LivePerson Inc (LPSN) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank your for standing by. Welcome to LivePerson's Third Quarter 2006 Earnings Conference Call. At this time, participants are in a listen-only. Later, we will conduct a Q&A session. At that time, the operator will give you instructions. As a reminder, this conference is being recorded today, November 2, 2006. Speaking on today's conference call will be Robert LoCascio, Chief Executive Officer of LivePerson, and Tim Bixby, President and Chief Financial Officer.

I would now like to turn the call over to Mr. Bixby. Please go ahead, sir.

OK. Thanks, very much.

During the course of this conference call, comments that we make regarding LivePerson that are not historical facts are forward-looking statements and are subject to risks and uncertainties that could cause such statements to differ materially from actual future events or results. Any such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. It's routine for our internal projections and expectations to change as the quarter progresses, and therefore it should be clearly understood that the internal projections and beliefs upon which the Company bases its expectations may change prior to the end of the quarter. Although these expectations may change, we are under no obligation to inform you if they do.

Our Company policy is generally to provide our expectations only once per quarter and not to update that information until the next quarter. Actual events or results may differ materially from those contained in the projections or forward-looking statements. Many factors could cause LivePerson's actual results to differ materially from those described in the forward-looking statements. Listeners are referred to the reports and documents filed from time to time by LivePerson with the Securities and Exchange Commission for a discussion of these important risk factors.

Now, I' would like to turn the call over to LivePerson's Chief Executive Officer, Robert LoCascio.

Thanks, Tim. Good afternoon, everyone, and thank you for joining us.

During the third quarter of 2006, we generated record revenue $8.9 million, up 55% from a year ago, and 20% sequentially, as compared to the second quarter of 2006.

Excluding the Proficient acquisition which closed during the quarter, organic sequential growth rate was 12%. This represents one of our largest sequential revenue increases ever. In fact, organic revenue growth was more than 45% greater than any quarter in our history. We are also positioned to have a strong finish this year with an expected sequential growth rate at least as high as what we saw in the third quarter.

Earnings per share was $0.01 and in line with our guidance. This includes the impact of stock compensation expense.

EBITDA per share was $0.03, also within the guidance range we provided 90 days ago.

Twenty-four months ago, we set out on this new strategic course with the development of our Timpani platform. We saw an opportunity to develop a product that could create tremendous value by helping businesses increase online sales and conversion rates. Today, the results of that strategic shift is beginning to be reflected in our financial performance. Our goal at the beginning of this year was to reach double-digits sequential quarterly organic growth rates. We achieved this goal in Q3 and grew by 12% organically. With the Proficient acquisition, we obtained 20% growth rate quarter over quarter. Based on the information we have now, we will continue to achieve our double-digit growth rates during Q4 as we anticipate revenue to grow between 12 and 13% sequentially. This will put our annual organic revenue growth rate at 45% with the Proficient acquisition at about 50%.

As you can imagine, Tim and I are very excited and would like to now give you an overview of the successes we are seeing in both our enterprise, small business groups.

Our small business group, or SMB team, we currently have about 4,500 small businesses from around the world who customers are usually a good leading indicator of changes that happening in the overall online world. The SMB team reached a major milestone during Q3 by exceeding $1 million per month in return revenue. To give you a feel for the magnitude of this accomplishment, in 2004 their quarterly sequential growth rates were between 5 to 8% and total revenue for the year was about $5 million. In 2006, the SMB group's average quarter over quarter growth rate is about 11% with total revenue exceeding $11 million. This group more than doubled their business in 24 months in one of the most competitive product segments we serve today.

Our small business group has also seen a marked decrease in attrition rates. In 2004, attrition rates were averaging approximately 2.5% per month. Today, attrition rates are approximately 1.7% per month or a 35% decrease. When we launched the SMB product in 2001, we were selling a basic quick-to-chat product. Today, we are selling a fully integrated contact center product which includes email, knowledge based chat, and now voice. SMB started selling quick to call voice product in Q1 in this year. And we already have 400 plus customers who have purchased it. As these small businesses effectively and efficiently drive site traffic from search engines like Google, they are looking for ways to consistently communicate with that traffic in order to create more revenue opportunities. Chat is one product area by which they can achieve this goal.

