International Business Machines Corp (IBM) 2007 Q2 法說會逐字稿

Welcome to the Kenexa Second Quarter 2007 Earnings Conference Call.

(OPERATOR INSTRUCTIONS)

And now, I'd like to turn the conference over to Mr.

Rudy Volk, the Chief Financial Officer at Kenexa.

Please go ahead, sir.

Thank you, Shirlon.

Today we will review Kenexa's Second Quarter 2007 Results, which were announced after the market closed this afternoon.

We will also provide guidance for the third quarter and update the full year 2007 outlook and then we will open up the forum for 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 products.

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

I will discuss the reconciliation of adjusted numbers to GAAP 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 thanks to all of you for joining us on the call, as we review our second quarter financial results, which were at or above the high end of our guidance, from a revenue and profitability perspective.

In addition, we had another very successful cash flow quarter.

And at the halfway point of the year, your cash flow from operations is up more than five-fold compared to the first six months of 2006.

We continue to benefit from our participation in an attractive market that is experiencing strong demand and growing awareness.

We are pleased with the high level of execution across all our global organization.

With approximately nine months now under our belt and significant progress made, we consider the BrassRing integration complete and our end to end management team is entirely focused on executing our growth strategy.

We are optimistic about our outlook for the remainder of the year and we continue to be very excited by our long term potential, based on the expanded breadth and depth of our solutions, growing market share and the strength of the talent management market momentum.

Now, taking a look at the numbers for the second quarter, our total revenue came in at $45.2 million, an increase of 83% year-over-year and near the high end of our guidance, which you will recall was increased mid-quarter.

Similar to our presentation in previous quarters, if we were to subtract the revenue run rate of companies acquired in the past year from our second quarter revenue, we estimate that Kenexa's organic revenue growth would have been in the range of 30 to 35% on a year-over-year basis.

The most important component of our business, subscription revenue, came in at $37 million and 86% year-over-year.

The strength of our subscription revenue growth was driven primarily by continued strong bookings across all our key product categories and the inclusion of the results from the BrassRing acquisition in the fourth quarter of 2006.

From a profitability perspective, we generated record non-GAAP operating income of $9.2 million, slightly above the high end of our guidance and representing an operating margin of 20%.

We generated another $6 million in cash flow from operations during the second quarter, bringing our halfway total to approximately $12 million, which is up dramatically from approximately $2 million at this same point last year.

The second quarter was strong from many perspectives, and it starts with the fact that the talent management market continues to experience significant demand and growing awareness.

The key underlying drivers of market demand remain the same, the aging of the workforce, declining tenure of employees, increased globalization, fluidity of organizational structures and pressures on the HR department to minimize cost.

All of this combines to create a war for talent.

While strong market demand serves as a wind behind the back of all companies in the talent management market, Kenexa continues to gain market share in part because of what we believe to be our growing brand recognition and proven track record of delivering results for our customers.

For example, during the second quarter, we received over 50 inbound inquiries for our total solutions during a single week.

Only 12 to 18 months ago it would have taken as long as a month to receive that level of inbound interest.

We think that this shows the momentum of the market and the customer's recognition of Kenexa as a market leader.

Kenexa is unique in our ability to serve as a trusted advisor and partner to our customers.

And our unique experience and capabilities helps us to deliver business results.

We believe that we are differentiated by the breadth of our solutions across both hiring and retention, proprietary content services and outsourcing capabilities.

Equally, or more important, are the people at Kenexa who provide us with a significant domain expertise advantage.

If you look at the type of people employed at Kenexa, the types of sales reps that Kenexa uses and the thought leadership we have brought onboard by several acquisitions, all are very different than what you see from a typical software company.

And we think that all clearly distinguish us in the talent management market.

Unlike most software companies, our beginning focus is how to solve business problems for the HR department and business executives as a whole.

And then we go about doing so by using the best combination of technology, content and services.

A real world example of our value at work is a national retailer that utilized Kenexa's total solutions offerings to determine that sales associates that score above the 71st percentile on Kenexa skills assessments tend to sell $35 more an hour on average compared to those scoring below the 40th percentile.

This makes a difference of approximately $73,000 in sales per full time employee per year.

Kenexa's roughly two decades of experience in the talent management market, growing knowledge base of content and volumes of surveys that we have conducted for our customers positions us uniquely to be able to help customers such as this retailer in finding and retaining the best employees.

This ability to deliver tangible results for our customers continues to attract new customers to Kenexa.

And during the second quarter, we added over 40 preferred partner customers in the quarter.

On the hiring side, we completed business with customers such as Dow Chemical, Network Appliance, KPMG, Los Angeles County, Quintiles Japan, Telerx Marketing, BDO Seidman and CLS Behring, while on the retention side we had the customers such as AETNA, Starbucks, T-Mobile, Murphy Brown, Dairy Crest, NRG Energy, Wyndham Worldwide and Sharp Healthcare.

High-quality customers such as these provide ample opportunity for Kenexa to expand our presence, over time, as we prove out our value, which is evidenced by consistent and solid growth in our PQ metric.

