International Business Machines Corp (IBM) 2007 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

Thank you for standing by.

Welcome to the Kenexa Third Quarter 2007 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.

Instructions will be provided at that time for you to queue up for questions.

I would like to remind everyone that this conference is being recorded and would now like to turn the conference over to Don Volk, Kenexa Chief Executive Officer.

Please go ahead.

Thank you, Chris.

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

We will also provide guidance for the fourth quarter, update our full year 2007 outlook and then provide high level thoughts as it relates to 2008.

We will then 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 current 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 Office, Rudy Karsan.

Thanks, Don, and thanks to all of you for joining us on the call as we review our third quarter financial results.

As we shared in our press release, we were pleased that Kenexa was able to meet our non-GAAP EPS guidance in spite of the fact that revenue came in light during the quarter.

Our top line performance was impacted by a single contract with the customer that faced the Company's specific business issue in addition to longer sales cycles in the EPO and assessments component of our business.

While we have readjusted our 2007 forecast as a result of these factors, we remain confident in the underlying growth profile of the Company as we approach 2008, based on Kenexa's differentiated value proposition, significant number of new customers adopting our solutions, growing brand and high profile customer wins across both the hiring and retention segments of the talent management market.

This confidence is evidenced by our preliminary 2008 forecast of low to mid-20% revenue growth, non-GAAP operating margins of 20% plus and strong cash flow.

We are very confident that our management team and global organization will effectively work through the challenges in front of us.

Our expectation is that Kenexa will continue to grow at a rate materially in excess of the market and we've always said that even during challenging times we will do our best to product and grow our profitability.

Our guidance for 2007 and 2008 is reflective of both these factors.

Taking a look at the numbers for the third quarter, our total revenue came in at $46.8 million, an increase of 67% year over year.

If we were to subtract the revenue run rate of companies acquired in the past year from our third quarter revenue, we estimate that Kenexa's organic revenue growth would have been in the neighborhood of 25% on a year over year basis.

Subscription revenue came in at $38.2 million, an increase of approximately 65% on a year over year basis, and up 3% on a sequential basis.

The strong year over year growth in subscription revenue was driven primarily by continued strong bookings across all our key product categories and the inclusion of the results on the Brass Ring acquisition beginning in the fourth quarter of 2006.

From a profitability perspective, we generated record non-GAAP operating income of $10 million, representing an operating margin of 21%.

Non-GAAP EPS was $0.33 in the quarter, in line with our guidance of $0.31 to $0.33.

Our high level of operating profitability was a primary driver to our strong cash flow in the quarter.

We generated another $10.8 million in cash flow from operations during the third quarter, bringing our year to date total to approximately $23 million, which is up over 100% on a year over year basis.

We believe that Kenexa is unique from a perspective that it is generating year over year revenue growth which is well above the market average while also delivering best in class profitability margins with strong cash flow.

We currently expect each of these characteristics to continue as we head into 2008.

We continue to see growing awareness of the business benefits associated with talent management solutions.

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 the pressures on the HR department to minimize costs.

These were key themes that we heard from HR professionals at the recently hosted HR tech show which many Wall Street professionals attended.

In addition, at the end of our third quarter we hosted our annual user's group conference for our customers to share best practices amongst one another, in addition to the value that they're generating from the use of Kenexa solutions.

There were more than 350 attendees at the conference, including presentations from senior HR executives that are customers such at Tyco, CitiGroup, Wachovia, IKEA, Glaxo Smith Klein, Beecham, United Health Group, [Cont] Beverages, and Philips among others.

An example of the discussions included one of the largest financial institutions in the world sharing that they decreased tele turn over by 45% in just six months from using our online assessment tools, at the same time increasing customer satisfaction.

In addition, one of our customers leveraged Kenexa's software content services total solution to better identify high quality sales professionals.

The end result, hiring only those candidates scoring above 50% on Kenexa's evaluation would lead to over $44 million in incremental revenues.

These are tremendous returns and customers of all sizes and across all verticals are looking for ways to improve the quality and productivity of their organization.

We were very pleased with the positive turn from customers at our user's conference as well as with the continued level of customer interest in our solutions.

I'd like to touch on the areas that negatively impacted our overall performance in the quarter.

The first area relates to large customer contract.

An [off-shore] component of the Kenexa's overall value proposition is providing not only the technology solutions needed to automate a customer's talent management needs, but also providing the ability for customers to outsource the entire recruitment process.

We refer to this as the EPO portion of our business and it is approximately 15% to 20% of our overall revenue.

While EPO is the smallest component to our overall business, it is highly strategic because it provides Kenexa with domain expertise that no other provider of on demand software solutions can match.

For example, it's only because we manage the recruitment process of a portion of our customers that we know first hand what pains our customers are going through, where improvements can be made and where opportunities lie.

For the most part, EPO deals are multi-million dollar, multi-year arrangements.

One of the primary reasons we adjusted our full year revenue forecast is related to one of our larger EPO customers.

