International Business Machines Corp (IBM) 2010 Q2 法說會逐字稿

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  • Operator

  • Greetings and welcome to the Kenexa Corporation second quarter 2010 earnings conference call.

  • At this time all participants are in a listen-only mode.

  • A brief question and answer session will follow the formal presentation.

  • (Operator Instructions).

  • As a reminder, this conference is being recorded.

  • It is now my pleasure to introduce your host, Mr.

  • Don Volk, CFO for Kenexa.

  • Thank you, Mr.

  • Volk.

  • You may begin.

  • Don Volk - CFO

  • Thank you, Manny.

  • With me is Rudy Karsan, our Chief Executive Officer, and Troy Kanter our President and Chief Operating Officer.

  • Today we will review Kenexa's second quarter 2010 results and provide guidance for the third quarter and full year 2010.

  • Then we will open up the call for questions.

  • Before we begin, let me remind you this presentation may contain forward-looking statements containing risks and uncertainties associated with the company's business..

  • These statements may contain, 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 factor that could cause Kenexa's performance to vary from current expectations are 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 is currently available on our company website, www.kenexa.com with the press release issued after the close of the market today.

  • I will now turn the call over to Rudy Karsan.

  • Rudy?

  • Rudy Karsan - CEO

  • Thanks, Doug.

  • And thanks to all of you for joining us on the call to review second quarter results which was highlighted by accelerated revenue growth, continued strong revenue in our deferred revenue, and cash from operations that materially exceeded our reported profitability.

  • The state of economic recovery remains uncertain, however our longer term confidence continues to grow.

  • Kenexa is competing for and winning opportunities with the growing number of the largest Global 5,000 organizations.

  • In addition, we believe our competitive position is growing stronger as a result of our technology innovation, and increased investments to raise awareness relative to Kenexa's unique end to end integrated HR value proposition.

  • As we will discuss in more detail in a moment, we are increasing our revenue outlook for the year, and we are continuing to invest in sales, R&D, and customer-facing professionals to position Kenex for market share gains as the economy and IT spending environment improve.

  • Taking a look at our results for the quarter, total revenue was $44.9 million, which was the high end of our guidance and represented a sequential increase of 13% and a year over year increase of 14%.

  • From profitability perspective, non-GAAP operating income came in at $3.8 million.

  • This is consistent with our expectations and reflected increased investment in sales and marketing that we have discussed on recent calls.

  • Deferred revenue, was again strong ending the quarter at $57.8 million which is up from $54.5 million at the end of the prior quarter and it was up 37% on a year over year basis.

  • We also generated $7.2 million in cash from operations bringing our first half total to $16 million, which is approximately double the company's non-GAAP operating profitability over the same time frame last year.

  • From a macro perspective, we believe the purchasing environment remains tighter than pre-recessionary levels.

  • That said, we have seen a slow but steady improvement in business conditions during the first half of 2010.

  • This can be seen in Kenexa's increased revenue run rate during the second quarter combined with the growth in our deferred revenue, and it is reflected in our increased revenue outlook for the year.

  • While recent trends in the market place are encouraging, we expect the pace of economic recovery to be choppy over the balance of this year as well as 2011.

  • Key economic reports continue to be mixed and the stock market remains volatile.

  • In addition we believe our Kenexa employee confidence index or ECI provides further data suggesting that the economic recovery the recovery will be choppy.

  • The Kenexa was ECI was 98.4 for the second quarter, which was a solid increase from the 95.6 reading in the first quarter though it was still slightly below the fourth quarter peak at 2009.

  • As we have discussed before, we found the ECI to be a good predictor of macroeconomic indicators.

  • And the variability in the ECI over the last six months is a good reflection of what we have seen in the global markets over this time.

  • While we are eager to see an improvement in the economic and hiring environments, we have said in the past we believed we only needed the hiring environment to stabilize for Kenexa's revenue to return to growth.

  • The unemployment rate remains relatively high near a 10% level, but it is stabilized and it is expected to creep down at a slow pace looking ahead.

  • While the growing momentum of Kenexa's business was previously only apparent in the growth of our deferred revenue, it is noteworthy that our second quarter total revenue experienced its highest level of organic sequential growth in over three years.

  • In addition to improving macro conditions, we believe Kenexa is benefiting from the fact that we are continuing to execute on our product innovation plans and the market place is increasingly becoming aware of and appreciating Kenexa's highly differentiated value proposition.

  • We are continuing to see a growing number of large global organizations evaluating vendors based on the breadth of their offering, domain expertise, ability to serve as a strategic partner to help customers implement be practices as well as global presence.

  • Kenexa's global customer base spans over 60 countries and we believe our unique combination of strong technology, content, and services positions Kenexa well to meet the sweet spot of where we see customer demand evolving.

  • From a technology perspective, we are currently in the market place with our new Kenexa 2x platform, including applications such as 2x Recruit, 2x BrassRing, 2x Onboard, and our first in market 2x Mobile solution.

  • Kenexa has been recognized for delivering the first HR software platform that truly offers business integrated talent management, and we are continuing to invest and build on our momentum.

  • By the end of 2010 we plan to launch our 2x Perform solution and further out we will be adding 2x Success to its analytics, and 2x Survey to the 2x platform.

  • In the past, Kenexa has somewhat underplayed the strength of our technology as we believed customers are most interested in total solutions and business partners to help them achieve their goals.

  • We also believe Kenexa clearly stands out in this area.

  • That said, from a pure technology perspective, industry analysts such as IDC and Gartner are increasingly taking note of the strength of our technology and functional capabilities as Kenexa is investing more time in sales and marketing resources to make sure our message is getting out there.

  • During the second quarter we hosted an industry analyst event which provided a view with our current product suite as well as new product introductions to over 20 leading analyst firms.