This metric increased to just over $1.1 million in the second quarter, which is up from over $1 million during the first quarter and up from $800,000 at the end of 2006.

Entering this year, we stated our goal was to grow our PQ metric by 30 to 50% over the course of the year.

And I'm confident that we will be at least at the high end of the range, based on where we are today and our outlook for the remainder of the year.

This level of investment in Kenexa by our customers is evidenced by the strategic nature of talent management solutions and Kenexa's status as a trusted partner.

I'd like to finish by providing details that highlight the progress we have made in the integration of BrassRing into our operations, which provides us with further optimism on Kenexa's long-term abilities to capitalize on the opportunity at the large end of the market.

First, among our new customers added during the quarter, we were pleased that Network Appliance, KPMG, Comet Group, Carestream, and CBS Corporation all decided to initiate relationships with Kenexa based on our Kenexa recruit of BrassRing application.

On previous calls we have noted several large customers, such as British Petroleum, Volvo and Xerox, that all brought Kenexa back to the revaluation process after we completed the acquisitions of BrassRing.

Similar to these situations, Kenexa had previously been eliminated from competition at CBS Corporation due to our lack of global capabilities.

However, we were able to reemerge in the evaluation process as a result of BrassRing's capabilities, ultimately winning the selection against the primarily competition at the very large end of the market.

A second positive development we've started to see relates to Kenexa's many existing customers with multi-language needs.

Most of these customers are choosing to move over from either Kenexa Recruiter or Kenexa Recruiter enterprise to our Kenexa Recruiter BrassRings solutions.

During the second quarter, such customers included Air Products, a longtime Kenexa Recruiter enterprise customer as well as Quicksilver, a more recent customer.

Many of our customers are thrilled that they have this option, as their language needs change over time and they can continue to work overtime with Kenexa and expand our overall relationship over time.

Third, similar to our commentary last quarter, we continue to be pleased with the renewal rates of customers in the Kenexa Recruiter BrassRing solution, with customers such as Williams Sonoma and Staples renewing during the quarter.

Finally, we're seeing some of the initial signs of cross-selling successes.

In particular, we have seen progress in the areas of cross-selling Kenexa's assessments into the traditional BrassRing customer base.

We believe there is a considerable cross-selling opportunity from a long-term perspective, given the growing breadth of our solutions and the size of the customers that are attracted to the Kenexa Recruiter BrassRing solution.

BrassRing has been a part of Kenexa for close to nine months, as of today's call.

There is still much to be accomplished as we have only scratched the surface of opportunity for our combined organization.

That said, I'm pleased to share with you that I believe the heavy lifting has been completed with respect to the integration of their operations.

We're successfully bringing the BrassRing talent acquisitions solution to market.

The efficiency of our back office operations has improved considerably in the last six months and our executives are squarely focused on executing our growth strategy as opposed to dealing with integration issues.

I'm very proud of the teamwork and efforts from employees on both sides to make this integration into a single cohesive organization go as well as it has.

With the talent management market continuing to remain highly fragmented and consolidation expected to continue in the years ahead, I believe Kenexa's proven ability to find synergistic acquisitions and execute on the integration of those companies is a core competency and competitive advantage.

During the second quarter, we took the opportunity to make a tuck in acquisition of Straight Source, which brought us best in class domain expertise in the area of EPO.

This area of our business is strategic because it reinforces Kenexa's domain expertise advantage and significantly enhances our credibility with customers, as we know the exact challenges they are facing from a business process and technology perspective.

From an overall perspective, our strategy is to continue gaining market share on an organic basis and execute tuck-in and strategic acquisitions that will best position Kenexa to be the ultimate winner in the talent management market.

In summary, our second quarter results were strong from a revenue, profitability, and especially a cash flow perspective.

We believe that our overall business momentum is strong.

Kenexa is gaining market share and we are highly focused on executing on our growth strategy with the heavy lifting of the BrassRing integration now complete.

Our organization is executing well and we are optimistic about our outlook for the remainder of the year, and even more so from a long-term perspective.

I will now turn it over to Don Volk to review the financials in more detail.

Thanks, Rudy.

I will now review our results for the second quarter of 2007, which were quite strong and at the high end or ahead of our expectations.

Let me start with the details of our second quarter results, beginning with the P&L.

total revenue for the second quarter was $45.2 million, an increase of 83% over last year and near the high end of our updated guidance of $43.6 million to $45.5 million.

As a reminder, we added $600,000 to our original second quarter guidance to account for the final month of revenue from Straight Source, which we acquired effective June 1, 2007.

And our actual results from Straight Source slightly exceeded our expectations, due primarily to success fees realized in the quarter.

Within total revenue, subscription revenue is the majority of our revenue and it is the strategic component of our business that encompasses our on-demand solutions.

During the second quarter, our subscription revenue was a record $37 million, representing growth of 86% on a year-over-year basis and 7% sequentially.

At 82% of total revenue, subscription revenue has been running ahead of our targeted mix of the high 70% to 80% range.

