&D expense came in at $2.2 million or 7.9% of revenue, an increase when compared with both the prior quarter and the year-ago period.

  • We continue to invest in broadening and deepening our solutions suite from an overall perspective. We believe that Kenexa has a highly efficient R&D organization that is a result of our significant offshore presence and we believe the efficiency of our ISO certified and high-quality R&D processes is a key competitive advantage.

  • The combination of better-than-expected revenue, increased mix of subscription revenue and a focus on operational excellence led to record non-GAAP income from operations of $5.5 million for the third quarter. This represented an increase of 104% on a year-over-year basis and an all-time high margin of 19.6%.

  • Our non-GAAP net income was $4.9 million, based on 20.9 million shares outstanding for the quarter. We generated non-GAAP diluted EPS of $0.24, which was $0.02 above the high end of our guidance.

  • During the third quarter, our non-GAAP tax rate for reporting purposes was again 22%. And we expect our effective tax rate will be 22% for the fourth quarter of 2006.

  • Turning to our results on a GAAP basis, which includes $600,000 related to the allocation of stock-based compensation and $0.2 million related to the amortization of intangibles associated with previous acquisitions, the following were expense levels determined in accordance with GAAP. Cost of goods sold, $8.4 million; sales and marketing, $6 million; R&D, $2.2 million; and G&A, $5.8 million. For the third quarter, our GAAP income from operations was $4.8 million or a margin of 17%. For the September quarter, the GAAP net income applicable to common shareholders was $4.2 million, resulting in GAAP diluted EPS of $0.20. A reconciliation of GAAP to non-GAAP expense in income from operations can be found in our press release and current report on Form 8-K filed with the SEC.

  • We ended the quarter with a strong balance sheet. Cash and investments were $83.1 million at September 30, 2006 -- an increase from $76.9 million at the end of the prior quarter. The increase in cash was a result of approximately $8.8 million in positive cash from operations offset to some degree by cash payments of $3.4 million related to acquisitions completed during the quarter.

  • For comparative purposes with the prior year, cash from operations would have been $9.2 million in the third quarter, excluding the impact of approximately $400,000 due to the excess tax benefit associated with the implementation of FAS 123(R).

  • Our cash flow performance represents a substantial increase from the prior quarter due to the strong momentum of our business, solid collections and the evening of timing differences with the prior quarter. We have said many times that quarterly cash flow is skewed by the timing of payments and collections. What is most important is the foundation that is in place to drive long-term cash flow, solid controls and processes, significant profitability and business momentum. We believe we are well positioned to drive long-term cash flow and we believe our cash flow for the full year will be in the mid-20s, barring any quarter enterprises related to the timing of payments or collections.

  • Accounts Receivable ended the quarter at $18.2 million. This was in line with the end of the prior quarter. DSOs at the end of the quarter were 54, a decrease from 60 at the end of the prior quarter and 57 at the end of the year ago quarter. Our deferred revenue at the end of the quarter was $18.8 million, an increase of 10% sequentially and 70% on a year-over-year basis.

  • I would now like to turn to guidance for the fourth quarter of 2006 and a preliminary look at the full year 2007. For the fourth quarter of 2006, we expect the following. Revenue to be $28.9 million to $29.3 million; subscription revenue to be $23.7 million to $24 million; non-GAAP income from operations to be $6.4 million to $6.7 million. Assuming a 22% tax rate for reporting purposes, and 21.2 million shares outstanding, we expect our diluted non-GAAP earnings per share to be $0.29 to $0.30. Of note, these estimates do not include the impact of BrassRing as we do not know the specific timing of when the transaction will close.

  • I would like to now provide an update to our preliminary 2007 topline and profitability forecast. For the full year 2007, we expect the following -- total revenue of $177 to $181 million which is a slight uptick from the $176 to $180 million we provided a few weeks ago; non-GAAP operating income of $36.3 million to $38.3 million; and non-GAAP earnings per share of $1.14 to $1.19 assuming a 30% tax rate and 21.3 million shares outstanding.

  • In summary, we're very pleased with our third quarter results. We continue to build a strong operating track record and we have again increased our topline and operating income forecast based on our third quarter results, continued momentum and further analysis of the expected benefits from the BrassRing acquisition.

  • We will now turn it over to the operator to begin the Q&A session.

  • Operator

  • (OPERATOR INSTRUCTIONS). Jason Maynard, Credit Suisse.