We are excited about the momentum in the SMB group and believe that their overall business execution combined with the shifting demands in the market form a solid foundation to grow over the next several quarters.

Let me now give you an update on our enterprise product lines. First, our sales team continues to perform strongly in the market with increasing momentum. We enter the fourth quarter with the highest level book quarterly revenue in our history. Two weeks ago, we held our annual customer summit. Some of our largest enterprise customers gathered for two days of best practice discussion and debate. There were some great takeaways from this event that outline the market changes driving our accelerated growth rates. Key among them were how many of our customers are finding new and exciting ways to implement Timpani and how there seems to be a shift happening where chat is becoming a primary channel for online customer communications.

Chat, for many years, has been a secondary channel to voice and email. However, I was amazed when a few customers said they would like to remove email as a way of communicating with their customers. Three years ago for many of these companies, email was their primary channel for online communication. They had hundreds of operators answering emails, and today, they only have a handful. And for these customers, Chat has one of the highest customer satisfaction ratings and the lowest cost per interaction basis as compared to email and phone.

Furthermore, one of our large contact center clients decided to try an interesting test with Timpani in their customer support area rather than in online sales, tested the use of our rule ending modern knowledge based searches. If one of their customers searches a knowledge based and receives a wrong answer, Timpani recognizes this and proactively sends an invitation to chat. The goal is to determine if through the use of Timpani phone calls resulting from failed knowledge based searches could be dramatically reduced.

Preliminary results showed a nearly one to one correlation between reduced calls and increased chats. Given that each phone call cost $3.00, a chat cost only $0.80, they anticipate seeing a significant savings going forward. This story illustrates the sophistication of Timpani as a platform to accurately match the right channel of communication with the right customer at the right time.

I think we are starting to see more of these innovative implementations. From one key metric that indicates a significant change in how our customers are implementing Timpani is a growth on our average deal size. Twenty-four months ago, our average revenue per customer was approximately $200,000 per year. Today, our average Timpani customer pays us approximately $300,000 per year or a 50% increase. This could further grow as businesses look to increase the depth and intelligence of their online customer contact.

As chat becomes a primary channel for online communication and our platform provides an intelligent way in which to reach targeted customers, we should continue to see a greater adoption by market leaders. And one of the benefits of signing market leaders is they carry a significant amount of thought leadership within their industries. A good example of how these thought leaders stimulate sales within the specific industry can be seen in the telecommunications segment. We initially signed AT&T, and today we have almost every major telco in North America, including, AT&T, Verizon, Bell South, Quest, Cingular, and Bell Canada. We have been targeting other verticals like financial services, travel and leisure, hardware and software, and [retail] and expect to see additional wins in these industries.

If we combined our target industry verticals, we see the overall addressable market for our products totals about $900 million in annualized revenue. We get to this number by applying our current revenue per customer of $300,000 against a total target base of 3,000 potential customers. This large addressable market, coupled with the shift in chat being a primary channel for online communication and the strategic nature in which Timpani is deployed within each customer, gives us the confidence to believe that we will continue to have significant opportunities in the future.

I would now like to speak about our overall business model.

The ultimate goal of any company should be accelerating top line growth coupled with the expanding margins. Twenty-four months ago, we made a conscience decision to invest more of our cash into developing and launching our Timpani product line. We increased our head count by an additional 30% in all areas, including, sales, marketing, implementation support, research, and research and development. We now are at an inflection point where we can expand revenue without having to make major investments. The result is gross and operating margins are starting to widen. In Q3, excluding the impact of the Proficient acquisition, our EBITDA margin increased by 500 basis points from 14% to 19%, so our gross margins improved a full percent from 78% to 79%. I believe that on a long-term basis, the return on invested capital for the Timpani product line will be very strong.