By contract, we cannot share the customer's name, but they are not in a sector that is sensitive to economic cycles as they are in the health care vertical.

This customer encountered Company specific issues that have been publicly disclosed and which eliminated the need of Kenexa's outsourced services.

They continue to use a subscription based talent management solutions, but given their circumstances we relieve them from their committed EPO obligation.

This was the right thing to do.

However, from a short term perspective, it impacted our third quarter revenue performance and it will impact our full year 2007 revenue by approximately $3 million.

As I mentioned up front, we have also seen longer sales cycles associated with the EPO portion of our business.

This is not a high volume business so a small handful of deals can make a huge difference.

That said, certain companies that we were targeting for EPO deals have been rethinking the global allocation of their workforce and what their best recruiting outsourcing strategy might be as a result.

There are certain things that we can do better position Kenexa on a long term perspective, including optimizing the use of our low cost, global execution capabilities and we believe these issues will work themselves out over the course of the next few quarters.

The two most important factors of Kenexa from an overall perspective are one, EPO is the smallest portion of our business, so the impact is limited to our overall business and two, most importantly, we continue to execute at the highest levels for our customers as evidenced by the fact that Kenexa was again ranked as the number one provider of end to end recruitment process outsourcing services by HRO Today magazine.

As long as this is the case, Kenexa will be okay from a long term perspective.

The final area that is a factor in our updated guidance for the year relates to our assessment solutions.

This is an area of our business in which we believe Kenexa has best in class solutions and industry leading domain expertise.

We have not seen any change in this regard, however we need to improve our day to day sales executions in the international markets in particular.

To help improve our performance and assessment, we made a management change in this area of our business to do exactly that.

It may take a quarter or two to realize the benefits of our changes, but we are confident that we will be successful based on our very strong market position in the assessments market.

The reason we remain optimistic about the Company's overall outlook is that our business tied to a broad range of technology based total solutions, which is the strong majority of our business at approximately 80% to 85% of our revenue, continues to be quite robust from an overall perspective.

During the quarter, we again added over 40 preferred partner customers, which is an increase of over 30% compared to over 30 new preferred partners announced in the third quarter of 2006.

On the hiring side, we completed business with customers such as Walgreen's, Rolls Royce, First Data, Tischman Spire, Seymans, America Signature and a high profile not profit foundation.

On the retention side, we completed business with customers such as General Motors, Hershey, Circuit City, Deutsche Post, [Bechtel] and Prime Therapeutics.

During 2007, we have not only seen a significant increase in the number of customers adopting Kenexa solutions, but we have also seen a significant increase in the number of large global organizations within that mix.

We believe this is a result of Kenexa having more ways to penetrate the largest organizations in the world, compared to our competitors that had much narrower value propositions.

The acquisition of Brass Ring last year instantly made Kenexa a primary vendor of choice at the high end of the market when it was an area that we previously did not target.

We continue to win new customers with our recruiter Brass Ring solution with First Data joining other customers such as British Petroleum, Volvo and Network Appliance that we have highlighted on previous calls.

In addition, our recruiter Brass Ring solution provides a high end global solution for our existing customer base to upgrade to as a seat to expand the talent acquisition deployment on a global basis requiring the support of multiple languages.

During the third quarter we saw Tischman Spire upgraded from Kenexa's recruiter applications to recruiter Brass Ring following the direction such as CBS and Air Products in the prior quarter.

In addition to winning new business, we remain very focused on delivering world class service levels to the existing Kenexa recruiter Brass Ring customer base and we believe our success in doing so is highlighted by several facts.

First our renewal rates with KRB customers has been in the upper 90% in the close to one year that we have had them as a part of Kenexa.

Second, customer satisfaction can be seen when companies are coming back and purchasing additional solutions and we've been quite pleased with the level of cross selling of our other products and services, such as assessments and outsource recruiting among others.

Customers such as Conagra, Rolls Royce, Abbott Labs, and [Ofviar] are examples of KRB customers that have expanded their relationship with Kenexa following the acquisition.

We're working hard to continue earning our customers business and in the third quarter we successfully released Kenexa recruiter Brass Ring 10, this latest release includes over 30 functional enhancements that supports the needs of job candidates, hiring managers, staffing contingencies and corporate recruiters.

In addition to receiving customer feedback that goes into all of our product releases, our Kenexa recruiter Brass Ring client advisory counsel, which includes Fortune 50 and Global 100 companies, has been instrumental to the success of our integration, has then provided feedback and guidance while maintaining constant communication with Kenexa.

We are very appreciative to them and value their commitment and partnership.

High quality customers, such as I just cited, provide ample opportunity for Kenexa to expand our presence over time as we prove our value, which is evidenced by consistent and solid growth in our PQ metrics.

This metric increased at [tier] level that is approaching $1.2 million in the third quarter and we are on track to reach the high end of our 30% to 50% growth target from the $800,000 level we delivered in 2006.

During the third quarter, we also continued to deepen the global capabilities of our end to end suite of solutions with the tuck in acquisition of HRC in Germany.