  • The response was terrific, with Burton commenting that we are the first to show mobility and reality and exactly how we are accomplishing it.

  • Gartner said that integration will become more important as HR organizations look to improve data quality and process consistency which plays to the strength of Kenexa.

  • Gartner also mentioned that the need for mobile applications will intensity as HR professionals, employees, applicants and managers rely on mobile devices to conduct business, again playing to an emerging strength of Kenexa's.

  • Our investments to grow awareness are taking place on a global basis.

  • During the second quarter we hosted the first annual leadership event in Shanghai.

  • Financial results are always somewhat up and down on the quarter to quarter basis when entering new geographical markets, but we are excited about the potential of the Chinese market and Kenexa's growing progress in the region.

  • In total we again added 30 preferred partners across the globe during the second quarter which is consistent with last quarter and up from the over 20 level during the second quarter of 2009.

  • A majority of our new preferred partners continue to be from multiple elements of our end to end offering suite.

  • On the higher-end front, customers such as Facebook, Avaya, Mayo Clinic and Cracker Barrel selected Kenexa.

  • In RPO, we signed engagements such as Avis Budget Rental Car, NSAP and we also added Volvo Service Master and others to our growing list of customers using Kenexa for employee retention and engagement.

  • During the second quarter we saw rebound in our other revenue which was partially the result of an uptick in revenue related to surveys and other strategic services.

  • As we pointed out last quarter, these tech service revenues are variable during 2010 and potentially into early 2011 given the currently dissipated pace of the economic recovery.

  • What is most important from our perspective, is that these offerings help further differentiate Kenexa from the competition over and above our strong technology platform and broad suite of applications.

  • Another source of differentiation is our RPO business which generated revenue of approximately $11 million which is up from the $9 million range in recent quarters.

  • In addition to the previously mentioned RPO wins we also added a small handful of RPO customers with more narrowly defined parameters than our traditional RPO engagements.

  • The goal is to expand these customer relationships over time as the economy and hiring environment improve and as Kenexa delivers on its value proposition.

  • We believe our RPO capability serves a is a competitive advantage for Kenexa as it provides domain expertise that other vendors simply cannot have otherwise and it enables us to build deeper relationships with customers when they adopt a broader range of our software and services.

  • RPO is the most cyclical component of our business, and we are optimistic the worst is behind us in this area, and there is upside potential longer term as the economy recovers.

  • We have certainly seen an increase in activity levels in this area of our business, but it will take time for that to translate into results considering the time it takes to close customers, ramp engagements and then for increased hiring to take place.

  • We have extended our leadership position from a domain expertise perspective with the acquisition of a Center for High Performance Development or CHPD which is a specialist leadership development in management training company.

  • The leadership model has been used by more than 100 organizations around the world and its database of more than 10,000 leadership profiles is recognized as one of the foremost benchmarking tools available in the industry.

  • Their extensive research on leadership development, diversity and inclusion adds to Kenexa's existing research portfolio as well as the proprietary content we make available to all our customers.

  • Don will discuss the financial impact of this transaction in moment.

  • We are excited to welcome CHPD to the Kenexa family and to bring our expanded value proposition to the market place including both of our exercising customer bases.

  • In summary, we are pleased with the company's performance in the second quarter.

  • With uncertainty regarding the pace of the economic recovery, we remain cautious from a macro perspective.

  • However, we are increasingly optimistic about Kenexa's medium to longer term outlook.

  • We are winning strategic engagements with the large global organizations in the world.

  • We are launching new solutions and further strengthening our technology leadership positions and we are investing for growth.

  • A consistent theme that you have heard from us and will continue to hear from us in the near term is that we are highly focused on profitable market share gain and ensuring that Kenexa is one of the ultimate long-term winners in the HR solution space.

  • We have proven our ability to scale the company's margins in the past and we continue to deliver solid profitability and cash flow throughout the economic downturn.

  • We now believe it is time to invest and to reignite the growth of our business.

  • With that, let me turn it over to Don to review our financials in more details.

  • Don?

  • Don Volk - CFO

  • Thanks, Rudy.

  • Let me begin by reviewing our results for the second quarter starting with the P&L.

  • Total revenue for the second quarter was $44.9 million, above our guidance of $41 million to 43 million, and up 14% compared to last year's second quarter.

  • Subscription revenue was $36.1 million, a an increase of 6% compared to last year and 9% on a sequential basis.

  • And it represented 80% of our second quarter total revenue.

  • Our services and other revenue came in at $8.8 million, up 61% compared to last year and 36% sequentially and representing the remaining 20% of our second quarter total revenue.

  • We continue to expect our subscription revenue mix to be in the upper 70 to 80% range from a long-term perspective and in a more healthy economic environment.

  • From a geographic perspective, the revenue mix of domestic versus international revenue was 73%/27% compared to 78%/22% last quarter.

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

  • During the second quarter, overall renewal rates for our suite of solutions were over the 80% level.

  • We continue to expect renewal rates in the 90% range for the long-term perspective as the business environment improves.

  • A common metric that we share, which includes RPO along with our other consulting services and technology solutions is our P3 metric which measures the average annual revenue contribution of the top 80 customers.

  • This metric came in at over $1.1 million during the second quarter which was above the $1 million mark level in recent quarters.

  • Turning to profitability, we will be providing non-GAAP measures for each second quarter 2010 expense category which excludes $1.3 million of share-based compensation charges associated with FAS 123R and $800,000 of amortization of acquired intangibles.

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

  • Non-GAAP gross margin of 67% was up from 66% in the year-ago period and 65% last quarter.

  • From an operating expense perspective , non-GAAP operating expenses of $26 million were up about 2.3 million on a sequential basis and up from $21.5 million in the year ago quarter.