And the approximately $1.1 million overage during the quarter, compared to our subscription revenue guidance of $34.9 million to $35.9 million was due to the continuing strong momentum of our business.

The remaining $8.2 million of total revenue in the second quarter came from other and professional services, which increased 71% over last year and 8% compared to the prior quarter.

The majority of the revenue from this line item comes from discrete professional services, though we may occasionally have a perpetual license that will go into this line item.

We did not sign any perpetual deals during the second quarter.

Our clients typically purchase multi-year subscriptions with an average length of approximately two years.

Our revenue continues to be highly visible as a result of our diverse customer base, long-term contracts, 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 40 preferred partners.

And the average annual revenue from out top 80 customers, what we referred to as P-cubed, was over $1.1 million, which is up from the $800,000 level at the end of 2006.

From a long term perspective, we believe that there is significant upside to this number, given the growing breadth of our talent management suite, the fact that we are underpenetrated within the majority of our customers and the consolidation that we believe will continue to happen at customers and across the talent management industry.

Turning to profitability, we will be providing non-GAAP measures for each second quarter, 2007, expense category, which excludes stock based compensation charges associated with the implementation of FAS 123R, and amortization of intangibles associated with previous transactions.

All comparisons will be using the non-GAAP current period results.

Non-GAAP gross margin was 72% in the quarter.

This was down approximately 1% from the prior quarter but at the midpoint of our long-term target of 70% to 74% and consistent with our full-year gross margin during 2006.

Looking at operating expenses, non-GAAP sales and marketing came in at $8.9 million, or 20% of revenue.

The increase in sales and marketing on an absolute basis from the previous quarter was primarily due to increased marketing spending.

We ended the quarter with over 150 people in sales and marketing, compared to over 140 people at the end of the prior quarter.

Similar with prior quarters, approximately 75% of these employees carry a quota.

Non-GAAP G&A expenses were approximately $9.1 million, or 20% of the revenue.

G&A declined by approximately $300,000 sequentially, primarily due to lower payroll taxes as we paid out employee bonuses in the first quarter.

Non-GAAP R&D expense came in at $4.2 million, or 9.4% of revenue.

As a percentage of revenue, R&D came down from 10.1% in the first quarter.

We continue to target R&D spend at 6% to 9% of revenue from a long-term perspective.

A combination of growing revenue and focus on optimizing the efficiency of our global operations led to record non-GAAP income from operations of $9.2 million for the second quarter.

This represented an increase of 94% on a year-over-year basis and a margin of 20%.

During the second quarter, our non-GAAP tax rate for reporting purposes was 30%, resulting in non-GAAP net income of $7.1 million, an increase of 69% compared to 2006, when our tax rate was 8% lower, at 22%.

Based on 25.7 million shares -- diluted shares outstanding for the quarter, we generated non-GAAP diluted EPS of $0.28, which was at the high end of our $0.27 to $0.28 guidance and a year-over-year increase of 40%.

Turning to our results on a GAAP basis, which include $1.1 million related to the allocation of stock-based compensation and $200,000 related to the amortization of intangibles associated with previous acquisitions, the following were expense levels determined in accordance with GAAP.

Cost of goods sold, $12.6 million.

Sales and marketing, $9.1 million.

R&D, $4.3 million.

And G&A, $9.8 million.

For the second quarter, our GAAP income from operations was $7.9 million or a margin of 18%.

For the June quarter, the GAAP net income applicable to common shareholders was $5.8 million, resulting in GAAP-diluted EPS of $0.23.

A reconciliation of GAAP to non-GAAP expenses and 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 $108.5 million at June 30, 2007, a decrease from $111.7 million at the end of the prior quarter.

The decrease in cash was primarily a result of our purchase of Straight Source, net of our strong operating profitability and solid working capital management that drove our cash flow during the quarter.

During the second quarter, our cash flow from operations was $6 million, a significant increase compared to $1.4 million in the prior period - the prior year period.

In addition, for the first six months of 2007, Kenexa has generated $12.2 million in cash flow from operations, a dramatic increase from $2.3 million in the first 6 months of 2006.

The significant increase in cash flow on a year-over-year basis has been driven by our strong profitability, incremental improvement in the efficiency of our operations following the integration of the BrassRing acquisition and strong momentum of our business.

Accounts receivable DSOs adjusted for the Straight Source acquisition and closed with one month to go in the quarter ended the quarter at 66 days, compared to 62 days at the end of the prior quarter and 58 days at the end of the year ago quarter.

Our deferred revenue at the end of the quarter was $32 million, an increase of approximately 87% on a year-over-year basis and up slightly from the $31.7 million at the end of the previous quarter, which, as a reminder, was an unusually high level for a first quarter ending balance.

The strong increase in our deferred revenue on a year-over-year basis was a result of continued growth in bookings and renewals.

I'd now like to turn to guidance for the full year and the third quarter of 2007.

For the full year 2007 we now expect the following, total revenue of $188 million to $192 million, subscription revenue to be $150 million to 153 million, non-GAAP operating income of $40.7 million to $42.8 million.