In addition to further extending Kenexa lead in proprietary content, HRC provided Kenexa with a direct presence in Germany and an additional region to mainland Europe.

We are focused on replicating Kenexa's domestic leadership position throughout the world and we're making the necessary investments to do so.

We have already made product investments including language support and product localization in 12 countries, via our acquisition of Brass Ring, in addition to proprietary content in regions such as the U.K.

and Germany.

In addition to obtaining a direct presence in Germany during the third quarter, we also recently opened an office in Melbourne Australia, building our existing presence in this Asia pacific region.

In summary, while we have revised our forecast for the year, we're confident that our businesses remains well positioned for growth and profitability moving forward.

The underlying health of the talent management market and our outlook remain robust.

We continue to gain market share and are optimistic about our outlook for 2008 and beyond.

I have said many times that we believe the talent management market is growing somewhere in the mid-teens range and our goal is to grow at materially above the market rate.

We're just beginning our planning for 2008, however on a very preliminary basis, we currently expect to deliver top line growth in the low mid to 20% range.

We also expect to continue delivering non-GAAP profitability margins that are in our best in class levels for the on demand industry with strong cash flow.

From a long term perspective we believe there will be a couple of very large companies to come out of the talent management market in the next three to five years.

Kenexa is differentiated by the breadth of our solutions across both hiring and retention, proprietary content, services and outsourcing capabilities.

And we believe Kenexa is well positioned to becoming one of those winners.

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

Thanks, Rudy.

I will now review our results for the third quarter of 2007.

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

Total revenue for the third quarter $46.8 million, an increase of 67% over last year and an increase of 4% on a sequential basis.

Within in total revenue, subscription revenue was $38.2 million, in line with our guidance and representing growth of 65% on a year over year basis and 3% sequentially.

At 82% of total revenue, subscription revenue is at the high end of our targeting mix of 78% to 82%.

The remaining $8.6 million of total revenue in the third quarter came from other and professional services, which increased 77% over last year and 5% 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 third quarter.

Looking at other key metrics, our clients typically purchase multi-year subscriptions with an average length of approximately two years and our diverse customer base continues to renew on the 90% plus range.

During the quarter, we again added over 40 preferred partners, demonstrating the solid momentum in our business.

The average annual revenue out of our top 80 customers, what we refer to as P-cubed, increased from $1.1 million during the quarter and is approaching the high end of our target for the year, which is $1.2 million.

That would be up from the $800,000 level at the end of 2006.

Turning to profitability, we will be providing non-GAAP measures for each third quarter 2007 expense category, which excludes stock based compensation charges associated with the implementation of FAS 123R, amortization of intangibles associated with previous transactions, one time consulting fees related to research and development credit carry backs and one time tax benefits of research and development carry backs.

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

Non-GAAP gross margin was 71% in the quarter, this was down approximately 1% from the prior quarter, but within our long-term target of gross margins in the low 70% range.

Looking at operating expenses, non-GAAP sales and marketing came in at $8.5 million, or 18% of revenue, a slight decrease in absolute dollars on a sequential basis.

Non-GAAP G&A expenses were approximately $8.9 million, or 19% of the revenue, also representing a slight decrease in absolute dollars on a sequential basis.

Finally, non-GAAP R&D expense came in at $4.5 million, or 9.7% of revenue.

As a percentage of revenue, R&D was in line with the prior quarter.

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

The combination of growing revenue and focus on optimizing the efficiency of our global operations led to record non-GAAP income from operations of $10 million for the third quarter.

This represented an increase of 81% on a year over year basis and a quarterly operating margin of 21%.

During the third quarter our non-GAAP tax rate for reporting purposes was 23%.

Resulting in non-GAAP net income of $8.6 million, an increase of 75% compared to a year ago when our tax rate was 1% lower at 22%.

Based on 25.9 million diluted shares outstanding for the quarter, we generated non-GAAP diluted EPS of $0.33, which was at the high end of our $0.31 to $0.33 guidance and a year over year increase of 38%.

This 7% decrease in our tax rate, quarter over quarter, accounted for $0.02 to the bottom line.

Turning to our results on a GAAP basis, which include $1.2 million related to the allocation of stock-based compensation, and $1 million related to the amortization of intangibles associated with previous acquisitions, the following were expense levels determined in accordance with GAAP.

Costs of goods sold, $13.7 million.

Sales and marketing, $8.8 million.

R&D, $4.7 million, and G&A, $9.6 million.

Our GAAP net income included a one time benefit from research and development credits carried back to prior years in the amount of $822,000, which accounted for a one time benefit to our GAAP EPS of $0.03 per share.

We do not recognize this benefit in our non-GAAP results to be clear, this was only to our GAAP results.

For the third quarter, our GAAP income from operations was $7.7 million or a margin of 16%.

For the September quarter, the GAAP net income applicable to common shareholders was $7.1 million, resulting in GAAP diluted EPS of $0.27.