  • Jason Maynard - Analyst

  • Congratulations on the quarter. I have a couple of questions for you, Rudy, maybe first to start, just about the market. Your average deal size for your PQ customers are really picking up, and I think it is ahead of what most of us were modeling. Can you maybe comment a little bit about what is going on the market, how is human capital management becoming a little bit more of a priority item, and then as a side, ADP has been fairly acquisitive with employees and buying Virtual Edge. Maybe talk about what dynamic you think that brings into the space longer-term. And then I have a follow-up for Don.

  • Rudy Karsan - Chairman and CEO

  • First, a PQ -- North of 800 is a number and I think we had kind of guided the market to about a 40% organic growth rate, and if you stick those numbers in there, you would have seen that we would have expected it to in the high 700s. 770, 780, and that range. The pleasant surprise we had is that Kenexa's brand is getting stronger and as the brand is getting stronger we are attracting bigger names. And I think when I was going through some of the lists of the people that attended our conferences, you can see we are now moving in above what we considered to be our sandbox, which we have often talked about as being the 5,000 to 30,000 employee pool.

  • We are now getting companies that are north of 30,000 employees. Therefore, they are buying larger solutions. We are also selling to more divisions and then the obvious one, also, is that a number of solutions by PQ customer continues to decline. And so now if I take the entire PQ vertical -- because now we are add over 40 customers with multiple solutions, I think at last count we were like at 46 or something. And we are realizing now that number is becoming meaningless.

  • So what we would like to do is just for our entire PQ customer base, the average number of solutions has now hit -- I think it is like 1.8 or 1.9, in that range. And so we will start reporting that number beginning next quarter as to the total number of -- or the average number of solutions for our total PQ group.

  • That updraft, if you will, for lack of a better work, is something that we are reasonably confident should continue for at least the foreseeable future. Can we continue to go at 40%, I do not know. But I think we are fairly optimistic that we are expecting that number to climb.

  • ADP entering into the space with employees and with -- sorry, with the Virtual Edge -- I guess it is a welcome for us, because we believe that as the organization -- it is kind of -- when the elephants come and play and you are a gazelle you are going to welcome it, because it is establishing the space for you as well.

  • And their interest is telling us that it is really not just a figment of our imagination. So that is the first, and it's good news.

  • The second reason it is good news is that larger companies that put on a level of discipline on organizations that kind of insist on a minor issue called profitability; and that kind of helps Kenexa as the marketplace gets more and more sane, as you go looking forward.

  • So all in all, we are excited that ADP coming into the space. Are we a little concerned? Of course. I mean, they are the 800 pound gorilla. But all in all, I do not think it should materially affect our numbers in '07, '08.

  • Jason Maynard - Analyst

  • And Don, the follow-up I had was on you're obviously upticking guidance just a touch versus what you provided on the last BrassRing call. I would assume that's just confidence in the core business as you continue to move forward. Is there any other color you can talk about because the numbers are just inching up a little bit?

  • Don Volk - CFO

  • It is based on our expectations for the combined company. I would not place it on one side or the other.

  • Operator

  • Peter Goldmacher. Cohen.

  • Peter Goldmacher - Analyst

  • Can you talk a little bit more about some of your PQ customers and when they are signing up? What are the sales dynamics when they are signing up for more of the same versus incremental products? And how you approach that, if you prefer one over the other?

  • Rudy Karsan - Chairman and CEO

  • The strategy on that still remains unchanged in that what we do is we try and follow the material of the various trade publications that are sizing organizational development and we lead with our largest survey products and our assessment. If they are talking about skill-based testing, we lead with that. In terms of the strategy over the last four to six quarters, that has remained virtually unchanged.

  • What we are noticing now is we are -- when we are on pitches, so to speak, or on discussions with prospective partners or clients, we tend to talk more about our suite rather than just one product. We make it more into a strategic sell. So one of the phenomenon that we have noticed is that at the time of signing historically in '04 and '05, we used to see only one solution being sold at a time. Now we are not surprised to see two at one shot or sometimes even three.

  • Peter Goldmacher - Analyst

  • That is good. One good question, Don, on the cash flow. Should we model Q4 free cash flow up sequentially from Q3? Is that right way to think about it?

  • Don Volk - CFO

  • Well, we are guiding to operating cash from operations -- we believe that comes from a strong profitability in the quarter, growth in deferred revenue and a positive contribution from working capital. And we are guiding to mid-20s for the year.

  • Operator

  • Brendan Barnicle, Pacific Crest Securities.

  • Brendan Barnicle - Analyst

  • I was interested in what the impact in '07 would be if there a slowdown in the economy or any slowdown in hiring.