Assuring a 30% tax rate for reporting purposes and 25.7 million shares outstanding, we expect our diluted non-GAAP EPS to be $1.18 to $1.25.

For the third quarter of 2007 we expect the following: revenue to be $48 million to $50 million, subscription revenue to be $38 million to $40 million, non-GAAP income from operations to be $10.8 million to $11.3 million.

Assuming a 30% tax rate for reporting purposes and 25.9 million shares outstanding, we expect our diluted non-GAAP earnings per share to be $0.31 to 0.33.

In summary, we are very pleased with our second quarter results, which were at the high end of our expectations.

Market demand is strong.

Kenexa's brand recognition continues to grow.

And we believe we have turned the corner on the integration of BrassRing with our end-to-end management team, focused on executing our growth strategies.

We are optimistic about our outlook for the remainder of the year and even more so from a long-term perspective.

We'd now like to turn over to the operator to begin the Q&A session.

Shirlon?

(OPERATOR INSTRUCTIONS)

We'll have our first question from Brendan Barnicle, Pacific Crest Securities.

I was looking at the Q3 guidance a little bit and the operating expenses seem a little bit higher than what I was expecting, just a bit and I was wondering if we -- is that reflective of the acquisition?

It looks like it's a little higher than a typical seasonal increase.

Are there some other things that are going on that would account for that increase?

And then I was also interested -- CapEx was a little bit higher than what I would have expected, if there are some additional CapEx purchases in the quarter.

Thanks a lot.

Well, we talked about operating expenses for an increased marketing.

And other than that, it's a typical increase from Q1 to Q2.

CapEx, we are in the process of building a building in [Byzak], and as that progresses, we are making payments on that building.

And related to that increase in marketing, are you guys -- you don't have a user conference or anything that's coming up, is it?

Is that -- what specifically is the marketing around?

Yes, there was a couple of big conferences this quarter.

There will be a couple again next quarter, and then it kind of eases up a little bit in the fourth quarter.

The first quarter is notoriously light for conferences.

Great.

And then, Rudy, you'd mentioned some of the cross-sell opportunities that you were starting to see.

I was wondering if you could give us a little more detail on the -- you mentioned assessments, any other areas that are doing particularly well and in cross-sells and areas that we might want to look at in any sense, and, you know, what percentage of, say, subscription revenue we could think about cross-sells as.

We're seeing -- here's an interesting data point.

I think, in Q2, for the first time since, I'd say, over three years -- I guess the first time ever, more than 50% of RFPs had two or more solutions that were attached to it.

Now, some of it was through the RFP process, as requested by the customer, or by the perspective customer, and some of it was Kenexa trying to be a little bit more aggressive in its sales process.

But that, I think, was an interesting kind of benchmark or point in time reaction to this cross-sell.

If I look at the cross-sell in general, the two areas where there is the greatest amount of synergies that are now taking place is between the applicant tracking system that existing BrassRing customers are now picking up, either our Selector or our Prove It!

or Selector and Prove It!

combined together.

We're seeing some of that.

We're seeing our Career Tracker latch on with our survey's business.

And then you got the surveys.

And then some companies include the 360 as part of the solution.

So you see a different and varied combination.

What's interesting to note is there's very little cross-sell, if you will, between the ATS and the performance management solutions.

So that bridge hasn't been yet successfully done.

Great.

And then, is the cross sell -- is that the largest reason for the increase in P3, or is -- do you have any way of quantifying, sort of, what percent has that improved the P3 number?

I would say cross-sell to larger sized customers was probably the primary driver of that, but I don't have the data in front of me, so -- and I don't remember it exactly.

Great.

Thanks so much, guys.

You're welcome, Brendan.

We'll have our next question from Jon Maietta, Needham and Company.

Hey, thanks very much.

Rudy, the first question I had was just wondering if you could remind me roughly what percentage of your customer base has multiple solutions today, multiple modules?

That's a number we haven't given out.

What happens is the number we've given out is the number of solutions for our P-cubed customers averages somewhere between two and three.

Got it.

Okay.

And then, as you look out into 2008, what's kind of a reasonable expectation with regard to operating margins?

Is 100 to 150 basis points of operating margin expansion reasonable?

According to our model, I think we talk about the number at $50 million to $60 million being 22% to 24%, so I guess that falls into the range that you're giving, 150 basis points.

However, we have not given guidance for 2008.

So spoke the CFO.

Thanks very much.

You're welcome, Jon.

We'll go next to Jason Maynard, Credit Suisse.

Looks like I'll have to ditch my FY'08 guidance question so --

You try every quarter though, Jason.

It's an asking world.

Maybe talk a little bit about the proprietary content part of your business.

I think that's maybe one of the areas that your competitors don't really play in this space, they perhaps don't understand this space.

How does that impact and influence your average transaction size and your ability to cross-sell?

I guess, if you take a step back and say that the content forms the foundation of thought leadership within the space.

So go back to the phrase I've used quite a few times, which is Kenexa is an HR company selling a lot of software content and a lot of services, rather than a software company selling HR apps.

