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Taleo Corporation (NASDAQ:TLEO)

Q3 2008 Earnings Call Transcript

November 3, 2008, 4:30 pm ET

Executives

Nate Swanson – IR

Katy Murray – EVP and CFO

Mike Gregoire – Chairman and CEO

Analysts

Tom Ernst – Deutsche Bank

Brad Reback – Oppenheimer

Brendan Barnicle – Pacific Crest

Andrey Glukhov – Brean Murray

Adam Holt – Morgan Stanley

Natesh Daloo [ph] – Merrill Lynch

Steve Koenig – KeyBanc Capital Markets

Sasa Zorovic – Goldman Sachs

Michael Clark – FBR

Operator

Good day, ladies and gentlemen, and welcome to the quarter three 2008 Taleo Corporation earnings conference call. My name is Misalle, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Nate Swanson. Please proceed, sir.

Nate Swanson

Good afternoon and thanks for joining us for Taleo’s third quarter 2008 earnings results conference call. This is Nate Swanson, Investor Relations for Taleo. And with me on the call today is Mike Gregoire, Chairman and Chief Executive Officer, and Katy Murray, Taleo's Chief Financial Officer. Mike and Katy will offer some prepared remarks lasting for approximately 25 minutes and then we'll open it up to Q&A.

Please note that our remarks today contain forward-looking statements. These statements include, but are not limited to, statements regarding Taleo's future financial performance and future demand for our solutions. These statements are based solely on information available to Taleo as of the date of this call and should not be relied upon as representing Taleo’s views of any date subsequent to today.

Taleo undertakes no obligation to update these forward-looking statements to reflect events or circumstances after today. Our forward-looking statements are subject to a number of risks and uncertainties that can cause actual results to differ materially. We refer you to specifically to the risk factors set out in our annual report on Form 10-K filed on March 14, 2008 and our quarterly report on Form 10-Q filed on August 11, 2008. Both of these filings are available through the Investor Relations section of our website at www.taleo.com or through the SEC’s website at www.sec.gov.

In addition, during our discussion today, we will be using GAAP and non-GAAP numbers. Our GAAP numbers and reconciliation of our non-GAAP numbers to our GAAP numbers are contained in our Q3 2008 earnings press release that’s available on Taleo's website at www.taleo.com and in the filing on Form 8-K. In addition, please note that a webcast of today's call will be available on the Investor Relations section of Taleo's website.

And with that, it’s my pleasure to turn the call over to Katy.

Katy Murray

Thanks, Nate. And good afternoon, everyone. As you have already seen in today’s press release, we have posted another strong quarter, not only in a tough economic environment but also after closing the Vurv acquisition on July 1. In the past, I have gone through the income statement line-by-line, but starting this quarter I’m changing the format and will spend sometime on the key financial highlights in the quarter, go through our financial guidance, and then turn the call over to Mike who will discuss the quarter and our overall outlook in more detail.

In regards to revenue, this quarter we reported non-GAAP revenue of $50.6 million. As a reminder, the non-GAAP revenue includes that revenue that would have been recognized by the acquired deferred if it were not required to be written down in purchase accounting We expect the non-GAAP revenue adjustment to decrease sequentially and to basically cease by mid 2009. This is due to the fact that the acquired contracts are predominantly build on a quarterly basis.

In terms of new enterprise visits, we added 22 new enterprise customers, which is an increase over the 17 in the third quarter of ’07 and slightly down from the 26 signed last quarter. For Taleo Business Edition we added 210 new business addition customers, up from 191 in Q3 of last year and 207 last quarter. We closed 60 over the first year ASP greater than 250,000, and this compares to 10 last quarter and 7 one year ago.

As you can see from the numbers we posted, despite the economic uncertainty and the view that the third quarter can be a seasonally slower quarter, we continued to show business momentum. Our non-GAAP gross margins were down sequentially as expected to approximately 68% due to the duplicate costs that were incurred in Q3 for data centers and costs related to support the Vurv products.

Operating expenses were in line with guidance, and we are exiting the quarter with a non-GAAP operating margin of 10.6%, a significant increase over the 8.6% reported in Q2. The increase in our non-GAAP operating margin is a direct result of decisive actions made in conjunction with the acquisition as well as continuing to focus on leveraging operating model.

In regards to amortization expense, this quarter we recorded $3 million of expense related to the acquired intangibles, and in addition, we recorded an intangible impairment of approximately $2.3 million related to the intangibles associated with the Optimize product. As we have previously discussed, our intention is to sell this product and the associated assets and liabilities, and as a result, those intangibles acquired have been impaired. This is a one-time expense.

This quarter we recognized a minimal tax benefit, as we guided to. However, in the fourth quarter, while we do expect to incur a GAAP loss, we do expect to incur income tax expense of less than 5% on a GAAP and non-GAAP basis as a result of international taxes and AMT taxes. One additional note, we continue to anticipate the favorable settlement of an ongoing Canadian investment tax credit audit in the near-term. And if so, this may reduce the tax expense settled in the fourth quarter.

Turning to the balance sheet, collections were strong this quarter and DSOs on a non-GAAP adjusted basis were 58 days after taking into account the change in deferred revenue and customer deposits. From a cash flow perspective, we are pleased with our performance this quarter. As we guided last quarter, we did expect to see cash flow from operations come under pressure. And as expected, we did use approximately $6 million of cash this quarter. The cash usage is related to one-time expenses such as severance and retention payments made this quarter, as well as some other one-time duplicate operating expenses.

As you see in the financials, deferred revenue increased by a net $10 million over the prior quarter. And while a portion of this was related to the acquired deferred from Vurv, the overall growth in deferred was in line with the momentum from the quarter.

In regards to headcount, we ended the quarter with 852 employees compared to 678 at the end of June. We have 75 individuals compensated on sales achievement, of which 33 are quota carrying reps focused on the enterprise business and 21 on our SMB business. We have an additional 21 individuals focused on renewals and up-sell opportunities.