  • The sequential increase in operating expenses was largely related to increased investments in our sales organization as well as increased marketing programs.

  • New product launches required marketing support.

  • We hosted an industry analyst event to educate them on our new and future product capabilities, and we hosted our first significant marketing event in China during the quarter.

  • This led to non-GAAP income from operations at $3.8 million, consistent with our guidance and representing an 8% non-GAAP operating margin.

  • Non-GAAP was $0.13 for the second quarter in line with our guidance.

  • Turning to our results on a GAAP basis, the following were expense level determined in accordance with GAAP.

  • Cost of revenue $15.1 million, sales and marketing, $11.3 million, R&D $2.1 million, and G&A $10.6 million.

  • For the second quarter GAAP income from operations is 1.7 million.

  • Net income allocable to common shareholders was $1 million resulting in $0.04 GAAP net income per share.

  • The reconciliation of non-GAAP to GAAP expenses and income from operations can be found in our press release and current report on Form 8-K filed with the SEC.

  • Turning to our balance sheet, Kenexa has cash, cash equivalents and investments of $65.5 million at June 30, 2010, an increase from $62.6 million at the end of the prior quarter.

  • Cash from operations was $7.2 million during the second quarter.

  • Accounts receivable DSO were 62 days at the end of the quarter, relatively consistent with last quarter.

  • And our deferred revenue at the end of the quarter was $57.8 million up $3.3 million from the end of the first quarter and up 37% from the end of the second quarter of 2009.

  • I would now like to turn to guidance and we will focus my initial comments excluding any contribution or impact related to the CHPD acquisition.

  • Assuming continued stabilization in the unemployment rate and a slightly improved business environment in the second half of the year, we are currently expecting our full year revenue to be in the range of $175 million to $179 million, with the low end of our updated guidance above the high end of the previous guidance range of $162 million to $169 million.

  • On last quarter's call we pointed out we were tracking closer to the middle of our original non-GAAP operating income guidance of $14.5 to $18.5 million.

  • Kenexa got off to a faster than expected start with respect to ongoing sales resources, and we are continuing to invest in sales, marketing and R&D to further accelerate the company's growth as we come out of the economic downturn.

  • With half of the year now complete, we believe it is appropriate to narrow our non-GAAP operating income guidance range to $14.5 million to $16.5 million.

  • As a reminder, we expect that our 2010 non-GAAP operating margin will be depressed by approximately 250 basis points as a result of litigation expenses related to the patent lawsuit we are pursuing.

  • Such matters can often change without lengthy advance notice, but we are currently expecting the case to extend into 2011 based on where we are currently in the process.

  • Assuming an effective tax rate for reporting purposes of approximately 20%, and approximately 23.2 million shares outstanding, we expect non-GAAP net income per diluted share to be $0.52 to $0.59 cents for the full year 2010.

  • Turning to the third quarter of 2010, we are targeting core Kenexa revenue in the range of $44 million to $46 million which represents the second time in as many quarters that we are increasing our targeted quarterly revenue range.

  • As Rudy pointed out, there is potential for variability in our other revenue which experienced significant growth in the second quarter.

  • We are targeting third quarter non-GAAP operating income of $3.4 million to $3.6 million.

  • Assuming a 20% effective tax rate for reporting purposes and 23.2 million shares outstanding, we expect non-GAAP net income per diluted share to be $0.12 to $0.13 for the third quarter.

  • As it relates to the acquisition of CHPD, we currently expect to pick up approximately $2.5 million in revenue during the second half of the year with approximately $1 million of that occurring during the third quarter.

  • To be clear, this would be additive to the 2010 and third quarter revenue ranges for Kenexa I just provided.

  • So our combined total revenue guidance for the year is $177.5 million to $181.5 million.

  • And our third quarter guidance is $45 million to $47 million.

  • We do not expect the acquisition to have a material impact on our non-GAAP operating income or non-GAAP earnings per share in either the third or fourth quarters.

  • In summary, we are pleased with the company's second quarter financial results.

  • Kenexa has executed during the most difficult time period the company has ever faced, and we believe we are starting to come out of the other side of the tunnel.

  • The revenue has returned to growth in the first half of 2010, and we are targeting growth that approaches or slightly exceeds double digits for the full year.

  • In addition, we have increased our full-year revenue guidance for the second time in as many quarters.

  • From a near term perspective, we believe it is important that the company continues with a higher level of investments in sales and marketing as well as R&D which is consistent with our messaging from recent calls.

  • We are highly focused on re-establishing Kenexa's growth profile and capitalizing on what we believe is a large market opportunity in Kenexa's highly differentiated value proposition.

  • We also remain committed to running a business that generates significant cash flow and solid profitability.

  • And we are confident we can scale both of these over the longer term.

  • We would now like to turn it back over to the operator to begin the Q&A session.

  • Operator

  • (Operator Instructions).

  • Our first question is from the line of Brendan Barnicle with Pacific Crest Securities.

  • Please go ahead.

  • Brendan Barnicle - Analyst

  • Thanks, guys.

  • It looks like some nice improvement continuing in the margins.

  • As we think of it and you touched on it briefly there, Don, as we think about what that might look like next year, would we go back to a historic range of 200 to 300 basis points a year, or any idea of balancing that investment with maybe some recovery in the top line?

  • Don Volk - CFO

  • Brendan, we haven't given guidance on 2011 and we are really not ready to answer that question.

  • As we said in the past, we have a target model.

  • As we go toward that target, it is going to be a slower recovery in bottom-line operating margin than it has been in the past.

  • The margins will not increase as quickly as they had in the past as revenue continues to go up.

  • Brendan Barnicle - Analyst

  • And as we think about sales and marketing for Q3 and modeling kind of the change from Q3 into Q4, how much in Q3 does it get impacted by the user conference?