  • Rudy Karsan - Chairman and CEO

  • It is kind of a theoretical question for us because we have never really seen it in the current model of Kenexa, because when we last saw the recession, it was when we had less than 50% of our revenue was in a subscription model and 38% of our revenue was selling to the tech companies, and there was a tech blow-up in '01. So it is a real tough question for us to answer.

  • We would be speculating like anyone else. So I do not really want to touch it from that standpoint. I just do not know.

  • Brendan Barnicle - Analyst

  • In terms of -- you guys have done the shelf offering, (indiscernible) acquisition. What is the timeframe on whether you might do some sort of secondary to finance some of this?

  • Don Volk - CFO

  • The shelf offering was done to give ourselves flexibility. We do not have a timeframe or anything particular in mind.

  • Brendan Barnicle - Analyst

  • And then lastly, Don, breakdown between small, medium and large enterprises? You had mentioned the customers now over 30,000 employees. Any kind of breakdown of how that broadly splits out?

  • Don Volk - CFO

  • No. Not at this time.

  • Operator

  • Richard Davis, Needham & Co.

  • Richard Davis - Analyst

  • When you are thinking about acquisitions, because you've made a handful of good ones, what if you found a company with a good interface, good functionality and customer base, but it had a different architecture underneath? How do you think about that? How do you weight that, the fact that you have something good, but then you might also have to integrate? Assuming you continue to make acquisitions, it would be kind of helpful to hear how you think about that strategy.

  • Rudy Karsan - Chairman and CEO

  • What we want to do is our acquisitions, one of the things we look at accretive and upfront. So can we make the acquisition accretive first quarter out of the box? And what we mean by first quarter out of the box is the first full quarter after the acquisition is completed.

  • There's very few companies that can meet the criteria, and we realize and understand that. The other three things we look at is expanded solutions, expanded geographies and expanded verticals. If the architecture is very different, or in the database is very different, we generally think about it in terms of the added costs associated with the roadmap, with that particular product, and then we think about when we could start thinking about fusing the different products together, whether it is five years out or seven years out or what have you.

  • One of the things that we have done is we are very, very proud of our 90%-plus renewal rate of our customers, and that is something -- it is almost [sacrosanct] to us. So in customer discussions and dialogues, the customers will then I guess guide us to what they are really looking for.

  • Richard Davis - Analyst

  • And this may be more for Don, but do your salespeople get a different payout if they sign a perpetual deal versus a subscription deal, because it is interesting you have not signed a perpetual deal where there is great predictability and everything like that. But if you have an upfront fee, I would figure a sales guy might try to close those. Or is it just the customers are saying we just want perpetual? Excuse me, we just want subscription?

  • Don Volk - CFO

  • We are selling against the perpetual deals.

  • Rudy Karsan - Chairman and CEO

  • We can get a commission, but it does not affect the quota numbers, though. That's how we get them.

  • Richard Davis - Analyst

  • Trying to figure out what the motivation was.

  • Operator

  • Andrey Glukhov, Brean Murray.

  • Andrey Glukhov - Analyst

  • On the fiscal '07 guidance, on the revenue guidance, is your initial backlog coverage comparable to the backlog coverage that you had entering '06?

  • Don Volk - CFO

  • At the beginning of '07, we will give that number.

  • Andrey Glukhov - Analyst

  • I tried.

  • Don Volk - CFO

  • You always do.

  • Andrey Glukhov - Analyst

  • I know. And then, Rudy, business right now is getting skewed, basically 60% of the business right now is applicant tracking. BrassRing skus, that makes a little more. How do you think about it going forward? Would you prefer to normalize the business back to 50/50 mix over time, or are you just not concerned about that mix?

  • Rudy Karsan - Chairman and CEO

  • I am not really concerned about the mix as much as -- as long as we are under kind of 2/3, 1/3, 3/4, 1/4 -- as long as from a branding perspective the customers view us as a full suite, we are in great shape. If they start thinking of us as primarily acquisition or primarily as proponents management and surveys, then I think we would be a little concerned.

  • As of now, customers and clients are viewing us as a full suite, and they don't spend a lot of attention and a lot of time trying to figure out what percentage comes from what pocket. So as long as our customers respect our brand, we are going to continue to make the moves that we believe meet our acquisition needs of increasing the size of our footprint.

  • Andrey Glukhov - Analyst

  • Lastly, since after BrassRing you are going to have a three applicant tracking system, any more thoughts as to whether you need to kind of normalize the product footprint?