Turning to guidance for the fourth quarter. For the fourth quarter, we expect non-GAAP revenue in the range of $51 million to $52 million. This guidance takes into account the timing of the Vurv legacy, service implementations that are ramping down from last quarter. And therefore, we expect services revenue to decrease by approximately $900,000 from the third quarter to the fourth quarter. In addition, this revenue guidance also takes into account our decision to exit the Staffing Edition and Optimize business lines that were acquired from Vurv.

Fully diluted non-GAAP EPS of $0.15 based on fully diluted shares outstanding of $34.2 million for the fourth quarter. Non-GAAP blended gross margins of approximately 66% to 67%. Operating expenses to be basically in line with the third quarter. Stock compensation expense of $3.4 million, amortization expense of $3 million, and depreciation expense of $3 million.

For fiscal year 2009, we recognized that it is too early to understand the full impact of the current economic concerns. However, we do feel that we need to give our view regarding non-GAAP revenue and non-GAAP EPS. For fiscal 2009, we expect non-GAAP revenue in the range of $220 million to $225 million. On non-GAAP EPS, again based on our best visibility at this time, we feel that lowering our original estimate of $0.87 to $0.89 to a range of $0.80 to $0.85 based on 35 million fully diluted shares outstanding is the responsible thing to do.

This overall guidance takes into consideration our current understanding and view of the potential impact of the economic uncertainty on our business as well as on our customers’ businesses in 2009. In addition, while we are seeing favorability in exchange rates, specifically with the Canadian dollar and the euro, we cannot assume that they will continue into 2009 and that has also been taken into consideration in our guidance.

In closing, I was very pleased with the execution we demonstrated in Q3 by driving an increase in our non-GAAP operating margin, exceeding the third quarter financial expectations, and being able to raise our full year 2008 non-GAAP revenue guidance from the range of $175 million to $177 million to approximately $178 million.

With that, I would like to turn the call over to Mike.

Mike Gregoire

Thank you, Katy. Our third quarter of 2008 was another strong quarter for Taleo. And we were able to execute across every area of the business in spite of a very difficult economic environment. Sales were strong in our recruiting products as well as in our performance management products. Both enterprise and SMB business units performed well. And we made significant announcements at Taleo WORLD that will shape Taleo's future and the future of talent management.

But first, I’d like to comment on the current economic environment and how it affects Taleo. Given the recent financial crisis, and the immediate future looks like it will be a cautious and uncertain environment. And while we can’t predict the economic future, we remain optimistic about Taleo’s future and the longer term fundamentals of the talent management category.

Great companies take market share, especially in a down economy. And we intend to do just that. In fact, we believe Taleo’s competitive positioning and value proposition are stronger than ever. Competitively, we’ve proven our ability to execute, significantly expand our product offering, and continue to invest in new growth opportunities, all the while building one of the most profitable business models in the on-demand category.

Taleo’s value proposition and out pure on-demand architecture changed the way company’s buy and deploy software solutions in three main ways. First, as in on-demand application, our customers pay as they go. There are no large upfront purchases, which constrain tight budgets. Traditional software deals require big perpetual license fees, large hardware purchases, and lengthy third-party systems integration contracts. As an on-demand application, Taleo’s pay-as-you-go approach results in lower upfront cost with cost outlays spread out over several years. As a result, our customers view Taleo as an ongoing expense rather than a large cash expense or capital investment.

Second, Taleo’s software is quick to deploy with 100% track record of go-live and relatively low upfront expenses, creating a faster time to value in a high ROI. Companies are searching for ways to do more with less. An automating labor intensive paper-based processes driver material hard dollar cost savings. For example, at the HR Tech Conference in Chicago last month, one of our customers, Whirlpool, discussed how its investment in our talent management software helped them reduce expenses by 10%, which resonates strongly with customers and prospects alike.

And third, these tumultuous times highlight more than ever the need for talent management systems. Given the recent events in the financial services industry, the ability to rapidly consolidate and integrate workforces is becoming an essential competency. For example, one of our customers, a large financial institution, recently acquired another large financial institution, which required it to very quickly consolidate the business and on-board tens of thousands of employees in just a few weeks. In fact, they on-boarded 1,400 new employees in one day, a new record for them, impossible to achieve without a robust scalable talent management system.

We are happy to report that many of the financial services firms that are weathering the credit crisis the best are Taleo customers, including Bank of America, Citigroup, JP Morgan, Goldman Sachs, and BNP Paribas. A bad economy does not eliminate turnover. In 2007 voluntary turnover, those employees willfully leaving their jobs as 23% in the US across all industries. During the last recession in 2001 and 2002, voluntary turnover was 22%. And so far in 2008, the voluntary turnover rate stands at 21%. These are remarkably high numbers through good times and bad. Over one-fifth of the workforce are voluntarily leaving their jobs.

The reason for this is that the workforce is mobile and opportunistic. Employees know when their company and perhaps their industry is not doing well. And they will move to find a better opportunity in an industry that is growing and offers a better career path. In particular, the generation now entering the workforce, known as the Generation Y or the Millennials, is leaving jobs in greater numbers than ever seen before. They view a potentially better job is just a clip away.

Turbulent times create massive shifts in workforce and industries downsize and retrench, others continually to grow rapidly. We see this effect of the job creation numbers and job elimination numbers tracked by the US Bureau of Labor statistics. During the last recession in 2001 and 2002, 63 million net new jobs were created. 63 million jobs is almost half the total number of non-farm jobs in the US.

Also during 2001 and 2002, $63 million jobs were eliminated by companies. So you can see that while there was zero net new jobs created during this period, there was a tremendous shift of jobs from companies eliminating jobs to companies creating them. This movement of jobs from one sector to another results in more jobs, more candidates, and more transactions, which drives Taleo’s business.

For individual companies facing the difficult business environment, it is critical to retain their best people, the ones that will leave them through the trough environment, in a tough environment into a better one. A performance management system with career planning and career development capabilities can show your best employees the path to greater opportunity and potential advancement within your company rather than outside it.

And with a workforce in transition, the total turnover including involuntary and voluntary reaching 40% in 2007 and so far in 2008 exceeding 38%, a succession planning system is critical to replace employees who either choose to leave or are let go. Talent management is the next frontier for businesses looking to optimize their operations and increase business performance.