  • Don Volk - CFO

  • A significant amount.

  • It is probably $400,000 or $500,000.

  • Brendan Barnicle - Analyst

  • Great.

  • And you also mentioned some large deal activity in the quarter.

  • Any characteristic to it in particular, in terms of verticals or products that are particularly driving those larger deals?

  • Troy Kanter - President, COO

  • Hi, Brendan, Troy.

  • What we are seeing on those deal flow side, the larger ones, is the -- our strategy has been to pull together the science, pull together the outsourcing and the tech, and that's really what we are realizing within the funnel.

  • It is people are really looking at more sort of productivity and talent, holistic approaches to their purchases as opposed to individual category buys.

  • We are seeing that across all industry verticals.

  • Brendan Barnicle - Analyst

  • Is that something that has changed in the way you have gone to market or is that maturation of the customer?

  • Troy Kanter - President, COO

  • I think it is the maturation of the customer.

  • We have had this strategy from the beginning.

  • I think we were a little ahead of the curve in the market place.

  • Now especially coming out of a downturn, I think a lot of executives are asking different questions of their HR department than they had in the past as they are rethinking their human resource strategies on the way back out of this.

  • And as those questions become more sophisticated and complicated, I think that really lends itself to our value proposition.

  • As the level of accountability continues to rise in the HR department, the level of expectation continues to rise.

  • The questions change -- there is always the cost management questions, but then they start to evolve to where what is the HR department's impact on our operating metrics, on the opportunity side of our income statement?

  • That's where our value properly resonates and that's what we are seeing more and more of.

  • Brendan Barnicle - Analyst

  • Great.

  • Thanks a lot, Troy.

  • Operator

  • Thank you.

  • Our next question is from Peter Goldmacher with Cowen and Company.

  • Please go ahead.

  • Peter Goldmacher - Analyst

  • Hi, guys.

  • Just want to follow-up on a couple of questions.

  • Don, you talked about a target model, and I know you don't want to give guidance for 2011, but in general, can you give us a little bit more of how you are thinking about margins because the guidance -- if we come in at the mid-point of your guidance for the September quarter, we actually have another drop in operating margins.

  • So is there a floor you don't want to go below that you can talk about?

  • And then in two years where would you like to be?

  • Just to give us a little more without a firm commit meant, just a little more insight into what you are thinking?

  • Don Volk - CFO

  • Sure, Peter.

  • Right now we are looking at the opportunity to expand our revenue base.

  • We are taking advantage of that opportunity by investing in sales and marketing.

  • When we invest in sales and marketing, it is giving us the ability to increase our revenues as we have proved in Q2 and as our guidance for revenues for the rest of the year shows.

  • With that being said, we are going to evaluate what's going on and evaluate whether we continue to invest in sales and marketing or we keep that money for margin expansion.

  • In the target model, we have always had the target model, which is 22% to 24%.

  • We have achieved as much as 18% to that back in the year 2008.

  • And have been on a run rate of 20% in certain quarters.

  • We have proven we can do this, we can expand margins, but it is going to be a slower period going forward.

  • I think that possibly by the time we get to the $80 million range per quarter we will be at that 22% to 24%.

  • Peter Goldmacher - Analyst

  • Okay.

  • And then, Troy, you talked about a year now about these big deals.

  • I know your P3 deal has picked up which is nice to see, but you had talked beyond P3 at some of the big contracts were out to bid when you guys were partnering.

  • How are those working through the pipeline?

  • Troy Kanter - President, COO

  • They are all progressing.

  • The real big deal people reference in the industry over in the UK, That's a long-term -- that's a multi year sale cycle.

  • Some of the other things we are working on, you can see our growth in revenue.

  • Again, it is starting to play out, starting to come true in the market place more and more in these products in categories we wrap together.

  • You know, the bigger and bigger the deals are getting.

  • That has been one of the more asides of the growth of the business has been the multi-element deals, the combination of on you product services and technology.

  • Peter Goldmacher - Analyst

  • I guess I am looking for a more specific answer.

  • Are you starting to close some of these bigger deals, or are they still to come?

  • Beyond P3?

  • Troy Kanter - President, COO

  • The biggest deals are still in the funnel.

  • Peter Goldmacher - Analyst

  • And if everything breaks your way is that a 2011 thing?

  • Troy Kanter - President, COO

  • Yes, without trying to dramatically trying to raise for 2011 -- the bigger deals have a longer sales have a longer cycle as they come on line.

  • It takes a little bit of time to get them to the income statement.

  • But we are optimistic we will see some of those come through and continue into 2011 and beyond into 2012 and 2013.

  • Peter Goldmacher - Analyst

  • Yes, I don't think you guys have to worry too much about raising expectations.

  • I think expectations are pretty subdued.

  • You might want to just think about raising them a little bit.

  • Thanks a lot, guys.

  • Operator

  • Thank you.

  • Our next question is from Laura Lederman with William Blair.

  • Please go ahead.

  • Laura Lederman - Analyst

  • Yes, a few questions.

  • When you talk about the multi-element deals, what are some of the most common elements you are now selling in those multi-element deals?

  • And I have a few other questions.

  • Troy Kanter - President, COO

  • In RPO deals, most of them are including elements of our technology and analytics.

  • A lot of them include assessments where on the performance side almost all of those transactions include elements of our content related to survey assessments and leadership measurements.

  • So that primarily if the decision is driven around talent acquisition side, then you see a combination of the services on that side of the equation.

  • If it's driven by the performance management side, you see the combination of the content and science there.

  • And what we're finally seeing now is a breakthrough where a lot of companies are now looking at that holistically and joining those together.