A reconciliation of GAAP to non-GAAP expenses and in -- excuse me, and income from our operations can be found in our press release and current report on form 8K filed with the SEC.

We ended the quarter with a strong balance sheet.

Cash and investments were $113.8 million at September 30, 2007, an increase from $108.5 million at the end of the prior quarter.

The increase in cash was primarily a result of positive cash from operations offset b capital expenditures and acquisition related payments.

During the third quarter, our cash flow from operations was $10.8 million, a significant increase compared to $6 million in the prior quarter.

On a year to date basis, Kenexa has generated approximately $23 million in cash flow from operations, more than double the $11.1 million we generated in the first nine 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 Brass Ring acquisition and solid momentum in our business.

Accounts receivable adjusted DSOs were 60 days, compared to 66 days at the end of the prior quarter and 54 days at the end of the year ago quarter.

Our deferred revenue at the end of the quarter was $33.3 million, an increase of approximately 77% on a year over year basis and 4% over the previous quarter.

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

For the full year 2007 we expect the following -- total revenue of $181.5 million to $182.5 million, subscription revenue to be $147.7 million to $148.5 million.

Non-GAAP operating income of $37.5 million to $37.9 million.

Assuming a 28% tax rate for reporting purposes, and a 20 -- and 25.7 million shares outstanding, we expect our diluted non-GAAP EPS to be $1.14 to $1.15.

For the fourth quarter of 2007 we expect the following -- revenue to be $47.3 million to $48.3 million.

Subscription revenue to be $37.8 million to $38.6 million.

Non-GAAP income from operations to be $10.2 million to $10.6 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 $0.30 to $0.31.

In summary, a couple of factors impacted our third quarter revenue, but we were still able to meet our profitability target while delivering strong cash flow.

As we look to 2008, we remain optimistic about our outlook, which is reflected by our current expectation of growth in the low to mid 20% range, complimented by non-GAAP operating margins that are 20% plus.

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

Chris?

Thank you.

(OPERATOR INSTRUCTIONS).

We'll go first to Brendan Barnicle with Pacific Crest Securities.

If you think about Q4 and you think about the deferred revenue, typically we see a seasonal up tick there, it looks like deferred revenues followed the typical seasonal pattern, based on the lowered guidance, what do you think in terms of directionally -- what deferred revenue should look like based on sort of -- based on historically?

Well, Brendan, historically the deferred revenue spikes in Q4.

At this point we see no reason why it shouldn't follow historical patterns.

So there's nothing with this change in the guidance that would impact that longer term piece of business?

I don't believe so, Brendan, because the flushing of the budgets should continue.

Bear in mind that these are ad hoc payments on the part of customers.

So it's almost impossible for us to predict on that.

We're usually pleasantly surprised in the last, call it two to four week - or two to three weeks of the quarter that the budget flush starts to occur at.

And sometimes as close as the last two or three days of the year.

Okay.

And as I look at the beginnings of the '08 guidance, it would look like the subscription revenue would suggest a sequential improvement as we get into Q1 of next year off the sort of flat this quarter too, Q3 to Q4.

What gives you confidence that we see that sort of reacceleration.

Well, our pipeline is very, very strong, as I mentioned the bookings have -- are very good.

If you kind of just take a step back from a look at our numbers at the highest level, you'll see that we came in line on the subs.

You could say the majority of our shortfall has been in the other.

So the subs have continue to maintain strong, if the other catches up we should start to see this thing move back again to historical numbers.

And then just broadly, as you look out to '08, we're a ways out, how much of visibility do you have not in '08 in terms of that 20% to 25% for that -- mid-20% to low 20% growth you're talking about.

Is that - do you have 60%, 70% visibility into those numbers, can you give us any sense on that?

We have decent visibility on those numbers, but you've got to remember a few things, one is if you just look at the bookings in the backlog, it's gone up.

Our backlog has increased in Q3, our bookings climbed quite significantly.

The quality of the customers that we mentioned, the markets growing and the one kind of wild card to keep at the back of your mind is, if you remember when we did the Brass Ring transaction, we talked about six to nine month selling cycles, a couple of months for implementation, the sales on the Brass Ring application would start to hit in '08.

So we're seeing a good amount of visibility come out of that.

Great.

I'll hand it over to someone else.

Thanks.

We'll go next to Bryan Magrath with Credit Suisse.

Hey, guys.

Thanks for taking my questions.

It was in last quarter, I think we were talking about, or you guys mentioned organic growth in the range of 30% to 35% and of course it was down this quarter and I was wondering, is it all specific to the one customer in the health care industry that you talked about, or were there any changes kind of to the overall market that maybe you guys experienced and could talk to us about.

Just to break down the three things that we mentioned, right?

We said we'd lost a large customer, $3 million -- so it's about $1.5 million.

If we got that we would have been within our guidance and in that 30% range.

So that alone kind of takes us into the range.

Right.

The second thing is we said that in the EPO business the sales cycles had expanded, primarily due to the global restructuring and reformatting of our clients.

And then the third is that the assessment situation in Europe that we said we would correct.