Technology has automated the back office, the front office, as well as the supply chain. Businesses can now communicate 24/7 to a variety of mobile devices. And we now have a wealth of company information, both internal and external, at our fingertips. But businesses, large and small, still know less about their people than they do about their computer networks and accounts payable. People are the company’s largest asset as well as its largest expense.

We at Taleo believe that in difficult economic environment, we’ll highlight the need for more proactively – to more proactively manage and optimize the workforce to achieve better business performance. The age of talent management is upon us. And Taleo is positioned very well to take advantage of it.

The third quarter of 2008 represented one of the most remarkable in the company’s history and that we achieved record results in many areas in the face of a challenging economy and a spreading sense of fear and uncertainty. In spite of this, Taleo had a tremendous quarter. Taleo Performance continues to gain rapid traction in the marketplace.

At the beginning of the year, I committed that we would close 12 performance management deals in 2008. This was an ambitious goal for a new product entering a market with mature competitors in a tough economy. But Taleo Performance is a groundbreaking new product that has been very well received in the market. I’m happy to report today that Taleo Performance has surpassed its goal of 12 customers with still one quarter to go.

New Taleo Performance customers in Q3 include Humana, CSC, Renault, PG&E, Bic, Vertex and Wilber-Ellis Company. During the quarter, we launched our second major release of Taleo Performance, including succession matrix and Review Calibration capabilities. In the Bersin & Associates report called The Essential Guide to Employee Performance Management Systems released this month, Bersin concluded the following and I quote. “Taleo Performance is truly a next-generation platform. It uses collaboration, analytics, visual indicators, performance support, contextual content and modal views to engage end-users and help them make better decisions.” Taleo Performance is a breakthrough product for us and we anticipate its continued success in 2009.

Taleo Recruiting continues to extend and lead in the marketplace. Over the last few quarters, the competitive dynamics have shifted in favor of Taleo, and Taleo has been able to increase the separation between us and other recruiting vendors. Some have had financial troubles, some have products reaching scale limitations, and some have not been able to keep up with Taleo’s significant annual development investment in recruiting. As Gartner Group highlighted in its recent Magic Quadrant for recruiting, Taleo is the clear leader in the market. And with our new version called Monarch due out in 2009, we expect not just to maintain this lead, but to increase it.

Taleo Enterprise recorded 22 new customers, including six deals over $250,000. New Taleo Enterprise customers in North America include Apria Healthcare Group, Baptist Health South Florida, ConvaTec, Conway, Frost Bank, Jackson National Life Insurance, LifePoint Hospitals, National Oilwell Varco, Newmont Mining Corporation, Panasonic Corp of North America, RGIS Inventory Specialists, Wilber-Ellis & Company, and Woodforest National Bank.

In our first full quarter of selling Taleo Edge to the mid-market accounts, we are happy to report that Taleo Edge has proven to be an effective and efficient way to service mid-market accounts. We have been ailed to leverage the technology investment of our Taleo Enterprise products with a customized implementation and services offering tailored for mid-market customers. This reduces the cost of implementation for these customers, but they still get the same scalable, feature rich Taleo Enterprise product that they will need should their requirements grow.

International revenues continue to accelerate growing at 113% compared to a year ago. International now comprises of 13% of our total revenue, an increase of 10% of total revenues a year ago. New international customers include Bic, Prudential Distribution Limited and Vertex. During the quarter, Taleo announced a strategic partnership with Worldwide Compensation that included an equity investment in the company with an exclusive option to buy the company in the future. This partnership represents an important entry into the compensation market for Taleo.

Our customers are telling us that they want to work with fewer talent management vendors, not more. And they want to work with larger, financially stable vendors, not cash strapped small companies. At the same time, these customers are demanding a seamless integrated solution that includes all core talent management functions; recruiting, performance and compensation.

During the quarter, we completed the acquisition of Vurv. And we are reporting consolidated numbers for the first time. The migration of Vurv customers to Taleo's platform is proceeding as planned, both for enterprise and SMB customers. So far, we have met with or talked to all major Vurv accounts and introduced them to Taleo and discussed their migration options. And over 80 Vurv customers came to Taleo WORLD to learn more about Taleo and our products. Most are happy that they can work with an industry leader that is financially stable and deeply committed to talent management.

Taleo Business Edition also had a very strong quarter, closing 210 new customers, a new record. Up-sells have continued to increase, as existing Taleo Business Edition customers both deploy more widely into their organizations and upgrade to the premium version. New Taleo Business Edition customers include Tesla Motors, CollabNet, Jaguar Land Rover North America, Texas AirSystems, LA Federal Credit Union, Michael & Susan Dell Foundation, Doostang, Tremor Media, Collaborative Solutions, Datascope and Axcan Pharma.

In addition, during the quarter Taleo introduced the Taleo Business Edition Perform, our performance management product significantly designed for the needs of the SMB market. Now Taleo can offer an integrated recruiting and performance management solution for companies of any size.

Taleo has over 3,100 SMB recruiting customers, and they will be our initial target for this solution. But we also expect significant interest from net new customers Taleo Business Edition Perform will shift in Q4 of 2008. In September, at our Annual User Conference that was held in Boston, where a record number of almost 1,000 customers, partners, prospects attended to hear about the future of talent management and Taleo’s plans to address it. I was impressed with the enthusiasm of our customers and the incredible diversity of Taleo implementations around the globe.

At Taleo WORLD we introduced the Talent Grid, our cloud computing strategy for talent management. The Talent Grid leverages the leadership position and the sheer scale that Taleo has established. Here are some statistics that highlight our position in the market. 100 million candidates have applied for jobs through Taleo and 10 million more apply every quarter. Over 400,000 new requisitions are posted every quarter. 2.6 million unique users access Taleo from over 3,800 customers of all sizes, all geographies and representing dozens of industries. And Taleo has over 50 partners and solution providers.

The Talent Grid will allow Taleo to leverage the scale, market leadership and expanding ecosystems to bring new capabilities to our customers and our partners. The Talent Grid includes an open platform allowing partners to enhance and complement our solution; marketplaces where partner solutions, talent and domain knowledge can be shared and exchanged; and My Taleo, which is a customized view of all the resources on the Talent Grid.