And in closing, I want to personally thank every at LivePerson for working hard and making the goal of double-digit sequential growth rates a reality this year.

And with that, I would now like to turn the call over to Tim, so he can give you a more financial detail of our financials. Tim?

Thanks, Rob.

I do indeed think that we had a terrific quarter. Revenue exceeded our expectations while bottom-line results were right in line with our guidance from last quarter's conference call. The Proficient acquisition continues to progress on track. Gross and operating margins of the core business improved quite a bit quarter to quarter indicating that we are making significant progress toward our target margin model. And I'll give a little more detail on that in a few moments.

We added more revenue than we have ever added in any prior quarter, nearly 50% more in fact before the impact of Proficient is factored in. And this enables us to raise our revenue guidance for the year for the second time in as many quarters. And we'll, of course, talk a bit more about expectations at the end of this portion of the call.

We reported record revenue of $8.9 million in the third quarter, which was a 55% increase versus the prior year, and a 20% increase from the prior quarter, the second quarter of 2006. And this was well above our guidance range for revenue.

If we exclude the impact of Proficient on our revenues in the quarter, we saw a 12% sequential revenue growth as compared to our expectation of 10% to 11% organic revenue growth, and this organic growth represented a 45% increase from the prior year quarter.

GAAP EPS was $0.01, and again in line with our guidance, and this includes the impact of stock compensation expense, pursuant to FAS 123 as in past quarters this year.

EBITDA per share was $0.03, also in line with the guidance range we provided with our second quarter earnings release.

As in the past several quarters, we generated very good results in both signing new accounts, as well as, growing existing accounts. We signed several new blue chip clients, including travel leader, Orbitz. We further expanded business with many existing customers, including Bell Canada, Earthlink and others.

We continued to see traction with Timpani voice with initial deployments within several enterprises, large companies, including Bell Canada, PR Newswire, and the Nasdaq Stock Market, as well as, contracts signed with seven additional others during the quarter. Most interestingly, we were competing against established voice players in four of these deals that we won, and we think that this is a very important early indicator given the early stage of our presence in the voice sector of the market.

We also saw further penetration into the small business base with the voice product. And as Rob mentioned are up to approximately 400 paying users within the small business segment, as compared to roughly 200 last quarter.

In terms of overall deal size among our enterprise customers, we closed 45 enterprise deals in the quarter of material size, up from 40 in the prior quarter and averaging about $65,000 annualized revenue per deal. For Timpani Sales and Marketing the average new deal size was $120,000. With the up-sale activity we've been seeing with Timpani users, our average Timpani user is now generating revenue of roughly $300,000 per year. As Rob mentioned, this metric is up about 50% over the last 24 months.

In terms of revenue mix, about 70% of new enterprise revenue in the quarter came from Timpani Sales and Marketing deals, and 30% from more traditional contact center deals. This is about a 20 point shift from last quarter's figures away from Timpani Sales and Marketing. Given the huge swing toward Timpani Sales and Marketing driven by a small number of large deals in the prior quarter, this is well within our expectations.

25% of incremental revenue in the quarter came from new clients, new logos. And the remaining 75% from existing clients, also in line with prior quarter experience.

Our small business group had another strong quarter as Rob highlighted, bringing in roughly 9% sequential revenue growth. Solidifying what has been a strong year for that group.

As I mentioned, the Proficient integration is tracking well. We have already eliminated redundant positions that have enabled us to trim headcount by about 30%, while we are working closely with each of Proficient's existing clients and sales pipeline customers to ensure the maximum benefit from this acquisition.

We have minimized the cash burn in Q3 and expect to have approximately breakeven cash flow from Proficient alone in the fourth quarter.

Our client roster has been bolstered significantly with the addition of several of the world's largest financial institutions in conjunction with this acquisition in addition to CarMax, E-Loan, and others.

I'll now give a little bit more specific detail on the results for the quarter.