  • Rudy Karsan - Chairman and CEO

  • What we're thinking of doing around that is, first of all, it is really hard to say, because we have not closed BrassRing, and while the probability of not closing it is very minute, as a prudent seller, they would say to you, "You can't really, really come and be extremely interested in our business." And we respect that.

  • So this is a tough question for me to answer in theory because our technologists have not gone in there and really dug through the code and everything else. But the thinking is that the clients again will decide. The roadmaps will be in place. BrassRing's version 9.0 is supposed to come out on December 2. I have been assured that it will make those dates. I asked the question 15 times over -- I know it's supposed to come out next year. These dates will be met. Kenexa 5.0 will come out.

  • I think what will happen as we look at it is we will talk to our customers, we will find out what the strengths and weaknesses are and then work with them as we figure it out going forward. The thinking is of today is just don't know because we have not had a chance to really dig through the actual code.

  • Operator

  • Brad Reback, CIBC.

  • Brad Reback - Analyst

  • When you are engaging the customers on a strategic level around suite deals, what type of feedback are you getting from them about holes in your offering right now, about things they would like to see you doing more of?

  • Rudy Karsan - Chairman and CEO

  • Where we are seeing the biggest holes is on our compensation on the performance management side. We are seeing holes around succession planning -- because we need to strengthen that. We are seeing holes around workforce planning -- which we're hoping that the BrassRing acquisition will take away some of those -- and a strengthening of the analytics tools.

  • Brad Reback - Analyst

  • And when you look at your development pipeline for '07 versus your acquisition wish list, is it 50/50? Is it 75/25? How do you address those needs?

  • Rudy Karsan - Chairman and CEO

  • Right now, most of those needs -- as we go through the roadmaps, we will always make the (indiscernible) build meet our criteria on acquisition as far as accretion goes and all the other steps that we go through as we check off the boxes. Once we are in that zone, then, if we find something that we need while we are developing it, we might just put on the brakes and say, "Let's look at this. We are aware of this company. It's our criteria. They are interested in selling; we are interested in buying."

  • We begin the dialogue. At that point in time, we would slow down development. So we really kind of think of the roadmaps to include those features and functionalities going out, and then an acquisition would then disrupt it. That is how we think about it.

  • Operator

  • Laura Lederman, William Blair.

  • Laura Lederman - Analyst

  • Good quarter. Just a quick questions. One is when you look at the pipeline going forward, how much that is for multideals? Can you give us a rough feel for that?

  • Rudy Karsan - Chairman and CEO

  • What do you mean by -- you mean multi-deal for -- ?

  • Laura Lederman - Analyst

  • More than one product. So not just a survey or not just applicant tracking or not just whatever.

  • Rudy Karsan - Chairman and CEO

  • I don't not look at our pipeline that way, but I would say if I was just going in on an anecdotal basis, it should be -- it is -- I would say it's around a 40% mark, because remember, we try to bust through the RFP using our suite solutions and our strategic solutions. Once we get into that zone, it is usually multiple.

  • Laura Lederman - Analyst

  • And what type of pricing are you seeing in the market? It always is a question I get, so I thought I would ask you as well.

  • Rudy Karsan - Chairman and CEO

  • 19.6% in operating margins.

  • Laura Lederman - Analyst

  • Okay. So is there any vendor out there that is pricing more or any color?

  • Rudy Karsan - Chairman and CEO

  • 19.6% in operating margins.

  • Laura Lederman - Analyst

  • Okay. Looking at what is growing quickly in you base, within talent acquisition, can you give us a sense of whether applicant tracking or skills assessment is growing faster and in performance management, what is hot there? Is it surveying, is it performance management? Just to give us a feel for what is particularly -- seems to be growing rapidly out there.

  • Rudy Karsan - Chairman and CEO

  • Our basic existing business is about 60/40 split between talent acquisition and performance management. Our new business this quarter was roughly 60/40, and then we don't break it down by module beyond that. So we were seeing both halves grow at about the same rate.

  • Laura Lederman - Analyst

  • Following up on your comments that the number one thing or at least you listed it first that you are missing is compensation. Is there really much out there to buy, or is that something that you are more likely going to have to build internally? And if you are looking at who is out there in the market, who seems to be doing well? And obviously, not that you would necessarily buy them; we are just curious as to who's important in the compensation space.

  • Don Volk - CFO

  • You usually do not expect us to the answer that, do you?

  • Laura Lederman - Analyst

  • A girl can hope. But is that one of the fastest-growing part of the market that you see? Or is it that your customers are asking for it? In other words, why the interest in comp?