The Talent Grid is the future of talent management and will allow our customers to be much more strategic in the use of all the resources on the grid. That brings together a full suite of talent applications with our ecosystem of customers, candidates and partners under one talent community. As the leader in talent management, Taleo is the only company that can put all the pieces of the Talent Grid, and we think this will cement our leadership position.

Overall, I am quite pleased with our Q3 results and proud of what Taleo has been able to accomplish during our first quarter integrated with the Vurv and in the context of the macroeconomic environment. We're going to be prudent in our view of the economic future, but we remain very optimistic about Taleo’s future.

We’ll now turn it over to the operator for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first quarter comes from the line of Tom Ernst with Deutsche Bank. Please proceed.

Tom Ernst – Deutsche Bank

Good afternoon. Thanks for taking my question.

Mike Gregoire

Hey, Tom.

Tom Ernst – Deutsche Bank

Mike, I think you made a strong case for why growth continues for Taleo despite a weak environment. The question is, if the environment is worse than you think, what is your ability to adjust a cost ramp in the model in real time, and perhaps you can flatten it out or reverse it? And then also what’s your commitment to doing that? In other words, if you find the environment is worse, do you drive your top line targets or do you commit to the bottom lines first?

Mike Gregoire

That’s a great question, Tom. And as I said in my opening remarks and Katy said as well, the future is not exactly crystal clear for any of us. We’ve been watching and monitoring large companies as well as small companies as talking to a lot of our customers. We do have an awful lot of flexibility just due to the model. I can slow down a release. For example, I can slow down the release of Monarch in 2009. I can slow down marketing spend. We can stop hiring sales professionals. We have a fair bit of flexibility in our model to adjust expenses. And what we would do if we bumped into something that was significantly or materially different than what we have planned for, we have to balance how much market share could we get and what would be the total cost of getting that market share compared to getting to the bottom line. As you know, philosophically our company, and Katy and I are united this, we want to be a profitable SaaS company. You can see the growth that we’ve done just this quarter alone going from approximately 8.7% to the mid 11% in operating margin. We’re able to do that in a tough economy. And we would want to be able to measure what’s the biggest business value. The top line is not there. You better make sure you’re driving the bottom line. But if the top line can be there, I think we can still preserve the guidance that we put into out bottom line and get to growth in the top line. Hey, Katy, do you have anything you’d like to add to that?

Katy Murray

No, I think that’s important. And then also, Tom, to my point about visibility, we have obviously from the model good visibility on revenues. So if things look like from a marketplace, we have the ability to see a few quarters out. So I think that that’s actually key as well to not overreacting or just reacting on the spur of the moment, which we have never done. But to be able to actually think about something more methodically going out into the future saying, when do we need to make these changes.

Tom Ernst – Deutsche Bank

Great. If you permit one follow-up, I’m curious if there is anything you are doing or plan to do tactically to try to ensure that you do stay at the top of the priority list, be it shorter payment terms, different ways of breaking the product up into smaller pieces, anything like that?

Mike Gregoire

We’ve not bumped into that with the customers we have talked to thus far, Tom. But once again, preserving as much flexibility as you possibly can have, we are very careful when we built a product, to build the product modularly. And given the choice of helping a customer get some business benefit, even if they couldn’t – they didn’t have the budget to do a full worldwide implementation, we’re obviously prepared to do that. If they can’t afford to have the whole suite, more than happy to engage in a relationship with them and get them going. The beauty of our integrated talent management platform is that there are benefits. If they only bought Recruiting, it’s the same system administration interface and it’s the same org structure. Similarly if they just bought Performance Management, they would be a leg up for their implementation to get Recruiting. So customers that can’t afford it having it all, we can show them how they can get as much as they possibly can afford and start to get some benefit and not fall behind. The biggest thing that I see though, Tom, is that this application is becoming more of a mainstream application, more of a must-have. You just can’t imagine dealing with hundreds of thousands of resume and the workflow required as people continue to shift jobs. I don’t think that that’s going to change. I think that people will understand if they are with a good company and they will probably stay there. But if they think that their company or their industry is not going to make it, they are going to take a look at their own personal situation and they are going to work hard at getting a new job. And to the extent that companies can’t handle dealing with a flood of resumes coming in or if they are one of the companies that are losing employees, they are going to want to have an automated system that helps them understand who their best employees are that they have to get out there and really embrace. So I don’t think the business need of our application has deteriorated in the tough economy. Getting people and convincing them that this is the way of the world, that’s something that our sales force is educated to doing, and we’re continuing to drive that with our sales force. Hopefully that’s helpful.

Tom Ernst – Deutsche Bank

Great. Thank you again.

Operator

Your next question comes from the line of Brad Reback with Oppenheimer. Please proceed.

Brad Reback – Oppenheimer

Hey, guys. How are you?

Katy Murray

Hi, Brad.

Mike Gregoire

Good.

Brad Reback – Oppenheimer

Any chance you'll give us the Vurv contribution on the deferred revenue line?

Katy Murray

Hey, Brad, I’ll take that question. I think that was coming to me. So – no, we are not going to break out the organic versus the inorganic growth on the deferred revenue. We talked about that back this summer. And I just want to remind everybody, we are no longer selling the Vurv products. They are being supported. Everything is being sold through Taleo. We are engaging with the customers going through up-sells, going through new sales cycles, and there really is no separate Vurv platform to track. There were some acquired deferred, as I talked about on the deferred revenue, deferred revenue did increase by a net $10 million. A portion of that came from the Vurv portfolio and the rest was driven from the Taleo, just the pure Q3 momentum. And we feel good about where the business is, feel good about what our metrics are, but we are not going to be breaking out today or in the future any of the organic or inorganic growth rates around revenue or deferred revenue.

Brad Reback – Oppenheimer

So, Katy, since you are not selling Vurv any more, in an 8-K filed during the quarter, I think at the end of June, the deferred – after the write-down – the deferred revenue after the write-down of Vurv was about $7.25 million. Would there be any reason I think that that number wouldn’t have been lower by the end of this quarter?