For the quarter, we reported record revenue of $8.9 million, a 20% increase versus $7.4 million in the prior quarter, and a 55% increase versus $5.7 million in the third quarter of 2005. Excluding the impact of Proficient, revenue grew 12% in the quarter to $8.3 million, representing a 45% increase from the prior year.

Deferred revenue was up significantly by about $1.2 million to $3 million, as compared to the prior quarter, and up nearly 80% from a year ago at this time.

Cost of revenue in the first quarter -- third quarter rather, was $2.1 million, as compared to $1.6 million in the prior quarter, and $1.1 million in the prior year, resulting in overall gross margin of 76%. Proficient contributed significant downward pressure on gross margins. And this will continue to have impact in Q4 and then net impact with diminish fairly significantly as that integration work is completed over the next two to three quarters.

Excluding Proficient, gross margin improved by nearly a full percentage point to approximately 79%, compared to 78% in the prior quarter. Gross margin overall should return to the high 70s and low 80s by the second quarter of 2007 as the Proficient integration continues.

Product development expense for the quarter was $1.4 million, as compared to $1 million in the prior quarter, and $.7 million in the comparable quarter in the prior year. As we discussed on the last conference call, we continue to ramp up our R&D resources to support product development and expect to continue the higher additional resources in the fourth quarter, although at a slower rate of increase than in the second and third quarters.

Sales and Marketing expense for the third quarter was $3.1 million, up from $2.9 million in the prior quarter and up from $1.7 in the prior year quarter. We currently have 13 quarter-carrying sales reps on the enterprise side of the business and expect that to grow to about 15 by year end.

G&A expense, excluding amortization of intangibles, was $1.8 million in the third quarter, up from 1.4 in the prior quarter due primarily to the impact from Proficient, and up from $1 million in the comparable quarter of 2005.

EBITDA, or earnings before interest, taxes, depreciation and amortization, was $1.3 million, up from $1.2 million in the prior year period. EBITDA per share in the quarter was $0.03, up $0.01 as compared to the prior quarter and flat as compared to the prior year.

We reduced our valuation allowance against deferred tax assets this year as a reminder resulting in an effective tax rate of zero. And there is also reconciliation between EBITDA and GAAP net income in the financial statements that are accompanying our earnings release.

Net income per share in the quarter was $0.01, and as I mentioned, this includes the impact of about $0.01 stock-based compensation expense.

I think most impressive in the financial results outside of the significant revenue gain was the expansion of our operating margins which was somewhat obscured by the impact of the Proficient acquisition. If we adjust for the impact of Proficient, our EBITDA margin and net income margins both increased by more than 500 basis points as compared to just the prior quarter. EBITDA as a percent of revenue increased from 14% to 19% while net income increased from 5% to 11%. The improvements were spread across the operating cost lines, cost of goods, sales and marketing and R&D primarily, with the bulk of the improvement coming in the sales and marketing line. This result supports our continuing expectation that we are on track to obtain our targeted EBITDA margin of 35% at an annualized revenue run rate of between $50 and $60 million as we discussed in our last call 90 days ago.

Turning now to the balance sheet, our cash balance at quarter end was up a bit to $19.8 million, up about a half million dollars. Cash flow from operating income in the quarter was offset by certain acquisition costs, prepaid expenses, some capital expenditures, as well as, an increase in accounts receivable.

Our accounts receivable balance increased to $3 million from $2.4 million in the prior quarter. And this is really due primarily to both increased sales levels, as well as, somewhat slower collections from larger clients. Our accounts receivable post quarter end is about 45% lower than the number you see in the earning release. And that's due to subsequent cash collected which is a typical pattern we see quarter to quarter. So our bad debt risk viewpoint at this point in the quarter remains positive and unchanged. DSOs are low, even with the increase in AR, running at about 35 days.

We'll now talk a bit about our expectations for the current quarter and the rest of the year. As we told two quarters ago, our goal for the second half of the year was 10% sequential growth or better, and I'm pleased we've been able to deliver on that promise and then some with 12% organic growth this quarter. We expect to equal or surpass that in the fourth quarter which is also ahead of our previous expectations. We are also raising full year revenue guidance for the second time in as many quarters.