  • A number of the deals that we have been winning now include sort of that -- instead of just a comprehensive approach to talent acquisition or a comprehensive approach to performance management, the buyers are now taking a comprehensive approach to the entire strategic HR portfolio.

  • And those are starting to come through the funnel as well as get inked up and gradually making their way to the income statement.

  • Laura Lederman - Analyst

  • Sort of a related question.

  • You mentioned during the call your competitive positions change and improving.

  • And so, these multi-element deals, is it you gaining share from the skills behavioral assessment side, or gaining share from the surveying side, or gaining share on the applicant tracking side?

  • Can you give us a sense where you are gaining the share is what I am trying to inarticulately ask.

  • Troy Kanter - President, COO

  • The share question is a tough question.

  • This is such a fragmented market place, and it is coming in from so many different areas.

  • This isn't a data driven answer as much as it's a gut feeling answer is that the buyers are shifting the way they buy, from looking at a piece of technology or an outsourcing engagement and asking more bigger organizational productivity kind of questions.

  • So a lot of the dollars that we are getting for these multi-element purchases are being pulled from multiple categories within their HR budget.

  • And some of the money is even coming from what they traditionally used to spend on contingency staffing or on the executive search or on recruitment advertising, things that -- places we hadn't gotten budget before, but they are pulling some of those dollars from those budgets because of the solutions when you wrap these together dramatically bring down costs in some of those other areas.

  • As we are selling these multi-element deals, the buyers have approached them with this slightly differently as well and where it is coming from is the multiple budget categories.

  • Laura Lederman - Analyst

  • That's interesting.

  • Thank you.

  • Final question from me and then I will pass it on.

  • Rudy Karsan - CEO

  • By the way, when you think of market share, look at the IDC data and it says, I think, this year the market climbed up about 3% in all of workforce management, talent management.

  • If you look at our bookings number, it is up by 37 across the board, through all channels, right?

  • It talks about a 6% CAGR, your recruiting growing by 5.7% and performance management by 6.3%.

  • Given the increase in the deferred together with the year over year, the recognized revenue component, you can see that it doesn't matter what separate category you look at, we are gaining share across the board.

  • Laura Lederman - Analyst

  • That's helpful, Rudy.

  • Final question from me, and thank you for taking my questions.

  • If you look at the acquisition front, obviously you have made one recently, and for a couple years you were out of the market because of the economy -- can you talk a little about how active you are being at looking at different properties out there and what the pricing looks likes of things, or should we only expect very little and sporadic on the acquisition front?Thank you.

  • Rudy Karsan - CEO

  • We have always maintained the same position which remains unchanged.

  • If it can show us an increase in a different solution or offering, if we can get into a different geographical area or different or vertical market, we are very interested.

  • It has to meet the profitability test.

  • And we have to be accretive in the near future.

  • Those are the things we look for.

  • We have seen the pricing to become a little saner .

  • As Don pointed out, the CHPD I think adds whatever it was I think $5 million annualized -- a little bit over $5 million and $6 million revenue to our run rate.

  • That's annualized, and I think quarterly it's $1.5 million.

  • We paid whatever it was, paying between $4 million and $5 million for it, so a little under 1x.

  • That was kind of the going price.

  • I would say that certain properties you can get a lot more expensive if they have got a healthier margin.

  • We would go more, but we would want the margin discipline to be

  • Laura Lederman - Analyst

  • Thank you very much.

  • Operator

  • Thank you.

  • Our next question is from the line of David Hilal with FBR Capital Markets.

  • Please go ahead.

  • David Hilal - Analyst

  • Thank you.

  • Rudy you talked in the RPO business about getting, I think you said more customers with a narrowly defined requirement.

  • Historically that business has been one that's been characterized by small group of large customers.

  • And I'm just wondering if the strategy is changing a little bit to diversify it, to bring it from smaller guys that can grow with you or just being dictated by the current economic environment?

  • Rudy Karsan - CEO

  • I think it is yes to everything you said.

  • I hate to chicken out and say you are such a genius, but the reality is that's what is happening.

  • You are seeing more companies who wish to experiment a little bit that you are hoping to then upsell over a period of time.

  • What you are also seeing is the wrapping of the technology as a utility.

  • It is helping close the deal.

  • So a lot of times we are experimenting with utility-type pricing and utilization-type pricing.

  • So we have experimented with one or two small deals.

  • And we are also looking at getting into divisions in a small way and then expanding through the entire enterprise.

  • All the things you mentioned, the answer is yes to all of the above.

  • David Hilal - Analyst

  • Okay.

  • And then, in terms of outlook, there have been times in the last year and a half where you have been pretty pessimistic about the environment, and obviously correctly so in hindsight.

  • The fact that you are picking up your investments -- in terms of your confidence that things are getting better, how much is driven by what you see in the pipeline versus more of a macroeconomic opinion that you and the company may have?

  • Rudy Karsan - CEO

  • Yes, I would say the way to describe it is the bloom is off the pessimism rose, if you will.

  • I know that is a backward way of saying it, but if you look at the key pieces of data we look at, our employee confidence index and it says unemployment is starting to stabilize.

  • We historically said give us a stable unemployment environment at whatever level, and we can probably grow it double digits because the inefficiencies and opportunities that are available.

  • We believe that combined with the macroeconomic data says that the tide well may not have turned, but it is definitely stabilized.

  • The other thing we look at is the employee cost index.

  • That's coming down.

  • Productivity numbers are still pretty decent.

  • On the margin, kind of the key macroeconomic indicators we are looking at are saying, companies are going to get a little healthier in terms of the way they are looking to hire.

  • If you notice, our RPO revenue went up.

  • I think last quarter it was in the $9 million range and we are now in the $11 million range.

  • A lot of the growth was due to companies getting off their minimums.

  • So this is sending a positive vibe to us.