Katy Murray

There wouldn’t be. I mean – and so you’ve got to think about the deferred revenue that Vurv would have had. You are referring to the 8-K/A that was filed. And that revenue was subject to a write-down on the purchase accounting. So when things come through – again, the big thing about it is quarterly billing. The majority of their contracts were quarterly, very similar to Taleo. So as you can expect, deferred revenue is going to come back through Taleo at a 100% starting in the fourth quarter. And then again you’re going to see this deferred revenue write-down release cease by mid-2009 once the few annual customers cycle through.

Brad Reback – Oppenheimer

Okay. When we think about the guidance you gave, the bottom line $0.16, obviously you guys did – you did $0.17 this quarter. I understand the tax rate going from a benefit to a headwind. Are there other things we should think about? It would appear you should be getting a little more leverage than that as you integrate these two businesses and get going on that front?

Katy Murray

Well, I think, to your point, we are looking for the increase in leverage on that, but one thing that we – I did highlight as well is going into this quarter, we were determined to make the decisions around the products, around what we were going to do. This quarter we have – or actually this past quarter we’ve made the decision. I mean, we’ve not going to be sustaining activity in the Optimize and the Staffing Edition portfolio that came over from Vurv. So that is actually impacting the fourth quarter as well. And then also the services, the legacy services implementation are dropping very quickly. We knew we have to continue to meet the obligations that we took on on July 1, but all new service engagements are coming through from the Taleo sales and implementation. So that is actually something that we are sustaining the revenue drop and we are still – and the tax effect coming in and coming out with $0.16.

Brad Reback – Oppenheimer

Great. Thanks a lot.

Katy Murray

Thanks.

Operator

Your next question comes from the line of Brendan Barnicle with Pacific Crest. Please proceed.

Brendan Barnicle – Pacific Crest

Thank you very much. Guys, I was wondering about maybe some of the assumptions behind the ’09 guidance. Is there any metrics that you are using in terms of IT growth rate or a GDP growth rate that you’re looking at, or unemployment level or anything along those lines that you are using as the derivative for the guidance?

Mike Gregoire

Hey, Brendan, this is Mike. I think you need a two-part answer here. You need the business and then the financial. From a business perspective, we went through the pipeline pretty rigorously. I just spent the last two weeks on the road, just came back from the southwest on Friday, specifically talking to customers and prospects. And then we had HR Tech where I was able to talk to dozens of customers to get an understanding of where their head is with respect to budgets. So my whole purpose of these conversations was, first of all, just to do the client relationship activities that a CEO would do, but also find out how is their business tracking and how do they see their spending and try to make that as tight to a Taleo question as I possibly can. And in all of the questions that I’ve been able to answer, budgets at this particular moment in time are continuing to hold. Coupled with that, we had all of our North America sales force in town a week ago. And that was a great opportunity for me to get some casual conversations with our sales force and once again drill down into how are they viewing their relationship with their clients, what are they hearing from their clients. And our sales force is still bullish about their pipeline. So to the extent that I’ve been able to have conversations about the pipeline and that business professionals at this moment in time believe that they are going to be able to carry forward with their purchasing plans, I haven’t seen any material pushback at all. And so that’s a business perspective. Now on a financial perspective, once again, Katy already alluded to this, our model, we have – we walk into each and every quarter with over 90% of our revenue pretty much locked in. And Katy has got systems that have a waterfall effect of what is happening in our revenue. So she has the ability to take a look at, to a fair degree of confidence, at least the first half of the year. So I’ll turn it over to Katy.

Katy Murray

So – yes, Brendan. I mean, I think the thing to remember about ’09 is – I mean, it’s still November, we’re going through our ’09 planning season as well. And when you look at our business for next year, there are a couple of things that Mike and I have been very focused on this. Over the past several years, we planned ’07 and ’08. As you plan what you can see, you plan to spend what you can afford to spend. And when we are looking out, so while we do take into consideration the economic factors, try to understand some of the variables that we cannot – absolutely cannot control like FX and things along that line to make assumptions, we also build a plan based on revenue visibility. What are the priorities for the year? We highlight those. And we build out a plan accordingly to that. So there is economic impact on this, but a lot of this also is very much around the SaaS model and being able to spend what you see and making assumptions around renewals and next year’s bookings and the opportunity for growth where it becomes very mathematical.

Brendan Barnicle – Pacific Crest

So is it fair to assume that in the guidance that you gave us, you’ve taken sort of your baseline case of what you already have within the pipeline and the renewals, and that’s all that’s in this and there is no – there is not – or, to what extent is there I guess a factor for what may happen beyond that in terms of new business? And I guess maybe that we do more towards like the bookings-type growth rate.

Katy Murray

Yes. I mean, we have to make some assumptions as there will be bookings and momentum next year. But an example would be, when we entered into 2008, we did not build our ’08 plan based on an aggressive assumption around performance management and getting out to market. Very similar with ’09. We’ve got the partnership with Worldwide Compensation. We’ve got the option to look at buying that next year. Those are the things that I’m not going to make aggressive assumptions on for the ’09 plan, but they could be very positive to the plan and we’re looking to do that. We would not have been involved in that transaction have we not thought that it would be a positive impact to the business, but to build a plan off of that where you are building an expense model and willing to show leverage in your operating model is not what you would do. To your point there are some assumptions around the bookings and where the visibility is. But what Mike said is, I mean, you look out several quarters into the pipeline and you want to make sure that you can start to understanding some of the assumptions around the third and fourth quarter before you start building expectations around permanent expenses that are built.

Brendan Barnicle – Pacific Crest

And then just one last – that’s very helpful. One last one. Katy, do you see anything around collections? I think, Mike, you alluded to it that nobody had wanted any change in kind of billing terms. Did you see any change around that? We have seen that with another SaaS company earlier this quarter.