As detailed in the earnings announcement today, we expect the following financial results.

In the fourth quarter of 2006, we expect revenue of between $10.0 and $10.1 million. And this, the midpoint of that range, generates a sequential quarterly revenue growth rate of about 13%.

We also expect in the quarter EBITDA of between $0.04 and $0.05 per share and GAAP EPS of $0.02 for the fourth quarter. For the full year, taking into account these adjustments, we expect revenue of between $33.1 and $33.2 million. We expect EBITDA per share of between $0.12 and $0.13 and GAAP EPS of $0.04 for the full year of 2006.

As a reminder, our share count will increase by some amount up to a maximum amount of 2.05 million shares as of March 30, 2007 based upon the revenue earn-out provisions related to this acquisition of Proficient Systems.

Our practice is to give initial full year guidance for the coming year on the February conference call which we expect to follow again this year.

As you can see, Q3 results and Q4 revenue expectations are strong. I would caution, however, against simply straight-lining these very strong growth rates until we get more hard data under our belts, and we'll come with an update on our forecast in the first quarter.

These GAAP EPS expectations I highlighted already include the estimated impact of the change in accounting policy related to FAS 123. This change we expect to impact net income per share by $0.05 for the full year and $0.01 for the fourth quarter. Based upon the unamortized stock based comp expense as of September 30th and this includes the impact of the shared issuances to date related to Proficient acquisition. This impact may change, of course, based upon any additional stock option grants and forfeitures, if any, methodology refinement, or other factors between now and the end of the year.

CapEx in Q3 were about $130,000. We expect a total CapEx for the year to run approximately $600,000. Deprecation and amortization, excluding the stock comp expenses, is expected to be approximately $1.4 million for the year. This includes the impact of the amortization for intangibles related to the Proficient acquisition, and that item in isolation will run an approximately annualized rate of $1.2 million per year, and that effective as of the date of acquisition which was July 18th.

Those concerned with share count assumptions for the year, should be looking at approximately 44.5 million shares fully diluted by year end. And that includes the addition of the first 2 million share [indiscernible] related to Proficient.

That covers the financial review. At this point we would invite the operator to rejoin the call and give our listeners some instructions for Q&A.

[Operator Instructions]. Our first question comes from the site of Nathan Schneiderman from Roth Capital Partners. Go ahead.

Hi, Thanks very much. Hi, Rob. Hi, Tim. Nice job on the quarter.

Thank you.

I have a handful of questions for you. One is, I know you're not out with the '07 guidance, but I was wondering if you could just help us with your current understanding how the tax rate may change and what other kind of reasonable assumptions you think at this point for '07, '08? Do you go to a normalized rate or do you stay at the zero?

I think we should stick with our existing guidance which is where we expect the zero rate to continue to the end of the year. We'll true that up at year end. And then from a book perspective, we should continue to use a 35% to 40% rate for '07. To the extent that that is adjusted, you would likely be potentially favorable. But at this point based on the information we have, that's the right assumption to use.

OK. And then in terms of the impact of Proficient, any unusual impact on the balance sheet items, particularly the receivables or the deferred revenue?

Receivables nothing out of the ordinary and everything in line with reasonable collections and in line with the revenue run rate. And in terms of the other piece, there was some deferred revenue on the books, had some impact on overall deferred revenue, but it was fairly minimal.

OK. And then final question for you and then I'll drop off. I was just wondering if you could speak to the revenue seasonality of the business that you envision for Q4 and beyond? What do you see as the seasonal pattern? Is there any sort of typical software seasonality Q4 to Q1 that you're expecting or not? And I wasn't sure if the revenue seasonality may have changed due to Proficient being part of the mix. Any differences in that company's business?