  • And last, but not least, our pipeline is strong.

  • We don't hand out bookings, but if you look at the deferred number, it is up almost 40% year over year.

  • I think the exact number is 37%.

  • So those are all to us indicators we should start seeing growth again.

  • And we know the long time to maturation of sales force.

  • We know that the closing period hasn't shrank at all during the downturn and through the recovery.

  • We are expecting a longer selling cycle.

  • We say we have to make a bet sooner or later, and now is the right time to make that bet.

  • David Hilal - Analyst

  • All right.

  • Okay.

  • now let me ask Don on the capitalized R&D, will that -- is the product now considered feasible where capitalized R&D may go down in Q3?

  • Don Volk - CFO

  • There are some products that will be considered as feasible.

  • We did $3.4 million in capitalized R&D in the third quarter.

  • David Hilal - Analyst

  • Second quarter?

  • Don Volk - CFO

  • I think it will be fairly consistent in the fourth quarter.

  • David Hilal - Analyst

  • Okay.

  • Great, thank you, guys.

  • Good quarter.

  • Operator

  • Thank you.

  • Our next question is from the line of Mark Murphy with Piper Jaffray.

  • Please go ahead.

  • Mark Murphy - Analyst

  • Yes, thank you.

  • Rudy, wondering if you can comment on the demand trends you saw in Europe maybe in comparison to some of the headlines that are out there.

  • And in conjunction with that, is there anyway to drill down into your employee confidence index and tell us how that looked for the eurozone versus some of the other geos?

  • Rudy Karsan - CEO

  • I don't remember offhand because I just seen the data on a preliminary basis.

  • From what I recollect, most of the -- let me first answer the first part and then I will come back to the ECI.

  • The first part of the question is, if you look at the Q2 numbers, it went from I think 77/23 to almost flipped around.

  • I think it went from 78/22 to we are now writing more than a quarter of our business globally.

  • I think the number is up to 27% globally.

  • If I look at the 5 point or so improvement, China pretty well doubled.

  • We just went on this side of $1 million on a quarterly basis.

  • The annualized number is now north of $4 million, approaching $5 million.

  • And the balance of the increase came out of Europe, some of which came from sales from last year that are hitting our income statement this year.

  • And some of which is kind of the added part on the other in the RPO turn around.

  • I have been to Europe twice in the last five weeks because of the CHPD deal primarily.

  • And I would say that in general it is not as bleak as what I hear in the US about how bleak things are in Europe.

  • We seem to believe it is bleaker than the Europeans believe it is.

  • So the sentiment there, from the various discussions I have had with the business leaders, as well as a couple of people on the Street, and hedge fund guys, it doesn't seem to be that bleak.

  • From the employee confidence, don't quote me on this, but from what I remember, the employee confidence went up in Germany and it went up in France, and I think it remained stable in England which are the three main areas in terms of revenue for us.

  • So all of those three areas look slightly up.

  • The US, from what I recollect went up as well.

  • I think South America went down a little bit.

  • But on the margin it did go -- it was higher almost across the board in 11 out of the 13 countries between Q1 and Q2.

  • Mark Murphy - Analyst

  • Okay, thank you, Rudy.

  • That's great color.

  • Don, I wanted to ask you, I think it is arguably -- it is a little counterintuitive to see your revenue guidance has being guided higher materially on the year while the earnings guidance is being slightly reduced.

  • And I just want to clarify, is that strictly a function of increased hiring expenditures investments since the last time we spoke?

  • Or is it possibly also a function of maybe the other revenue mix increasing a little and possibly carrying a lower gross margins.

  • Any color you can add on that would help.

  • Don Volk - CFO

  • Sure.

  • Well, the first thing is we did deliver operating profitability that was consistent with our guidance.

  • Second, as the quarter played out, we had visibility into strong revenue performance, and as such we felt comfortable continuing with ourselves and marketing investment strategy.

  • And finally a portion of the top line overage related to revenue sources with lower margins, such as in our other revenue and China.

  • China delivered a better than expected performance in revenue.

  • But since that's early stage investment, those margins are not as strong as our total margin overall.

  • Mark Murphy - Analyst

  • And Don, you did comment that the other revenue could be volatile.

  • Is there any way, just given that it had a very big sequential increase in Q2, can you talk to us just directionally how the other revenue would trend into Q3?

  • Don Volk - CFO

  • Provided the unemployment rate continues to tick down, provided that the economic results and the economy continues in the way that they are now, we expect other revenue to be consistent or up.

  • But that's a variable piece of our revenue, so you have to be considerate of that when we are giving full year guidance and any quarterly guidance.

  • Mark Murphy - Analyst

  • Thank you very much.

  • Operator

  • Thank you.

  • Our next question is from the line of Sasa Zorovic with Janney.

  • Please go ahead.

  • Sasa Zorovic - Analyst

  • Thank you.

  • So you were commenting earlier that you have added a lot of sales people late last year, and by now they are -- at this point they should becoming productive.

  • And I was wondering if toward the end of the second quarter they have indeed become productive there with this sort of full productivity.

  • And then the reason why we are seeing you are investing more is you are adding new sales people on, or is it taking longer for those to become productive?

  • Rudy Karsan - CEO

  • Our sales portion has increased by 10%.

  • Our total sales count is now 140 and that is a one quarter increase.

  • That's not annualized.

  • That's quarter over quarter.

  • We have seen more rapid productivity from the sales force.

  • And part of that, you are seeing reflected in our bookings number continuing to climb.

  • And then also the added spend that we have put out on the marketing front.

  • I think on the year to date basis, the sales and marketing number is a lot higher than it was last year.

  • I can't remember how many percentage points, but I think it is close to five, right Don?

  • Don Volk - CFO

  • From same quarter or year to date?