Katy Murray

We actually had a 58-day DSO this quarter. It was a fantastic quarter for collections. Our collections momentum, I have not seen any change in that. And I think that from a deal perspective, I’m very involved in those types of negotiations around payment terms and have really yet to see any of the pushback around that type of structure. To Mike’s point, and what we’ve talked about earlier too, we have never been a company to predominantly bill upfront. We bill on a quarterly basis. It allows people to help manage their cash flow. But it also allows them to get visibility and they get benefit for what they are doing and they pay ongoing. So really for us on a quarterly basis, I would expect to continue to see cash coming in on a quarterly basis to match the services that we’re providing. And again, on an upfront basis, it could be a bit different just because of the challenge of getting someone to pay upfront for something that they are going to get over the next 12 months.

Brendan Barnicle – Pacific Crest

Great. And then lastly, tax rate that you assumed in that ’09 guidance?

Katy Murray

The tax rate is we’ve got several open items that are out there still relating to the tax on it. What I would like everybody to do is to maintain the tax rate roughly around the 10% as I get better visibility. We obviously do continue to give that, but as you can even see in the third quarter and the fourth quarter, we have some variability between tax benefit and tax provision, just given our assumption of some of the NOLs coming in, some of the settlements around the tax audit. But for planning right now, I would say, use the 10% and as we get into ’09, we’ll be looking to true that number up.

Brendan Barnicle – Pacific Crest

Great. Thanks so much, guys.

Operator

Your next question comes from the line of Andrey Glukhov with Brean Murray. Please proceed.

Andrey Glukhov – Brean Murray

Yes, thanks. Mike, when it comes to sort of you meeting Vurv customers, maybe what are some of the pushbacks you’re seeing when you talk to them about transitioning to Taleo Enterprise? And sort of now with three months under your belt, are you making any adjustments to your assumptions around the conversion rate of those customers?

Mike Gregoire

Great question, Andrey. It’s oddly enough, it’s like we expected. In buying a lot of companies when I was at PeopleSoft, we bought an awful lot. It always follows the same pattern. There is the shock, the despair, and then you finally get educated and there is understanding, then there is negotiation and then eventually you get the customers to where it’s good for them and it’s good for the company. We are still in the early stages. We are coming out of the shock stage and into let’s understand this better. All of our assumptions are still holding. I’m very involved with that. I was in Europe at the beginning of the month talking to some of our larger European customers. And they are working through their process. The biggest thing is we’re a small company dealing with large companies for the most part. And the large companies are a lot used to small companies changing their operating environment. And so just getting through that emotional hurdle, believe it or not, takes a little bit of time. But when we are able to show them that they have had what the world looks like on the Taleo side, a company that has great operational excellence, we have the highest customer satisfaction in the industry. We have a deeper and broader support network. The technology works all day, every day, and it scales. Helping them understand these are benefits that they are going to get if – when they get to the Taleo platform, that seems to work pretty well. Secondly, it’s they realize that they have time. This is not something that we’re forcing to get done in three months a year. They have three years to do that. So they, in essence, have at least two budget cycles to work through a plan to make this happen. Now, we’ve already signed an agreement with one of our largest Vurv customers. Coke is going to come over to the Taleo platform. We’ve already started that migration. We know that that’s going to be a success because that is a large customer that drives an incredible amount of transaction volume. It’s a great brand name. And this is a customer that was looking forward to getting on to the Taleo platform for all of the reasons that Taleo is the industry leader with 47 of the Fortune 100, because we know how to handle that type of business. Is that helpful and specific enough, Andrey?

Andrey Glukhov – Brean Murray

Yes, that helps. And then, Katy, a couple of questions. I think we can all appreciate building in some slack for especially foreign exchange. What rate are you assuming in your guidance?

Katy Murray

Andrey, I’m not going to give out the specific rate I’m using for Canadian dollar and euro on the ’09 plan. As for anybody right now, it’s the best estimate that we can. We look to any of the leading banks looking for averages for next year, what they are expecting. If you look at the average for October, it is abnormally low. So we’re not going with some average rate of October. I can give you that. But it does – our rates do increase from that, but not back at the high.

Andrey Glukhov – Brean Murray

Okay. And just to clarify, is your planning process entering ’09 – for ’09 guidance, consistent with the planning process that you used entering ’08?

Katy Murray

It is.

Andrey Glukhov – Brean Murray

Okay. Thank you.

Operator

Your next question comes from the line of Adam Holt with Morgan Stanley. Please proceed.

Adam Holt – Morgan Stanley

Hi, good afternoon. Can I ask a follow-up on the headcount side? Obviously now that you’ve closed for when you got a bunch of new people on board, can you update us as to what your conversion rate has been in terms of being able to keep people, in terms of offers that have been given out? And secondarily, in terms of the sales organization that’s now in place, do you feel like you have excess capacity or should we expect to see that number continue to grow?

Mike Gregoire

Hey, Adam, it’s Mike. With respect to Vurv, I think at the end of the day, we’re pretty happy with the crew that we kept on board. I would have – there is a few people that I would have liked to have seen stay with our company. But at the end of the day, as you‘ve been in business for a while, you can’t make people do something they don’t want to do and you can’t make people do something they can’t do over a long period of time. And some folks just do not want to be a part of a publicly traded company despite how qualified they are and despite their skill set. So, it’s not perfect, but I would say that of all the people that we really wanted to be part of this company and the people that wanted to be part of our company, I think we did exceptionally well. So if you take a look at the numbers, there were 330 people in Vurv when we acquired. And it looks like we kept about 158 of those folks. So we purposely cut pretty deep because we knew that – if you are going to make an error, you want to be more aggressive rather than less aggressive. And that was our philosophy going in. And we kept the kind of folks that we thought would be great for our company. On the sales side, I don’t think we have any excess capacity. We will continue to hire sales professionals. We’ll hire sales professionals in the TBE business line, probably get into double digits on that. And we will also add sales capacity on the Enterprise, but you should think of that in the five to ten total in 2009. So – once again, we’re planning on some growth next year. We do not view the world as completely broken. We think that our solution and the problem that we’re trying to solve doesn’t get any easier. It gets more difficult. And having sales professional being able to articulate that message in the marketplace at a responsible rate we think is best for business.