  • Rudy Karsan - Chairman and CEO

  • The question that more philosophical customers ask is, how can you really do performance management without compensation? You got to tie it in, you got to pay the right way, you got to reward and be punitive around compensation. So right now, the performance management role that's displayed is more around a tactical need of record-keeping and communication. And then tomorrow, when it plays a stronger role in terms of showing a line of site to the client's financial statement, they need to tie it in to compensation.

  • Ultimately, [10] years from now, it's going to be all tied in together. The question is when.

  • Operator

  • James Friedman, Susquehanna.

  • James Friedman - Analyst

  • Jamie Friedman at Susquehanna. Most of my questions pertain to India. If you could give us any observations you might have regarding attrition or wage inflation, headcount requirements in India as they stand now, that would be helpful. And I have a quick follow up.

  • Rudy Karsan - Chairman and CEO

  • Attrition is very high. It is running around the low 20s. Wage inflation is running in the high teens, very high, and then headcount climbs because our strategy of defending against attrition is to have shadows or what we call interns placed against an existing job. So if there is 100 developers, each one of those developers has an intern or what in India the term is used is "fresher", that somebody fresh out of school, who interns like students here in the summer do, but for the first year, year and a half upon graduation.

  • Hence, you will see our Indian headcount is a little bit on the high side, because you have two people in every job. And that is how we defend ourselves against attrition to the best way we can.

  • James Friedman - Analyst

  • And then a related note. It seems like there are a few geographies in the world that need applicant tracking more than India does. Is there any chance that you may be able to have some inroads in the companies in India, selling into the companies in India?

  • Rudy Karsan - Chairman and CEO

  • We certainly hope so. We are starting to attack that market -- I do not think we will see -- I think in previous calls we have said that we are going to begin more globalization around sales in '07. We have built it into our expenses, but we have not built into our revenue, that'll be a positive upside. We do not expect revenues starting to hit until '08.

  • Operator

  • Jason Maynard, Credit Suisse.

  • Jason Maynard - Analyst

  • I just had one follow-up on the cash flow guidance for fiscal '06. You said it's kind of the mid $20 million range.

  • Don Volk - CFO

  • Right.

  • Jason Maynard - Analyst

  • Does that exclude any cash related to the exercising of stock options?

  • Don Volk - CFO

  • Yes.

  • Jason Maynard - Analyst

  • What would that amount be, roughly?

  • Don Volk - CFO

  • Who knows? You never know when options are going to be exercised, right? It was 400,000 in this quarter.

  • Jason Maynard - Analyst

  • Is it reasonable to assume a similar amount? Maybe plus or minus a few hundred thousand? Is that the right ballpark?

  • Don Volk - CFO

  • I think that is reasonable.

  • Operator

  • Brad Mook, Boenning & Scattergood.

  • Brad Mook - Analyst

  • Good quarter. Question on salespeople -- you had mentioned you might satisfy a good portion of your increase for '07 through the addition of BrassRing salespeople. I think on your last call about BrassRing, you did not identify how many people were coming over. Do you have a better insight into that now?

  • Rudy Karsan - Chairman and CEO

  • Yes, we do. Don?

  • Don Volk - CFO

  • We have continued to -- with our overall analysis of BrassRing business, but it would not be appropriate to discuss potential changes until after the acquisition is completed and we have a chance to address the combined Companies' employees.

  • Brad Mook - Analyst

  • Maybe I can ask it a little differently. Do you sense any need to hire outside the additions from BrassRing to meet your needs for '07?

  • Rudy Karsan - Chairman and CEO

  • There will be the -- the net additions -- I think what we are looking at for '07 -- you see, part of the reason is we do not really comment on it, because we have not talked to the employees. We have not really seen their reviews and all that, again because we have signed, but we have not close. And those things happen after you close.

  • But the way we are looking at it is that, for '07, our growth rate will in salespeople will be at about the same as we have maintained in the past, which is about a 50% increase in salespeople to the growth of the organization. So if we are expecting to grow by 40% or 30% next year, our salespeople grow by 15%.

  • Brad Mook - Analyst

  • Let me come at it one other way. Without you having to discuss your plans for what you are going to do with the BrassRing salesforce, how many salespeople do they have today?

  • Rudy Karsan - Chairman and CEO

  • They have the same distribution of sales and marketing that we do, which is about one in six.

  • Brad Mook - Analyst

  • And then you mentioned the Gantz Wiley revenue impact in Q3, about $800,000. Any impact on margins?