  • Rudy Karsan - CEO

  • Year to date the last two years, last year and this year.

  • Don Volk - CFO

  • Oh, it went from -- marketing went from -- I'm sorry, 16.9 year to date to 20.9.

  • Rudy Karsan - CEO

  • So 4%.

  • That's where you see most of the money going.

  • Sasa Zorovic - Analyst

  • Okay.

  • And my next question is regarding M&A.

  • With this recent acquisition, do you feel that for the time being do you want to make sure you leverage this one well, or are you continuing to look for more opportunities actively?

  • Rudy Karsan - CEO

  • We will continue to look for more opportunities if they meet kind of our criteria around additional geographies or solutions or verticals.

  • If it meets our accretive criteria, it is the right acquisition or, we will continue to attack it.

  • We are still not doing land grabs yet.

  • We think there is a tremendous opportunity for organic growth.

  • We are not in the business of land grabs yet.

  • Sasa Zorovic - Analyst

  • Thank you.

  • Operator

  • Our next question is from the line of Steve Koenig with Longbow Research.

  • Please go ahead.

  • Steve Koenig - Analyst

  • Hi, guys, thank you for taking my questions.

  • A couple things I would like to get into.

  • One question, the EIC referrals, how much, Don, if you have it available, did that help the services -- the other line, the consulting compared to last year or any other part of revenue?

  • And was that fully reflected in the guidance?

  • Don Volk - CFO

  • Yes, it was fully reflected in guidance, and it was consistent with last quarter.

  • It was about $700,000.

  • And I do not have the break down between subscription and other.

  • Steve Koenig - Analyst

  • Okay.

  • That's fine.

  • Great.

  • And let's see, the increase in the RPO revenue, a couple things there.

  • Rudy, I didn't catch, how many of the large typical RPO deals did you say you signed this quarter?

  • Rudy Karsan - CEO

  • I didn't give a number.

  • I think it was one or two.

  • Two.

  • Steve Koenig - Analyst

  • Two new customers?

  • Rudy Karsan - CEO

  • Two new customers, and so if you think of the growth that went almost 20% sequentially in RPO, I would say the two new customers who signed did not add a significant amount to the revenue.

  • It did add to the deferred and it will add to future revenues.

  • Steve Koenig - Analyst

  • Okay.

  • Rudy Karsan - CEO

  • A lot of the increase in this quarter came in, and we had from a guidance perspective, expected to get over $10 million because of the signings we had in Q1.

  • And the balance -- the upside surprise was more companies got off their minimums.

  • Steve Koenig - Analyst

  • Yes.

  • Okay.

  • And did you have any renewals in the quarter?

  • Rudy Karsan - CEO

  • We haven't lost an RPO customer now in three quarters?

  • Steve Koenig - Analyst

  • Yes.

  • Okay.

  • Great.

  • And then I am curious to know -- so on the other line, we saw about a $2.3 million sequential increase, some of the T&M RPO or was that mostly performance in surveys that drove that?

  • Don Volk - CFO

  • There is a combination of time and materials consulting, revenue from China, reimbursed expenses and success fees in RPO were all up.

  • Steve Koenig - Analyst

  • That's right.

  • And the survey is more in the subscription line?

  • Don Volk - CFO

  • There is a piece of survey in the subscription line and apiece in time and materials consulting.

  • Steve Koenig - Analyst

  • Okay.

  • Great.

  • And then lastly, in looking at the increase you would have in full year guidance, wondering if you could give color on the sources of the increase in full year guidance, how much of that are you thinking is from RPO, how much is from other parts of the business be it surveys or consulting, et cetera?

  • Rudy Karsan - CEO

  • If you look at it from the various offering, every one of our products and every one of our services has moved up in Q2.

  • This is the first time this has happened in over three years.

  • There was no product, or no service that shrank in Q2.

  • RPO grew the most, sequentially, that's the one we disclosed, I think it is about 20%.

  • Everything else grew and everything grew across the board on deferred as well.

  • So when you look at the overall year guidance, we are showing growth across all product lines, which is incidentally running about the same as it was last year which is in the kind of midteens, the 13 to 16 range for most of our products.

  • The big reason why if you look at it sequentially and year over year, the RPO was shrinking through all this time while the rest of the -- and consulting was shrinking while the rest of the business was growing.

  • That headwind stopped, and so now the rest of the business which had been growing in the low double digits is starting to show.

  • And then the headwinds have disappeared.

  • Steve Koenig - Analyst

  • That's great.

  • That's very helpful.

  • I wonder if I could sneak in one last question which is about --

  • Rudy Karsan - CEO

  • On this call you can continue to hear the sound of your own voice, so keep going.

  • Steve Koenig - Analyst

  • Okay, great.

  • Thanks.

  • I was wondering in terms of your sales of performance management and talent acquisition -- are you seeing your win rates improve dramatically?

  • Or is the bookings growth you are seeing primarily a function of pipeline?

  • Rudy Karsan - CEO

  • I would say our win rates -- there has been a consolidation in the space.

  • Recently, Stepstone announced the purchase of MrTed out in Europe and China.

  • I would say win rates are creeping upwards, but there isn't any seismic move or quantum move in the win rate.

  • Just slight nudging up -- it could be noise, because there are not that many data points to it.

  • Steve Koenig - Analyst

  • But pipelines are a big part of the deal cycles getting closer, or really the equation of the inquests here to the bookings growth.

  • Rudy Karsan - CEO

  • And hence the decision to continue to expand on the sales force.

  • Steve Koenig - Analyst

  • Great, thank you very much.

  • Rudy Karsan - CEO

  • You are welcome.

  • Operator

  • (Operator Instructions).

  • And our next question is from the line of Michael Nemeroff with Wedbush.

  • Please go ahead.