Adam Holt – Morgan Stanley

And Katy, if I can ask you a question, what – post the Vurv close, what percentage – remind us what percentage of you headcount is in Canada and what the impact to earnings was in the quarter from currency moves?

Katy Murray

We actually don’t break out the foreign currency. That was something that we’ve talked about this. Foreign currency for us, while we do have some exposure on the Canadian side, we do have some in the international, both on revenue and expense. It doesn’t drive the business terribly where we can actually – if we are starting to see things move one way or the other, we have the ability to offset that. And the other piece of this is we have a large development center now in Jacksonville too. And so that’s US dollar base. From an overall headcount perspective, in Canada right now, it’s less than 25% of our total headcount of about 852. It’s less than 200 people or right around 200. It moves around with open headcount. But that’s it specifically. So again, we also have the R&D credits in Canada. So while the expense is impacted by foreign currency favorably, the R&D credits go the other way. So I mean, there’s a lot of ins and outs on that, but we have not been breaking out foreign currency in the past and will not yet do that either until it becomes material to us.

Adam Holt – Morgan Stanley

Great. Thank you.

Operator

Your next question comes from the line of Natesh Daloo [ph] with Merrill Lynch. Please proceed.

Natesh Daloo – Merrill Lynch

Thank you so much for taking my questions. Just one quick – two financial questions for Katy. One is on the amortization of intangibles – sorry, the impairment of intangibles on the Vurv’s Optimize product, was this something you all expected or was this something which came on later on?

Katy Murray

The only time you make decision to sell a product, you have to look also back at the intangibles and also any of the assets associated with that. So when we formalized that decision this quarter, we did know that we would have an impairment. It’s a one-time charge that obviously you have to look at that from the first accounting side. And we made the adjustment based on what we believe the fair value to be. So, not unexpected with the decision to sell a product line, it would be something that anyone else would see as well.

Natesh Daloo – Merrill Lynch

And where is the amortization broken out, the $5.2 million amongst – in the P&L?

Katy Murray

It’s actually if you look at the financial statements, the pro forma, we’ll break that out for you. It’s between sales. It’s specifically where that one is located, and there is also some amortization that’s sitting in application cost of sales.

Natesh Daloo – Merrill Lynch

Okay. And the other –

Katy Murray

That’s on the pro forma financials.

Natesh Daloo – Merrill Lynch

Okay. And for – on the cash flow statement, the use of cash was about $6 million. So if you take out the one-time adjustment, what would be the normalized cash flow for the third quarter?

Katy Murray

I told you [ph] in there we spent about $6 million roughly on severance, severance-related retention. There were one-time top of operating expenses. We would have been somewhere cash flow positive. Last quarter we were closer to $10 million. I don’t think we would have been there. It’s hard to capture specifically what some of the one-times were. But it was the cost and the payment of the one-time items that led us to be negative for the quarter.

Natesh Daloo – Merrill Lynch

Okay. And then just one quick business question is that, are you seeing any kind of change in the sales cycle, especially in the small business side?

Mike Gregoire

This is Mike. Haven’t seen anything in the small business side. As I said, it’s hard to tell. We did 207 SMB customers last quarter. We did 210 this quarter. So it seems to be moving along at the same pace without any real material change.

Natesh Daloo – Merrill Lynch

All right. That’s it for me. Thank you.

Operator

Your next question comes from the line of Steve Koenig with KeyBanc Capital Markets. Please proceed.

Steve Koenig – KeyBanc Capital Markets

Hi, thank you. Good afternoon.

Mike Gregoire

Hi, Steve.

Steve Koenig – KeyBanc Capital Markets

I’m wondering about some figures of the Analyst Day in terms of kind of sizing up the market and discussing growth rates. It was either Mike or Katy, one of you discussed kind of some of your expectations for how the markets were growing and talked about Recruiting growing about 15% to 20%, Performance Management growing about 10% to 20%, and I believe Compensation growing less than those figures. Right after that Analyst Day is when the credit markets kind of went more haywire even than they have been.

Mike Gregoire

There is no coincidence between our meeting and the credit markets going down. Was there?

Steve Koenig – KeyBanc Capital Markets

No, not meaning to suggest that.

Mike Gregoire

All right. Just wanted to make sure.

Steve Koenig – KeyBanc Capital Markets

Exactly. But I am wondering though how did you – how would you look at those numbers now in hindsight of some of those events and in terms of how those factor into your ’09 guidance?

Mike Gregoire

Well, we’re of the opinion that talent management is quickly becoming a need to have. It’s not a discretionary purchase. And if you take a look at the companies that seem to be doing the best, they have got a pretty sophisticated and mature view on talent management and the process to do that. And I can’t tell you what would have happened with one of our large financial institutions that they didn’t have a Taleo or a Taleo-type system in place when they started acquiring some of these other banks. You just couldn’t on-board that many employees and get them productive if you didn’t have an automated web doing it. And if you just decided at the minute you are getting ready to make the strategic decision that your talent management is important that particular day, I don’t think you have the system, material systems in place to be able to do that. So I don’t see that the market is changing with respect to this particular type of purchase. I think there will always be laggards in the market that just do not spend money on sophisticated systems, and then I think you always going to have a number of companies that really look forward to trying to automate their processes and also get the analytical data so that they can make better decisions. So I would be very comfortable with the market sizing that we did at Analyst Day. And quite frankly, we’ve hired a firm – we have had some new ideas on how the market should be, how the market is going to evolve, and we hired an outside firm to test our thesis. They haven’t come back with the reply, but we’ll obviously be talking about how we see that market as we get the data.

Steve Koenig – KeyBanc Capital Markets

Okay. And then just kind of finishing up that question then, did you assume close rates then – it sounds like you assume close rates for ’09 consistent with ’08, but with good growth in pipeline. And then I wanted to squeeze in as well. We had heard some good things about very fast implementations of Taleo Edge, and I wondered if you could comment on any growth from that or material revenue contributions in Q4 or in ’09?