There's no real distinction with Proficient that anything either material or distinct for our business. In terms of our overall business, I think it is fair to say that there is no real material seasonality in terms of the typical definition of seasonality which is a big spike in Q4 in the way of the holidays and then a drop off. There is a reality of our business, however, that when customers go live at whatever point of the quarter, that's when we start to recognize revenue from those customers assuming they're a new customer. And so this year we see a lighter schedule in December then we've seen in prior quarters and a heavier schedule in October, November and then sort of the same in Q1. And so that, I think, is part of the reason we're saying be circumspect in terms of forecasting beyond Q4 given that we're really seeing quite terrific growth in Q3 and Q4 and take that into account.

OK. So that comment about December could temper the sequentials in Q1?

To the extent that when a customer doesn't go live in December, let's say, their revenue therefore is not in place for the full first quarter and so that can have some impact on when they go live.

OK. Thank you very much.

Our next question comes from the site of Brad Mook from Boenning & Scattergood. Go ahead.

Thanks. Hey guys. Couple of questions here to start off with picking up off of Nathan's question. On deferred revenue, it did jump sequentially. If the impact from Proficient was minimal, what accounted for the increase?

We -- a couple things in the quarter, we had one fairly significant prepaid deal that went into deferred, probably as large as any prepaid deal we've had in history. Not seven figures, but close to that. So that was really the key drive.

So it's all in current deferred? That's a one year deal?

Yeah, it's on a six month rolling structure, but it is all in current. Yes.

OK. And are you seeing any change in customer payment preferences or any change in your future business along those lines?

Not any real patterns. [Run-offs] like this, because of the subscription model have a big impact. But it's not -- I'm not seeing a big trend where customers are really focused on payment structures. The trend I'm seeing are really around more overall growth and revenue rates, but not really much around payment structures.

OK. Fair enough. The 45 deals you mentioned in the quarter, how many of those were sales and marketing?

About, I guess, it's 70% impact from sales and marketing. In terms of deal count, about 20 sales and marketing, 25 contact center. So a little less than 50%.

OK. And then you've mentioned in the past last quarter I think you mentioned how many customers you had doing more than $600,000 a year in recurrent revenues. Is that a metric you can give us this quarter?

Yeah, we have sort of mentioned that anecdotally. That number is roughly eightish, nineish.

OK. And then a couple of others, one, sales force plans for 2007, you said you saw a nice bump in terms of margin impact this quarter on the sales and marketing line. Is that something you see going into '07 or are you going to need to add more heads or are you going to squeeze more productivity out of what you've got?

I think there is room to continue growing pretty decently on the existing sales force, meaning there unused capacity in the existing sales force that we are filling up as best we can. Like we said, we're still going to continue to hire, but we don't need to hire to sustain the growth rate. We would expect more rep growth would contribute to greater revenue growth.

OK. And is that a number like three to five or --

Well, I said plus two by year end which is might be by December 31, might be by January since we're pretty close to year end. And then that pace might be two to three per quarter in '07.

OK.

At the high end, but maybe one to two at the low end, somewhere in that range.

OK. And can you just comment on international progress? I know you started to get a foothold in the UK.

Yeah, the Proficient acquisition brought in several deals both existing and pipeline in the UK primarily financial services. We've also made decent headway with a very large telco based in the UK that has been an existing customer, but we've broadened our relationship through an increase in usage with them. And we've also beefed up our customer support capability in the UK in anticipation of further growth over there.

OK. Thanks. And then one last thing, are you seeing as this space matures a little bit and customers are clearly adopting these types of solutions are you seeing any preference for a broader set of solutions, other companies with broader product lines starting to dabble in your space? And I'm wondering whether the best of breed versus the broader solutions if there's any shift there especially by vertical?

Well, I think -- I'm sorry. Go ahead.

I think when we look at the broadening, I think it's more of the [existing] platform in the idea of delivering the channels intelligently seems to be what a lot of the customers are looking for right now. So I think having being the leader provider of chat and chat seems to be coming into vogue for these large enterprise customers to provide that as there primarily channel on line, coupled with the intelligence behind Timpani is sort of the winner here today. So I don't know if it is about adding chat and email and knowledge base on all those parts. I think it is more like coupling the right channel at the right time with the intelligent part of the platform. That's what's providing value today.