And so when we walk into a situation, we immediately focus in on where are - what are the business problems we're trying to solve, rather than what's the best way we can get this app into your organization in order for you to get a decent ROI.

So the approach that we take with the customers on the content piece is that we turn around and we say, okay, we know we have whatever, 25, 30 PhDs that work at Kenexa, over 60 or so kind of higher-degreed individuals.

They'll walk into the situation and end up teaching the customers something about their business that they didn't know and that gives us the leg up.

So what we hear is kind of the number one predictor of a successful sales call is when the customer turns around and says, thanks a lot for teaching us something new.

And that's the key.

So what we do is we continue to invest in that area.

We continue to increase the number of tests, we continue to modify them.

We see how it affects hiring models and practices, we help them go through their sourcing from various sources that they may have, what's the outcome, what's the retention rate, depending on the source -- the candidates gain from, using job boards and newspaper ads, things of that sort as well.

So, there's a lot of intellectual give and take between us and our clients to the point where we become partners.

So, Rudy, how many customers tend to procure those services and is there any way that you can quantify what lists that could add to your deal sizes?

We think it adds quite a bit.

So here's another way of looking at it.

If you look at our P-cubed group of 80 customers or so, the question I would ask you is how many software companies present to the highest executive team in a corporation, right?

So, the executive team at -- call it PWC -- their top 15 global partners that meet once a month.

Well Kenexa has presented to that group and we have done that with, I would say, 30 out of our 80 preferred partners -- I mean, P-cubed clients.

So that visibility at the very highest level, it's the true C Suite of the organization.

That's the way we measure it.

We measure how many times have we presented to the C Suite.

And usually it's not a sales presentation.

We're teaching them something about their work force, we're teaching them something about retention; we're teaching them something about hiring; we're showing them some global trends; we're showing them the cost of their bench.

That's the kind of conversations we're having.

And so that's how we're measuring it: how many times are we teaching it in front of the customer?

Okay.

And then maybe just one for Don.

As you've seen the ASP tick up, have you noticed any changes in billing terms, in terms of any customer saying we're going to bill - bill more upfront or bill more annually.

Anything there that you can maybe give us some color on, as we build out our models?

We continue to work on that, Jason.

And if you remember, last quarter, we said we'd moved that number up to [inaudible - background noise] and it stays at that number in this quarter.

There was some noise, I guess, in the background there.

I missed the punch line on the actual number.

3.6 months in advance at this point.

Okay.

Great.

Thank you very much.

We'll go next to Peter Goldmacher, Cowen and Company.

Hey, guys.

Strong free cash flow in the quarter -- it seems like the complexion of cash flow has changed.

In the first few years, it was really, really anemic in the first half and strong in the second half.

Can you help me understand a little bit what's going on with cash flow in the first half of the year now?

Also, can you talk a little bit about some of your P-cubed customers, how much flux there is in that customer set?

And then what are the kinds of things these guys are coming back to buy to increase their purchasing with you all?

On the cash flow question, Peter, it's not our practice to give specific guidance on cash flow, but we are very pleased with the strong cash flow performance year to date.

We expect cash flow to remain solid based on our positive operating profitability.

And then when you -- if you exclude the impact of non-cash expenses and then you can make an estimate of working capital accounts.

But typically, we had first quarter -- first two quarters are weaker because we pay out bonuses, we pay out maintenance on our databases and then the third quarter and the fourth quarter are stronger.

And we expect that to continue.

And the second question?

Just jog my memory.

I'm getting old.

Would you repeat it, Peter?

P-cubed.

The P-cubed customers.

Yes.

I was asking if you can help me understand how many of them were -- started out as Kenexa customers and then how many of them came in P-cubed, as BrassRing customers, and then the cross selling and then --?

Okay.

I'm going to go -- I'm going a little bit by memory here, Peter, but I think out of the P-cubed customers today, we've probably picked up either six or eight through the BrassRing transaction.

Call it -- call it 10%.

I think that number sounds right.

And so, if you noticed, I think it was back in July, we talked about one of the improvements that we came out with on the BrassRing application involved the seamless transfer of information between our testing and their applicant tracking system.

So it's now embedded in the BrassRing application.

It just requires a switch to turn it on or off.

So we're really focused pretty heavily on that.

And I would say, out of BrassRings 150-plus, almost 200 customers that are using that app, in the first six months of the year I think there were -- Don, correct me -- I think there's five customers that have now picked up, either Selector or Prove It!.

That's correct.

We've got quite a few proposals out there.

And when we're in that situation, clearly, we're in a non-RFP situation there.

Right.

Okay.

Thanks guys.

We'll go next to Brad Reback, CIBC World Markets.

Hey, guy, how are you?

Good.

Good, Brad.

Hey, one quick question.

A couple other companies that I follow that have significant Indian operations have complained about the rupee going against them.

I didn't hear that from you guys in the quarter.

Anything special going on there?

You know, Brad, we've often told you that we are lucky.

We happened to hedge right last year.

Don?