Mike Gregoire

I think, as Katy said, we’ve taken a similar approach to budgeting for 2009, like we did in 2008, which means we don’t get carried away with net new things we’re bringing to the market. So the Edge is – I would put in that category of a net new thing we are bringing into the market. And we haven’t really put a lot of budgetary expectations on that into the ’09 plan. Also going back to your point about competition, we also didn’t really favor in too much in our assumptions. We pretty much went with the same win rate that we’ve had in 2008 and our planning for 2009. But conventional wisdom would point to – especially with the economic environment that you brought up, that a company like Taleo with a strong balance sheet, the ability to generate cash to be profitable, a reputation for getting things done on time on budget would be a better selection in a competitive situation in 2009. Coupled with that, we took over our number one competitor in the market in July. So I would expect our sales force to be more competitive in 2009 than they were in 2008. Yet we use the same competitive metrics for our ’09 budget.

Steve Koenig – KeyBanc Capital Markets

Okay, great. Thanks a lot.

Operator

(Operator instructions) Your next question comes from the line of Sasa Zorovic with Goldman Sachs. Please proceed.

Sasa Zorovic – Goldman Sachs

Thank you. So my first question would be regarding the acquisitions. So now you’ve sort of closed Vurv, and on the one hand, sort of you have that one kind of behind you in a way. And then also looking at sort of the overall market, this is somewhat of a broader you look, the whole space it seems somewhat of a fragmented market. I mean, would you anticipate that with the market, what it being that – that the valuations, where they are going, you might be kind of increasing your appetite for acquisitions or – how do you weigh that versus kind of conserving clearly cash? And how do you look at acquisitions then going forward?

Mike Gregoire

Well, that’s a great question, Sasa, and very insightful. First, right off the bat, there is three categories I would take a look at. First of all, there is not a lot of big ones out there that are truly in the talent management space. They either have side services businesses or they’ve got some type of business in addition to talent management that make them – you know, first of all, they are not terribly as competitive as they might think they are in this environment. The customers usually see through that pretty quickly. They want to deal with somebody that’s good to spend an awful lot of money on R&D in talent management and make sure that they are going to be there in the future. So, most of the companies out there are relatively small. When you take a look at the revenue of some of these companies and you parse out what’s really truly in talent management, there is not huge revenue stream. So we have got plenty of cash to be able to do these types of deals. Secondly is, you can be creative in a market like this, like what we did with Worldwide Compensation. We’ve put some money down on an option to buy it outright and we can time the payments of that, should we decide to go forward, plus we can force them to prove to us that they are an enterprise player and they can handle the kind of customers that we are going after. And thirdly is, the valuations on privately held company are definitely getting squeezed because they are running out of cash. This is not going to be an easy place for them to raise capital. We get calls by VCs on a pretty regular basis for companies that have nothing to do with talent management, not to mention the ones that have something to do with talent management, as they are looking to get out and preserve their own cash and they are much more reasonable go forward. But we’re not talking about large operational issues and we are not talking about big cash outlays, Sasa.

Sasa Zorovic – Goldman Sachs

I see. And then my second question would be regarding your international opportunity. At 30% now of revenue and anticipating sort of relatively small compared to the rest of the US business, but kind of growing fairly and healthily. In this kind of a market environment, do you anticipate that you’re going to be kind of growing that now faster to a sort of point of kind of gaining share, if you would, or kind of exploiting in a way being a weaker economy? Or do you think the headwinds in Europe or I guess, as we know, somewhat tough as they are here domestically, so may not really see that much of an acceleration in internationally going forward?

Mike Gregoire

I think we’re going to see more of the same, Sasa. My crystal ball is no clear in Europe 2009 than it is in North America. I like the position we’re in. I think customers want to buy from a company that really has the ability to demonstrate execution, to demonstrate the ability to handle customer service. And right now, to tell you the honest to God truth, nobody wants to make a selection of something that is going to fail. And our track record is impeccable with respect to customers buying our software and going live. And you do not want to be making the decision buying a small company that either runs out of cash or they try to cut their own cost because they just can’t make payroll and slow down their innovation or slow down their ability to answer the helpdesk. You’re going to want to go with a company that can get the job done and has a proven track record, and I think Taleo fits very well into that mold.

Sasa Zorovic – Goldman Sachs

Thank you very much.

Operator

Your next question comes from the line of David Hilal with FBR. Please proceed.

Michael Clark – FBR

This is Michael Clark on behalf of David. Two questions. First, will you talk about any changes you noticed in intensity of the competitive landscape and also how the economy has impacted the pricing environment currently? And then second question, can you talk a little bit about the assumptions regarding new product revenue contribution in 2009? Thank you.

Mike Gregoire

With respect to competition, we haven’t seen a material change in competition. It’s still the usual suspects, and we face them in the marketplace each and every day. On pricing, pricing has remained stable. As Katy answered in her question, we haven’t seen any changes to payment terms. And we continue to move forward pretty much the way we were in Q2 and Q3. With respect to new products in the ’09 budget, I think Katy answered that question pretty clearly as well. We haven’t put anything in the 2009 budget with respect to Worldwide Compensation, which we’re working with Worldwide Compensation selling that. We have a new product for performance management in the SMB market segment. That has not – we have not put a lot of 2009 revenue for that. And we do have a new product, which is Performance Management, that we do think will get traction in 2009.

Michael Clark – FBR

Thank you.

Mike Gregoire

You’re welcome.

Operator

Ladies and gentlemen, at this time we will conclude the question-and-answer session due to time restrictions. I will now turn the call over to Mr. Michael Gregoire for closing remarks. Please proceed.

Mike Gregoire

Thank you very much. And thank you everyone for taking time out of their day. I know that it’s a big reporting day, and to spend so much time with Taleo, we really appreciate it. Q3 was a great quarter. Q2 was a great quarter. The economic and macro environment, we’re going to have to all be very careful as we work our way through that. But the momentum of this company, our ability to execute in our innovation could not be any stronger. I do feel that there is a sea change in the view of talent management where talent management is no longer a discretionary purchase. And in a good economy or in a tough economy, I think understanding your people and the people that really make it happen for you in your company is going to be more and more important. Thank you very much, and look forward to seeing you in the field.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Taleo Corporation Q3 2008 Earnings Call Transcript
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