OK. Thanks. Great job guys.

Thanks a lot.

Our next question comes from the Brad Whitt with RBC Capital Markets. Go ahead.

Hey, guys.

Hey, Brad.

Couple questions here I guess. What kind of -- maybe, Rob, you can answer this. What percentage would you say of your new customers is coming from inquiries like RPs and that kind of thing versus any outbound marketing initiatives that you generate?

It's still primarily skewed towards an outbound activity, because I think we're still just doing a lot more education in the market about how Timpani works and especially how I think chat has sort of gone to the next level. So I'd say 80% of our sales activity is still outbound, coupled with our marketing and then outbound with our direct sales force today.

OK. Curious as to if you've started to go through the Proficient customer base, what kind of reaction you're seeing there. Is there any opportunity to expand within that customer base? You anticipate you may lose a couple customers? What's your reaction so far?

I think where we see some opportunities with some of the very large customers who, as we saw, we originally took Bank of America away from them. And they were charging them a very small fee compared to what we charge today. There will be attrition probably of some small customers that don't really need the system. You know, they just need a quick to chat versus what Timpani can offer. So we look for about a 70% conversion of a base onto our platform, and that's kind of usually our target goal. And I think we're on target to do that. I think long-term, though, the revenue impact can be significantly on the upside, because of the ability for us to go into these large enterprises and give them a lot of service. And so where I even thought earlier it would be a little bit slower to get these customers going, it seems like they want to do deployments a little faster in different divisions and things like that, so we feel really happy about this acquisition.

And, Rob, to follow up on some of your comments, you mentioned that there was a customer that was testing the Timpani product with their knowledge base more of a, I guess, trying to intercept phone calls into the call center which are more costly than a chat. Was that type of opportunity factored into your market opportunity day that you gave us in the previous quarter where you talked about 2,000 companies, an average of 300,000 ASP?

No, it's really -- that number, we've been giving that number for the last almost a year is really around the sales and marketing implementations of Timpani. And so what we are amazed with is this customer gave a presentation in front of all of our other customers and was like, look I got my hands on Timpani, and I consider myself a leading adopter of chat. And this is what I did. And it's really exciting. And what we saw from some of our other customers is like that little uh huh, that could be interesting, I didn't realize I could do that on the service side. There was some -- there are some customers who are looking to -- who are sales and marketing customers -- who are looking to use our quick to chat. And now they are going, oh wow, I could use Timpani on the service side, and here's some interesting ways in which we could use it, especially with knowledge base.

What was interesting is that his focus was knowledge based chat, and this same customer who was a huge email proponent only a couple of years ago is like look I don't want to do email. If I can get my knowledge base as the first line of defense and then get the rest on to chat based on the rules that we can do with Timpani, this is a win, win for me. And so he was, they were really excited. So it's not factored into numbers yet. I don't think I can build in yet what the total impact will be financially like what's the market size, until we get our hands around where this is going to go. And I think Jim, our head of sales, will give us a little more understanding of how we can cross also.

OK. And then my final question would be around the competitive landscape. Are you seeing any change there? It doesn't really seem like there's a lot our there from a competitive standpoint. Also, are you seeing any pricing pressure either from competitors or from customers? And do you anticipate any significant changes in pricing as you move through 2007?

We haven't sent that yet. And as I mentioned, I wanted to really highlight the small business group which competes with free sometimes. And so that obviously is as hard as it gets. And yet they still continue to win, because we have the best product and we give the best service. On the enterprise side, I think we clearly have a leadership position. I'm hearing more and more activity from guys who are offering email and knowledge based and say, oh yeah, we're going into chat, and we're going to be in chat now. Because I think they think it's starting to get some real momentum. But we've always been there with the leader. And we're continuing with our research and development. And I think it's good. I would love to have more competitors out there knocking doors and stimulating growth, because we're going to be called in. We're going to be called into deals, and we'll win them because it's our strength. And so I anticipate competitors next year, but I think it's good for our business.