Yes, we hedged last year when the rupee was at 46 and we covered up through the end of the third quarter at 46.

And so it has not -- that decrease has not affected us significantly.

Got it.

Great.

And one quick follow up.

And on the acquisitions side, any commentary around pricing in the marketplace and people's expectations come in at all here lately and what's the environment like?

If you look at the first half of this year, last year I think we did five acquisitions of which three out of the five were tuck ins.

We did 1 in the first half of this year.

We did see the pricing move up to a point which did not meet our internal IRRs, even for the tuck in.

so we kind of backed off them.

We're seeing a little bit more sanity coming back into that space.

So -- and we've had a couple situations that the due diligence didn't work out or what have you and the sellers come back to us.

So there's a level of lumpiness here.

But we're definitely seeing a little bit less pressure on the pricing around M&A.

That's great.

Thanks a lot, guys.

We'll go next to Andrey Glukhov, Brean Murray.

Yes, thanks.

Can you guys talk about, I guess the organic growth that you're seeing?

Well, you know how we calculate that Andrey, we take the run rate of our previous acquisitions and we subtract that from our current quarter revenue and we compare it to the prior year and we're coming up with 30% to 35% organic growth.

Okay.

And how much did the trade source add to the deferred this quarter?

Nothing.

Okay.

All right.

Thank you very much.

We'll go next to Laura Lederman, William Blair.

Yes, thanks for taking my questions.

You beat our estimate for subscription revenue handily by about $1.1 million and yet you didn't beat EPS as much and I was wondering, was there certain things you spent more on that you had planned?

Because usually you tend to model conservatively and beat the street by about a penny -- so kind of a strange question, but the big license beat, and yet not a big EPS beat.

We beat subscription revenue and we beat operating income by $100,000 and that did not translate into anything on EPS.

So although we did beat subscription, our other revenue came in light.

And it has -- our other revenue has some variability quarter to quarter.

We did come in the range there, but we didn't beat it.

What came in light?

Did you expect the perpetual to close or what came in a little late on the other.

No, we didn't expect a perpetual, but that professional service revenue, it can be lumpy as we've said in the past and it's based on timing, when projects are started and can be different from our estimates for the quarter.

Kind of another strange question, which is last quarter you gave an organic growth rate of 35% and a point and this time you gave one of 30% to 35% and I was wondering why the range.

Yes, basically what it is, Laura, is as we look at it, as we're starting to -- as we've done a few of these acquisitions, we're now entering into third quarter where in the past we happen to have acquisitions right at the start of the quarter.

Right?

Now, because of the addition mid quarter, we don't want to give exactly a point in time.

So we're just saying okay, it's around 30% to 35%.

We're going to continue with that range because there's movement from month to month.

Separately, how much did Straight Source add to the full year for revenue?

Because, depending on how much that adds, it looks like you might have taken down total revenue guidance.

So can you talk a little bit about that?

We said $600,000 for a month, it came in slightly above that.

And you can project that from there.

We did increase our revenue guidance based on the Straight Source.

So the core business is not coming in enough above plan to take up the total revenue number and is that largely because of the other revenue having coming in a little light this quarter or is there anything you see in the market that makes you a little bit less sanguine if you look at the second half of the year?

Yes, we're pretty comfortable with the guidance for the balance of the year.

The way we're looking at it is we're fairly optimistic about the total growth.

I don't know how to answer the question other than we've grown 83%, organic is north of 30, we're adding a ton of customers, customers are buying more, inbound leads are up.

We had 50 in the first week.

We're feeling pretty good.

Okay, and final question, which is can you talk a little bit about the BrassRing pipeline, how strong that is.

And also, who are you seeing less of?

Who you seeing more of?

Obviously, Taleo and Verve are the other big players, but just kind of a sense of who you're seeing more of and less of there and how that market feels, the specific ATS market?

You're talking ATS, just as an independent solution, right?

As an individual solution?

Yes.

I think we're seeing more value, like you said, more Verve, less of some of the smaller players we used to run into.

We don't see Webhire at all for example.

But I would say, in general, the number of ATS providers has probably stayed about the same.

But the larger companies are now eliminating a lot of the smaller players based on their fiscal strength.

When we make the final two or three, it's usually one of these four or five companies is there plus one other.

And one of these four or five is either Taleo or StepStone, VirtualEdge, we started seeing them a little bit more, I've heard the name twice last quarter, it was pretty silent in Q1, after the ADT acquisition.

I say we've seen Peopleclick once or twice.

So I would say those are probably the five names that in that final two or three.

Thank you so much.

I appreciate it.

No worries.

We'll go next to Thomas Ernst, Deutsche Bank.

Actually this is Greg Dunham, on behalf of Tom.

Just touching on some of your comments about kind of having BrassRing under your belt and focusing more on growth here in the near term.

Do you see opportunities to accelerate the organic growth now that some of the distractions have gone and could you talk about some of the specifics there?

I think we'll continue -- I think we started this year, we were talking about organic growth at the beginning of the year at the 29 to 32% range.

That's the range we gave.

If I look at it in the first half of the year we've been about 30 to 35.