So if you add kind of all three components then you would see our organic growth to be well over 30%.

Most of which are not market issues, most of which are Kenexa issues.

Okay, fair enough.

And with regard to I guess your preliminary revenue guidance next year, have you made any changes to your assumptions of renewal rates?

No, we expect our renewal rates to remain in the 90% plus range.

All right.

Thank you.

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

Hi, guys.

Can you go into a little more detail?

I don't know what happened with the deal, the EPO deal that didn't happen.

I think a lot of people take a lot of comfort in the subscription model and that we shouldn't get a surprise like this.

So if you can go into a little more detail and tell us what happened and what other piece of the business are at risk for something like this, that'd be great.

Thank you.

Okay, so if you look at the EP of the contract that was cancelled, it was a large healthcare Company, not economically sensitive market.

They had Company specific issues, the came and talked to us, the bodies that we have in there, they asked to get relieved of the responsibility.

We felt that was the right thing, so we went ahead and did that.

If you notice, the miss did not take place in the subscription portion of the guidance.

Subscription portion of the guidance came in line, even though part of this miss was subscription related.

Now, the other thing that we build in to our guidance is we make estimate on when the sales are going to close and when we're going to start recognizing revenue.

On the assessment business, all the revenue assumptions that were made were made on the basis that the consulting arrangements would close during the quarter and they didn't.

Similarly, on the EPO, we were expecting - bearing in mind that we only have about a dozen customers, so you can get a sale every two quarters, you make an assumption on a close which didn't happen.

So the combination of those three things forced the - or made us miss on the total revenue line but not on the subscription line.

Does that mean that if you had booked that deal you would have implemented all the consulting in that quarter?

A good portion of it, yes.

Again, I go back to the math on it, you're $46.8 million, you add, call it $1.5 million, that takes you to $48.3 million, we're now within the range.

And the EPO miss, or a delay, call it $500,000 to $1 million, and then on the assessment side, call it $500,000 to $1 million, that takes you to the high end of the range.

Okay, on the competitive front, can you give us some color there?

Are you seeing any pressure at that HR tech conference?

I noticed Oracle and SAP were there, are they flexing any account control muscles?

Are the myriad of any smaller start ups getting any traction?

We haven't seen a lot of smaller activity from the smaller start ups as yet.

We don't expect that - a lot of smaller start ups are playing in that kind of mid market, in that SMD market that we don't play heavily in.

At the high end, this year so far, I think we've lost maybe two renewals to Oracle and SAP, maybe 3, in that range.

And I think we've gained one.

So it's a net loss of two.

We are - what we are seeing is they're offering that ad for free and our value proposition is if you include the implementation costs and include the total costs of ownership to PCO, we're still further ahead with better feature functionalities, ability and the like.

And generally that is winning.

The one thing that is unusual that we've noticed in the last one or two quarters is in the RFP process we have seen more of Oracle than SAP than probably the preceding three years combined.

I think we've seen them like four or five times.

Which says to me that the Oracle and the SAP shops that automatically had the business in the past or automatically lost it, clients are now bidding that out even though it exists as an ERP.

Okay.

Thank you.

You're welcome.

And we'll go next to Laura Lederman with William Blair.

Yes, could you talk a little bit about - could there be any economic impact in this, in other words Brass Ring, could that partly be economy.

And also separately, some other competitors in this space seem to be doing well.

So do any sense of maybe market share shifts a little bit to [layogony] maybe a little bit more competitive.

So maybe some other thoughts on what's happening in the recruiting space besides seeing more Oracle and SAP.

So, if I break out our business between the ATS, the testing act, career tracker, and our employee engagement surveys, all those apps primarily that are sitting in the subs portion of our revenue have been growing well.

So we are meeting the competition and continuing to growth the business.

Along the way we told the street at the start of the year, that the Brass Ring add would add a minimum amount of revenue, additional revenue in 2007, because of the way that we were recognizing the revenue.

We are getting the closes, we had a really good quarter in terms of closes on the Brass Ring app during the Q3 of 2007 and we're expecting to reap the benefits of that in 2008.

Now, the shortfall is on the other revenue.

Primarily driven from a) the cancellation of that one big contract.

That would have taken us to 30% or slightly north of 30% organic growth rate, you throw in the other two consulting pieces and go through the math and you would have found that organic growth would have been in that 30% plus range, which I think would be the same as any of our other competitors.

With a full - with the full Brass Ring being more or less level for calendar year 2007.

What about any impact at all from the U.S.

economy on anything in terms of what you're seeing particularly out of the financial services market because that's certain a question that's on the mind of investors.

Yes, we do have clients in the financial services market.

We have not seen significant down grades of any part of our business due to the financial factor, as of now.

Another related questions is, the assessments business has always been - I hate to say the rock of Gibraltar, but a really strong business.

What's different in Europe?

Is it your acquisitions?

What went wrong there?

Because it seems like a lot of execution issues are happening at the same time and I guess we're trying to go to a higher level issue of execution issues and not signing the EPO client you thought, the assessment in Europe.