  • Don Volk - CFO

  • It was a minimal impact on margin.

  • Brad Mook - Analyst

  • And you have also outlined some pretty nice development needs going forward in terms of your product portfolio as you consistently do. Should we anticipate that your R&D spending in the absence of acquisition activity continues to be pretty high?

  • Don Volk - CFO

  • Our R&D spending, our target is between 7% and 9%. (indiscernible) 6% and 9%. So it will be in that range.

  • Operator

  • Michael Nemeroff, Wedbush Morgan.

  • Michael Nemeroff - Analyst

  • Don, could you tell us what working capital requirements you would think would be necessary on a regular basis, on an ongoing basis for the Company?

  • Don Volk - CFO

  • We do not guide to that.

  • Michael Nemeroff - Analyst

  • And then, also, on the subscription revenue from BrassRing, could you give us -- you had mentioned it was similar to yours. Could you tell us, and then it also was composed of software, consulting services and other services. Could you kind of give us a little bit of a guidance as to how much of which BrassRing's revenue is composed?

  • Don Volk - CFO

  • Our target is 76% to 80%, and we run around 80%. Theirs is similar.

  • Michael Nemeroff - Analyst

  • The breakdown of the subscription revenue as far as software component, services, consulting -- bad breakdown -- do you have that information?

  • Don Volk - CFO

  • No.

  • Michael Nemeroff - Analyst

  • And the renewal rates, are they --? You had mentioned before that they were 90%-plus. Have they changed at all over the last couple of quarters?

  • Don Volk - CFO

  • No, they're in the 90%-plus range.

  • Michael Nemeroff - Analyst

  • How much do you expect the Gantz Wiley -- how much revenue do you expect Gantz Wiley could contribute in the fourth quarter?

  • Don Volk - CFO

  • We do not break that down.

  • Michael Nemeroff - Analyst

  • Also, you had mentioned that the operating cash flow for 2006 would be in the mid-20s. Would you care to take a stab at what you think it could be in 2007?

  • Don Volk - CFO

  • No, we have not historically provided cash flow guidance as a practice. However, we did provide 2006 to help investors because of the timing difference in cash collections during the second quarter. So we've provided preliminary guidance on the Company's revenue and earnings, but we're not going to provide 2007 cash flow guidance at this time.

  • Michael Nemeroff - Analyst

  • SO the cash collections in 2007 should mirror the net income of the Company going forward? Is that what you are saying?

  • Don Volk - CFO

  • No. I am saying that we are not providing 2007 cash flow guidance at this time.

  • Michael Nemeroff - Analyst

  • Could you also just refresh on the gross margin? You had mentioned that it was going to be down closer to the 70% level. Going forward, should we expect a gross margin and a similar type range? And could you also just give us an update on why exactly that gross margin has been impacted?

  • Don Volk - CFO

  • Our gross margin target is 70% to 74%. It has been 71% for six quarters in a row, and then it jumped up because of a special piece of revenue in the first quarter, and then because of some efficiencies. And we said it would probably trend down closer to the 71% range for the remainder of the year. And the reason it trends down is because we do some investing in resellable product and content. (multiple speakers) customers.

  • Operator

  • Brendan Barnicle, Pacific Crest Securities.

  • Brendan Barnicle - Analyst

  • Just one quick follow-up. What is the number of quote-carrying reps that we are at right now? End of the quarter?

  • Don Volk - CFO

  • 75% of our 98 heads.

  • Operator

  • Peter Goldmacher.

  • Peter Goldmacher - Analyst

  • Just one quick follow-up. Is there any change in the invoicing duration now that you guys are getting into bigger deal sizes with larger customers? Is it still generally monthly or quarterly invoicing?

  • Don Volk - CFO

  • Still three months in advance.

  • Peter Goldmacher - Analyst

  • And that has not changed?

  • Don Volk - CFO

  • Right.

  • Operator

  • And there appears to be no further questions at this time. I will turn the conference back over to the speakers for any additional or closing remarks.

  • Rudy Karsan - Chairman and CEO

  • Yes, I would conclude by saying No. 1, thanks a lot for joining us again on our quarterly call. No. 2, we continue to be bullish, as we were at the end of Q3. That bullishness continues into Q4. And point No. 3, last but not least, that bullishness is now further enhanced by the inbound calls that I referred to in the opening statements. So have an enjoyable evening and once again, thanks a lot. Good night.

  • Operator

  • That does conclude our evening's conference. We thank you for your participation. You may now disconnect.