I would say the second half of the year we're going to be in the 30 to 35 range.

I don't believe that the acquisitions have been that much of a distraction for us.

We were kind of equipped as a management team to handle acquisitions that was part of our stated strategy.

We had staffed for it.

We have a very, very strong BD team and we have a very strong integration team as well.

So -- I would say if I looked in the second half of the year, I'd say it's probably kind of more of the first half.

Okay.

And then I guess one quick question on -- where did the benefits from hedging show up in the income statement?

In terms of what the hedging you did with the rupee this year.

Is that in cost of goods sold?

That's in cost of goods sold.

Some of it's in R&D expense.

And some of it's in capitalized expenditures for fixed assets.

Okay.

So looking forward, in terms of gross margins, how should we think about those in terms of expansion?

I know you kind of talked about the 100 to 150 basis points over all, in terms of operating margins, but in terms of gross margins how should we model?

We expect our gross margins to be in the 70% to 74% range.

Okay.

Roughly guided 71% to 72%.

Okay.

Thank you.

We'll go next to Brad Mook, Boenning and Scattergood.

Thank you.

I don't want to belabor the organic growth issue, Rudy, but you're pretty quantitatively minded and the numbers that you've given us over time have slowed from 40% plus to 30 to 40% net, 30 to 35%.

And it seems that the organic growth rate is in decline.

Do you agree with that and do you think that it's an issue that we should be concerned with on the outside looking in?

Yes, what is -- okay, so if I look at it in '04 from what I remember and I'm just -- let me give a little bit of history there.

I think '04 we were at 40%.

'05 we were at 36%, '06 we were at 41%.

Did I get those numbers right, Don?

You're close.

So '05 there was a little bit of a downward tick, upward tick.

At the start of the year we thought it was 29% to 32% was the number we were comfortable with.

We're running 30% to 35%.

We were 35% in Q1.

We don't feel it.

I don't feel like a slow down.

Now, we might be a little confused because the business is - no, it has doubled in the last five quarters.

So it feels like we're still going very, very fast.

But there is a level of lumpiness, even if you look at the -- kind of our -- if you look at our deferred revenue over the last, call it 15, 16 quarters, you will see a lumpiness in the growth rate.

You will see a lumpiness in the deferred revenue growth rate.

I look at Q2 to Q1 growth on deferred, it's up from 31.7 to 32, but the average number of months went from 3.7 down to 3.6.

So that's $1 million right there, that discrepancy.

The -- I just feel like it's movement.

I'm not feeling like it is a slow down in organic, in fact I'm feeling like it's really, really solid.

Because it could be -- the lumpiness that you mentioned is in fact the issue and as we look forward -- because you're not giving '08 guidance but we need to put '08 and '09 in models.

You could be reaching an inflection point, either you see the benefits of the BrassRing and some of the other stuff you're doing and the growth holds in the mid 30s range.

Or it could be that we've stepped down, now we're 30% and next we see 25% and that's a pretty important distinction.

So I thank you for your color on that.

No worries.

Go ahead.

The other question, how do you define market share?

You talk about taking share organically and I know you've painted a broader picture in the past with market growth being 20% and your growth being 30%.

But market growth is kind of a vague categorization given that it depends what it includes and how it's measured.

So is that your primary indication that you're gaining share or are there other metrics that you're using?

Great question.

The way we look at it is we say ID -- we basically go back to what the analysts tell us - or the industry analysts tell us.

So IDC is saying 17.4 is their projected number.

We're accepting that as gospel.

It's -- we're at almost -- 1.8 to 2 times their growth, therefore we're gaining market share.

That's on an apples basis?

Yes.

It's apples and apples.

Okay.

All right.

Thanks very much, guys.

We'll go next to Robert Schwartz, Jeffries.

Thanks so much for taking my question.

You gave some detail on the call, Rudy, about cross sales BrassRing internally.

Maybe you -- would you kind of describe what you're doing in terms of your programs and were some of these sales initiated by customers and how you're working that into your sales cycles.

So, let me answer the first -- the last question first.

The sales cycle has definitely increased with the BrassRing application.

And I know in the prior call one of the things that has also increased and we mentioned this the last time is the duration to implementation.

If you look at kind of legacy Kenexa, our implementation cycle, let's call it four to six months.

If you look at the BrassRing application, on average, even though we can install it in -- within a month, month and a half, because of the complexity of a lot of these deals, like you take a BP Amoco with 80 -- I think 80 countries and whatever, somewhat 16 or 14 languages.

That will take us 11 months to install.

So when you -- if you increase in your modeling if you increase the implementation cycle then you're going to run into a situation where your subscription revenue will slow down a little bit before it kind of gets back to the norm level.

So, that's kind of -- I don't know if that's the color you were looking for.

Am I answering your question?

I'm not sure I did.

You answered an interesting.

I probably should ask it differently.

For -- you gave some examples in applicant tracking where people had switched from old --

Ah, switches.

Okay.

Sorry about that.

Wondering -- I'm wondering was that an issue -- were those initiated by the customer?