So, I was wondering, maybe, was the acquisition too much and it led to a little bit of loss of focus somewhere.

I'm trying to understand the genesis of some of the issues.

It's an issue that we have been struggling with internally too as we've tried to put - to try and get a better handle of our business.

We did make that assessment decision and said, yes, we need to strengthen the management over there.

We have been adding talent within Kenexa.

Totally we are growing pretty dramatically.

One of the questions we're asking ourselves is this normal growing pain, or is it just a perfect storm in our other revenue pool because if everything kind of kits simultaneously is that what caused this?

And the answer is, I guess the way we're looking at it is we're saying, okay, we know what we know, we know what the numbers are, we know here are the three issues that we need to tackle.

The first one we could not control at all.

The second one, we brought about personnel change.

The third one will continue to mirror the market, understand where they're heading, and continue to build that global footprint to be able to follow our clients.

So, given that most of the revenue shortfall, for lack of a better word occurred in the other bucket, the question I guess we've got to ask ourselves is can we do better on the services side, and the answer is obviously yes and we need to strengthen that.

All right.

I'll pass the baton and let someone else run with it.

Thank you.

Thanks, Laura.

And we'll go next to Patrick Walravens with JMP Securities.

Oh great, thank you.

I guess two questions.

First of all, just - so what was the renewal rate in the quarter?

It was 90% plus.

It still was, even with the EPO contract falling off.

And then I guess -

Patrick.

Yes.

So you know that we calculate our renewal rates so they're comparable to other companies in the space and we calculate that based on our product renewals.

Okay.

So that - so the EPO things aren't in there.

Yes, totally been the case that way, Pat.

Okay.

Okay.

And then I guess my second question would be just so that we can sort of get a feel for how much risk is left from the EPO area.

How many EPO contracts did you have at the beginning of the year and how many do you have now?

I think the number we have used - I don't know the exact number, so I can't answer that question, but if I recollect for 2007 we've been saying we've had about a dozen contract, so given that we've lost one, we've probably gained, two - we lost one, we did renew one one at the start of the year, so I think we have the same number of contracts left.

Okay and how much risk do you think there is in those remaining dozen contracts as we go into '08?

The one contract that cant - there's two components to the way we're looking at the risk, the first component is who or what doesn't renew next year or who or what arbitrary canceled because of their own personal situation or their own Company specific situation and then two how many sales do we get or we don't get for next year.

As we are thinking about it, we haven't made any assumptions for what we considered to be the dramatic event that happened this quarter.

We have built a nothing into our forecasts assuming that.

We've also built into the forecast minimal to no sales for the first half of next year.

So we are basically going to continue with the business that we currently have on hand.

Okay.

And you feel like that's -- you know, Rudy, this is the part of your business I worry about the most.

Right?

Yes, I know that --

Yes.

That's why I'm giving so -- if you look at the business itself though, if you assume that there is 15% to 20% of our business is EPO, then the 80% to 85% is basically where we're building most of our growth into.

Yes, so you feel like you've set a sufficiently conservative bar for next year though.

No, I don't want to say that, no.

No?

I'm just going to say, as of now, based on information that we have and based on our pipeline, our bookings and our backlog, in November of 2007, we feel comfortable calling out a number in the low to mid-20s, top line, profitability in the 20% range.

I think the right word is what, Don -- 20% plus range, without committing to one, two, three, four -- whatever that number you want to put after two is.

Okay, that's fair enough.

Thank you.

You're welcome.

And we'll go next to Richard Davis of Needham and Company.

Hey, thanks.

With regard to the EPO business, is that greater, equal to or less than in terms of corporate margins - in terms of margins of the business.

Or is it hard to say, does it depend by a project?

You're looking at the total profitability of the EPO business is slightly - I don't know.

Don, do you know?

No.

it's hard to measure for us because we wrap in with our EPO customers, we wrap in the product, at times, and applicant tracking and we don't particularly break out between the profits on the applicant tracking and the EPO hiring business.

Right.

So therefore it wouldn't - but it wouldn't be an illogical conclusion to say that its close, it's not like miles away either materially higher or materially lower.

Is that a fair statement?

Don't know.

Okay.

That's fine.

And then, I don't think this is an issue, because I've actually talked to corporate buyers about this, but have you seen it be - have you lost any deals due to the fact that you have a handful of platforms that over time you're going to migrate together, but have you seen any kind of push back on that at all?

I have not heard it form customers, but I wanted to hear from you guys if you've seen that.

I can categorically say to the best of my knowledge we've had zero sub situations.

Got it.

And then the last question would be, in term of - because some of the companies that we've talked to actually saw a fair number of just non-competitive deals in the sense that they were competing with either in-house or file cabinets and things like that.

Have you - has there been any change in the percentage of deals that are competitive for you or do you still see a bit of white space or is every deal highly competitive?

No, we do see white space.

That's what I figured.

Okay.

That's what I needed, thanks so much.