OK, thanks. That's all I have guys.

Our next question comes from the site of Richard Baldry from First Albany Capital. Go ahead.

Thanks. Last quarter you said that you thought your increase in R&D would step up by about 1.5 million annualized with the new initiative you're talking about. It looks like you basically did that this quarter if you took the delta and annualized it, so you're still talking about a sequential increase in the R&D side. Is that goal now changed? Is there a higher sort of annualize increment that you are looking at? Or is part of that sequential just basically due to the integration of Proficient, so it's still sort of the same target?

Yeah. I think you're probably looking at the total and therefore picking up the Proficient impact on R&D as well. And so our guidance indication was really focused on incremental outside of Proficient, so it's probably more or less in line with the guidance we gave previously. The increase -- Q4 will increase from a dollar perspective. But on a percent of revenue perspective, it's probably, worst case, flat ratio to revenue and might pick up a half a point or a point going into Q4.

On some of the other cost, like maybe particularly the gross margin side, the above line cost as you're doing further integration, on a dollar basis those lines could actually either flattish to down or is it more just about incrementally growing your way into more leverage as you get back to that second quarter where you think you're back in that 80 sort of zone?

Yeah, I wouldn't expect any significant declines. Sales and marketing might be the flattest of the lines just because that was not a significant impact of the Proficient acquisition. The other line items were more significant. But most of the gain, I think, will come in a slowing rate of increase rather than absolute decreases.

Then, I know it's really only one quarter, but without Proficient now out in the market as a competitor, can you talk a little about how that's changed the sales cycles if there's been maybe a one quarter pause as people have dealt with the fact that they weren't there or whether you think that those sales cycles can start to accelerate.

I think it's a little early to say. It hasn't really [indiscernible] yet. This is really a couple months into it from a customer's standpoint. That's something we will really see some hard data on in Q1 or Q2.

Thanks.

[Operator Instructions]. Our next question comes from the site of Michael Kern from Canaccord Adams. Go ahead.

Thank you very much, you guys. Just a couple of questions here. Can you give the breakout of the product segments, the sales and marketing, contact center, and small business, what they contributed to total revenue?

We're gradually getting away from that distinction. And so while the breakdown hasn't changed drastically, as we've talked about in prior conference calls, we're seeing more and more business specifically across contact center and sale and marketing. And we're also seeing customer using both. And also in the example Rob gave, sort of a hybrid. And so over time we're really seeing those, the product lines and customer bases really coming together and being treated as one segment. Small business, that is not the case. And their breakdown is roughly the same as it has been historically 35% plus or minus small business and the balance and the enterprise. So not a dramatic shift, but we just think that the sales and marketing and contact center distinction is going to be less important over time.

OK. Can you give us the percent of revenue from international, especially now that you've got Proficient over there?

That breakdown, again, that hasn't changed significant just because Proficient only had two and a half months of impact. It's in the roughly 20% range, and that has not been a big shift. I think the driver there will be significant growth within a UK based company. Which given the age of those customers, we'll probably get into that point in '07 where we'll potentially see some of those customers move up into the range where they might be a top 10 or top 15 customer. But today, they're not in that level yet.

OK. You had mentioned you had -- what is it, six to -- I'm sorry --eight to nine customers currently over 600,000. You had also given a count of how many you believe could get to that point. Could you give that to us again?

Yeah, I think that has not changed either. That number that we gave was in the 30 range. Those types of customers, I think it's safe to say, we probably add two, perhaps three, a quarter. so maybe that's up to low 30s at this point, but --

OK. That's all my questions. Thank you.

[Operator Instructions]. It appears that we have no further questions at this time.

OK, well thanks for tuning into our conference call for Q3, and we look forward to talking to you in January on our Q4 results. Thank you, bye.