Is that -- is there a plan out with the sales force to present BrassRing as an alternative for you and how does that affect your model?

Okay.

So I thought I'd answered your second half of the question, but clearly I misunderstood.

Yes, the first half, as far as the sales force goes and as far as the switching goes, there is a plan -- we've introduced a new job family at Kenexa that would call CRD, it's a client relationship directors.

We have about 12 to 14 CRDs and this is a client ombudsman within Kenexa.

They're really on our payroll, but they're really are, in their minds and in the clients minds, employees of the clients where their job is to make sure that Kenexa in its entirety is doing the best possible job in terms of teaching the client, in terms of helping them understand the advantages of the partnership with Kenexa and being their voice and their eyes and ears.

And this job family spends a lot of time physically on location with our clients and they are the ones who turn around and make recommendations as to where, within the customer, or who within the customer we should get together with to enhance the partnership.

And so that's how we're seeing this up tick take place.

Okay.

Now that you have more exposure internationally, a lot of companies are reporting relative strengthening demand in Europe to the US as being better.

I'm wondering if you're seeing -- through you're new to Europe, a surprise in the amount of demand you're seeing for your services.

Yes, it's -- I think we told the street, I think last year, that it would take us a couple of years to get to kind of the high teens, 20% mark.

And we're running at 13 based on currency already.

So, yes, we are pleasantly surprised.

Great.

And how much of your business is influenced by your partners, third parties, system integrators.

Very, very little.

I'd say we've picked up less than -- I would say we've picked up less than $600,000 in recognized revenue through partners.

Am I right with that number, Don?

Yes.

Yes, less than 2%.

Okay.

Last question, if I may, for Don.

You mentioned that you're hedged in the rupee through Q3, does that mean that you're unhedged and therefore face higher R&D expenses in Q4?

Yes, but we'll be looking at rehedging and based on our - what we think our expectations are on that currency versus the dollar.

So but if you look at what our spend there is in India, it's not a significant piece of our total spend.

Okay.

Thank you so much for answering my questions.

We'll go next to Nate Swanson, ThinkEquity Partners.

Oh, hi.

Performance management seems to be the fastest growing area of account management.

Can you talk about what you're seeing there and maybe quantify your growth rate or the number of new deals you signed this quarter?

Yes, we talked about kind of -- we look at it from a hiring or potential perspective and then we don't break down customers kind of -- we don't give data points of growth on the hiring side between ATS, Selector, Prove It!

or what have you and we don't do the same thing on the performance management side as well.

But if we look at total revenue growth for this year -- for this quarter, I would say we're probably 70% on the hiring and 30% on the retention.

Which has been pretty consistent for us over the last, I want to call it six to eight quarters.

Okay 70% in terms of growth or as a percentage of revenues?

Percentage of new revenues.

70% came in through hiring and 30% through retention.

Okay.

And if you broke that out on a growth rate, how would that compare?

It's about the same.

So I guess if you look at it from -- we -- I don't know the numbers from an organic growth rate by half, so I don't think we've ever looked at that data.

Okay.

So, Don, do you know?

No.

Okay.

And then I guess, just going back to your organic growth rate, if you were to break out the BrassRing revenues, in terms of bookings of revenues, would those be growing faster, slower than your organic growth rate or just can you talk about the overall, what you're seeing?

Well, as Rudy explained, as the BrassRing revenues are coming from the larger clients that have a longer implementation period.

So far the revenue from Kenexa Recruiter BrassRing has been fairly flat.

So we expect, as we get into the periods where we are doing the implementation that it will grow at that same pace as the regular Kenexa revenues.

Okay.

Thank you.

We'll go next to Chris Rowen, Soleil Securities.

Thanks.

Two questions.

First is housekeeping, the Straight Source revenue, was all of that hitting the other revenue or does some of that hit subscription revenue?

And if so what percent roughly?

And then secondly, I believe you said 18 months implementation at BP, for a BP level client and I think some of your competitors are quoting a much faster implementation time than that.

Do you feel like you guys are roughly in the ballpark of your competitors for large BrassRing type implementations or are there areas where you can accelerate?

Just to answer the question there, sorry, I must have had some noise in the background, I said BP is running about 11 months.

Not 18 months.

Okay.

But even so, I think that's above what we're hearing from some competitors.

Yes, but that was one illustration -- okay, I mean -- our mean runs between nine and 12 on the BrassRing app.

Like I said, we can do it in one month to two, but it depends on the complexity of the client.

We've done some in three, but --

Okay.

And the Straight Source subscription revenue is approximately 70%, slightly below what Kenexa subscription revenue is as a percentage.

Okay, great.

That's helpful.

Thank you.

That's all the time we have for questions.

I'll turn the conference back over to Mr.

Rudy Karsan for any additional or closing remarks.

I'd just like to thank the street again like for the support they've given us and our customers and our employees.

We've had a quarter we're pretty proud of and we're looking forward to the balance of the year in a very positive manner.

Have a good one.

Take care, bye-bye now.

That concludes today's conference.

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