You're welcome.

And we'll go next to Robert Schwartz, Jefferies and Company.

Thanks so much.

I was wondering in the guidance that you've given for Q4 and your comments about '08, did you make any other changes in your assumptions about close rates in your subscription business.

And what do you - in the EPO, we talk about stretching out, can you talk a little bit about what's going on with your customers that they're rethinking their decisions that would lead you to assume zero closes going over the next year to six months?

You can answer the first half.

I'll answer the first one, Rob, is that we made our guidance for Q4 and for 2008 based on our bookings, our pipeline and our contracted revenues and our renewals at our traditional 90% and Rudy, you can take the second part.

The second part is that what we are seeing is customers looking to redeploy their workforce globally.

So what we are - what we were seeing in the past was a fairly geographically limited type of use.

In the U.S.

we would see U.S.

deals, in England we would see England deals and on the continent we'd see continent deals.

Now, what we are seeing customers come up with is these global views by either a business unit or a job family.

And in those kinds of situations they're looking for a global vendor or a global partner.

We haven't seen a lot of - if any of those deals close.

So the reason we've delayed it is we're not sure whether the customers are going to go back to the way business was in early 2007 and 2006, which is geographically distributed or whether they're go into continue pushing their vendors for a full global footprint.

Given that uncertainty, we've slowed down in terms of making it - a lot of assumptions for 2008, first half.

That's helpful.

Why did your CapEx jump in the quarter?

Well as you know, we're building a building in [Bisak] in India and we made some payments on that building.

We expect that building to be finished sometime in the first quarter of 2008.

Okay.

And then, last quarter, you made some comments about the rupee and your hedging and that you were hedged through Q3.

Are you facing currency risks or how have you built in repeated appreciation for Q4 and beyond?

We've also hedged through now the end of 2008.

Okay.

Last quarter you said you saw some good cross selling of multiple products, but not much cross selling of the EPS, the performance management.

Was there any change in that?

No.

Okay.

And the last question is, with the new hires taking place in Europe, when do you think you'll see a pickup in the assessment.

Is it something that could happen in the first half or something you're planning on in the second half of the year?

Second half.

Okay.

Thank you so much.

You're welcome.

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

Yes, thanks.

Rudy, if you basically have shown willingness to release some of your EPO customers from their sort of contractual obligations, then what gives you guys comfort that some of the other customers that are in the economically sensitive sectors of the economy are not going to turn around and sort of ask you to do the same?

That's a hell of a question, Andrey, because it's the one we debated internally at length.

And I guess usually these become judgment calls then.

In this situation it was dramatic enough with enough data coming our way to say yep, we are going to respond this way and yes, it's the right thing to do.

And there wasn't -- there was a lot of publicly available information that allowed us to make that information.

So Company X who -- or client Y, if they run into an identical situation and it happened in Q1, would we make the same call?

I can't answer the question because none of these situations are completely identical.

As a general rule of thumb, we're not in business of suing our customers.

So if they come in and say to collect you're going to have to sue us, I don't know how to answer that question because we haven't really -- we have made sure that we don't get into those kind of situations.

Okay.

And then, directionally, what are [our magnate] how many EPO contract renewals are you guys going to have the next year?

We have three coming up next year, Don?

Yes, three.

Okay.

And then, I guess lastly, if I look at your guidance you are up for Q4, you are forecasting roughly flat subscription revenue and then up tick in the other revenue category.

Can you take us through the dynamic, I mean directionally sort of one of consulting revenue, Q4 is not necessarily a good quarter for that.

Well, certain of our revenues in Q3, because we didn't - because of our cycle have pushed out.

So we expect them to be recognized in Q4.

We have certain bookings and pipeline that leads us to believe that we will hit those other revenue targets inQ4.

So is that the business that have been closed but not yet recognized?

Or is it the business that still needs to be closed and will get recognized?

Part of both.

Okay.

Thank you.

And we'll go next to Mark Verbeck with Cantor Fitzgerald.

Hi, thanks for taking my question.

On this contract that was lost, is all the revenue in this other line, even though they had a contract?

No.

Okay.

Part of it was in subscription and part of it is in other.

And about, how would that break out percentage wise?

About 60%-40%.

Okay, and what determines which buck that it goes into?

If it's consulting material on a timely materials basis, or if its rewards for special performance it goes into other and if it's a subscription, where the customer pays us on a monthly subscription basis it goes into subscription.

Okay, that's helpful.

Then, another question.

If we look at the sequential impact, did you take a full quarter hit for that contract in Q3 so that there's no sequential impact to Q4?

Can you characterize that situation?

There will be some sequential hit in Q4.

I don't know the exact numbers, I don't have them in front of me.

Don, I don't know if you remember them or not.

But we're saying it's total of -- call it $3 million, so it might be like $1.35 million and $1.65 million or something to that effect.

Not sure of the exact numbers.

Don, do you have any more color on that?

I'm estimated at $1.5 million and $1.5 million.

So, Don, you're saying the same in each quarter, there's no incremental amount?