  • Michael Nemeroff - Analyst

  • Hi, guys, thank you for taking my questions.

  • Just to clarify, will recurring revenue and deferred revenue grow sequentially for the rest of the year?

  • And do you expect that to continue now, assuming obviously that the macro economy stays the same and the unemployment rate ticks down going forward?

  • Don Volk - CFO

  • On the recurring revenue, we expect that to continue to grow in 2010.

  • The deferred I think we talked about it flattening out in the increases in 2010 because of the change in revenue recognition policies .

  • We didn't experience that in Q3 where we had a $3.3 million increase -- in Q2, I'm sorry.

  • I expect that as it goes through the rest of the year to not be as

  • Michael Nemeroff - Analyst

  • But you don't expect it to go down?

  • Don Volk - CFO

  • No, we don't expect it to go down, but I don't expect it to increase by $3.3 million every quarter.

  • Michael Nemeroff - Analyst

  • Sure, okay.

  • And then how much -- you mentioned in your prepared remarks you expense the legal expenses to continue in 2011?

  • I was under the impression was the trial set for the fourth quarter of 2010.

  • Could you give us an update on that, how much you are spending on a quarterly basis and when if any a new trial has been set, what quarter that falls in next year?

  • Don Volk - CFO

  • A new trial has been set for December of 2010.

  • So you can't ever tell what's going to happen with that, and so we are expecting right now for that to continue in through 2011 and provide a 250 basis point depression on our operating margins.

  • Michael Nemeroff - Analyst

  • And you expect that to continue into 2011, the same level of litigation and legal expenses in 2011 even though the trial is in Q4 2010?

  • Don Volk - CFO

  • At this point, yes.

  • Rudy Karsan - CEO

  • Just so you know, this kind of litigation, our past experience has been a minimum of five, whatever you call it, extensions.

  • We had our first from October to December.

  • Michael Nemeroff - Analyst

  • Okay.

  • And Rudy, in your prepared remarks, and I think someone asked about this and you talked about getting your foot in the door with some small divisions on the RPO side -- how big are those customers that you are looking to expand business services, RPO services into?

  • Are those very large?

  • Could those potentially be very large RPO customers as of the size of the typical RPO customer?

  • Rudy Karsan - CEO

  • Yes.

  • The short answer is yes.

  • Most are brand names.

  • Most are I think -- because RPO is such a big sale when it does happen in terms of a full blown one, we usually run a press release on it the minute the signature gets completed, the signing gets completed.

  • Usually through the quarter we have released that information out, and most of the names we announced Whirlpool this year, Otsuka.

  • Don Volk - CFO

  • Yes.

  • Rudy Karsan - CEO

  • I can't remember all of the other names.

  • Those are generally companies with a minimum of 25,000 employees, a lot of them are a lot more than that.

  • Michael Nemeroff - Analyst

  • And just one last one.

  • I was under the impression that the success fee from the RPO business which you said was a big chunk of the upside of the revenue, I was under the impression those are high margin pieces of revenue.

  • Is that still the case?

  • And if those success fees do actually start as people do start hiring and you start placing people, is that potential for upside going forward?

  • Don Volk - CFO

  • And then if you notice our non-GAAP margin in Q1 from 65% to Q2 67% and that's a reflection of that.

  • Michael Nemeroff - Analyst

  • Thanks, Don.

  • Thanks, guys.

  • Operator

  • Thank you.

  • And our final question is from the line of Scott Berg with Feltl and Company.

  • Please go ahead.

  • Scott Berg - Analyst

  • Hi, guys.

  • Thanks for taking my call.

  • Nice quarter here.

  • A couple quick housekeeping questions, was the acquisition announced the center for et cetera, et cetera, my apologies, was it -- what were cash flows like in that income on the trailing 12 months for the company?

  • Were they pretty much break even or was there a loss at all?

  • Rudy Karsan - CEO

  • It is called CHPD and the price we paid was between $4 million and $5 million for revenues of $6 million.

  • The margins on that business were bleak.

  • Scott Berg - Analyst

  • Okay.

  • Fair enough.

  • And then in terms of the RPO business, do you have internal capacity right now to meet the additional need for the additional hiring on the RPO side, or will you need to hire additional individuals to support that business?

  • Rudy Karsan - CEO

  • Yes, we will continue to hire additional individuals to support the business when needed.

  • Troy Kanter - President, COO

  • From a need perspective, Scott.

  • You know, during the downturn we talked the reinvention of the back-office where we expanded capabilities dramatically in lower cost labor markets.

  • So over in Europe we have tremendous infrastructure in Krakow, Poland.

  • We have opened a center in Argentina that is doing exceptionally well.

  • In North America we have moved a lot of the labor with capacity to scale in Dallas, Texas and Lincoln, Nebraska.

  • We also have capacity in China.

  • So there are incremental head counts to add.

  • But we have also expanded the technology, expanded our footprints, expanded some of the core infrastructure that allows us to scale fairly quickly.

  • Scott Berg - Analyst

  • Okay, great.

  • And then my last question is with regards to renewal rates.

  • What were renewal rates in the quarter?

  • Rudy Karsan - CEO

  • 80%.

  • Scott Berg - Analyst

  • 80% again, okay, fabulous.

  • Thanks, That's all I have.

  • Operator

  • We have no further questions.

  • I would like to turn the floor back over to management for closing comments.

  • Rudy Karsan - CEO

  • Thanks, Manny.

  • I would like to take this opportunity to thank the Street for their support.

  • We are very cautious over the short-term, but continue to remain fairly optimistic medium/long-term.

  • Until next quarter, have a good one.

  • Operator

  • Ladies and gentlemen, this does conclude today's teleconference.

  • You may disconnect your lines at this time.

  • Thank you for your participation.