Its an incremental amount but it come through into other so that we're not predicting that or saying that we lost $3 million that we know of and then other consulting revenue that we probably would have gotten.

Okay.

I see.

Thanks a lot for the help.

And we'll go next to James Friedman with SIG.

Hi, thanks.

It's Jamie Friedman at Susquehanna.

Thanks for taking my questions.

So, Don, would you happen to have a current headcount number for the Company?

Approximately 1,300.

And can you remind us where that was in the Q2?

It was about the same.

For the EPO contract was the headcount on a timed materials basis associated with that headcount released or redeployed so it was utilized elsewhere?

Both.

So you, you did have some -

Some released, some were redeployed.

Okay.

Another housekeeping question, was there any foreign exchange impact in the quarter, Don?

Not material.

Okay.

And then my last question is, I was -- obviously trying like everyone else is to get to the numbers for Q4, is there any assumption and you may have said this and I missed it, with regard to other income for the Q4, Don?

Other income being below operating?

Yes.

Yes, we have interest income on our cash deposits, approximately $1 million.

Okay, because it seems like if you add in -- maybe I'm doing this wrong, but if you add in the $1 million of other income, it gets you above your guided EPS range.

And don't forget to take out taxes of 30%.

Okay, maybe I'll address this offline.

Thanks for taking my questions.

Okay, and just one more quick comment there, if I can add, is - just bear in mind that the growth is -- we're still looking in that low to mid-20 range, right?

For '08, and we're still expecting organic growth in '07 to be in the high 20s.

And so, in that -- if you're kind of thinking about it as you're modeling and comparing it to your market data, bear in mind that we're still what we think is materially above market, so we're gaining market share.

Okay, thank you.

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

Thank you.

A couple of questions, is it correct to assume - or did I interpret you correctly that the large healthcare customer with the EPO contract is still a software customer?

That is correct.

Okay.

And to clarify on Mark's question, the subscription revenue impact -- or the revenue impact from the deal in Q3, 60%-40%, was that 60% subscription?

Yes.

Okay.

And then lastly, Rudy, on your comments on the global deals and some of those deals not closing and not sure whether the customers are going to revert to their old behavior or push forward with this new behavior and taking a global perspective.

It seems a little odd that there would be a change across the customer base that quickly.

Is that true?

Is there actually a change going on in the greater customer dynamic or is that something specific to Kenexa and the way you're approaching the customer base that caused that change.

It's more of the latter because we don't get involved in the smaller deals.

We tend to stay focused in what we consider the K2500, the largest employers globally.

So, most of our deals - not all, but most, the majority of them are deployed in more than one country and sold at different locations that we have.

So that's the business we keep chasing and in that area we've seen a little bit of confusion.

So if there is a - for example, an employer with 1,000 employees that wishes to outsource 150 hires for a year, we're generally not playing a lot in that space.

Okay, so the shift has been across the same customer base and coincidentally at the same time?

We think so.

We're not sure on that, Brad, because if we had the data we would have shared it.

But at this point in time, bear in mind that the sample size is very tiny, we're talking about maybe a sale every quarter or three to four sales a year kind of a thing.

There's just not enough of a denominator for us to make a full blown assessment and be able to share it with the street.

Okay.

That's fair.

Thank you.

And we'll go next to Robert Breza, with RBC Capital Markets.

Hi, first let me apologize for the noise, but just want to clarify something I just heard you talk about.

You talked about organic high 20% growth rate, overall low 20% growth rate for the year.

I mean I guess - what gives you the confidence level here given the -- I guess what's included in the organic growth rate comment that you just made in the high 20's, relative to I guess what you just experienced you know in the current quarter, are we excluding certain things from that high 20% confidence statement, or kind of just help me reconcile those numbers.

Thanks.

So, basically, if you look at our year to date revenue and you subtract out -- I don't have the spreadsheet in front of me and we'd gladly talk off line on it, but if you subtract out on a quarter by quarter basis, the contribution of the revenues from the preceding year's same quarter by the acquisition companies and divide it by Kenexa's previous year's revenue, year to date, you would be in the high-20s.

I don't know whether that number is 27%, 28%, we know that in Q3 it was in the 25% range and in Q2 it was in the 32% range.

Right.

And in Q1 it was about the 30% range.

35%.

35% range.

That concludes the question and answer session today.

Mr.

Karsan, we'll turn the conference back over to you for additional closing remarks.

Thank you very much, Chris.

And just in summary I want to say while we know we have adjusted our 2007 outlook, we just want to remind the Street that for 2008 we're looking at growth in the low to mid-20s, we're looking at profitability in the 20% plus range and we're looking for increased growth in our markets.

So we do believe that these challenges we see, primarily believe are Kenexa related challenges should disappear in the second half -- I'm sorry the first half of next year where you should see the benefits of which would start to occur in the second half.

On that note, I thank everyone for joining the call and have a good evening.

This concludes today's conference, we do appreciate your participation.

You may now disconnect.