SkillSoft Public Limited Company F3Q09 (Qtr End 11/24/08) Earnings Call Transcript

SkillSoft Public Limited Company (SKIL)

F3Q09 Earnings Call

November 24, 2008; 4:30 pm ET

Executives

Chuck Moran - President and Chief Executive Officer

Tom McDonald - Chief Financial Officer

Michael Polyviou - Financial Dynamics

Analysts

George Sutton - Craig-Hallum

Bob Craig - Stifel Nicolaus

Trace Urdan - Signal Hill

Brandon Dobell - William Blair

Paul Condra - BMO Capital Markets

Dana Walker - Kalmar Investments

Presentation

Operator

Good afternoon. My name is Rachael and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2009 earnings call. (Operator Instructions) Mr. Polyviou, you may begin your conference.

Michael Polyviou

Thank you and good afternoon everyone. By now, you should have received a copy of SkillSoft’s fiscal 2009 third quarter results press release, which was issued a short while ago. If you have not received one, you may retrieve it from the company’s website at www.skillsoft.com or please call our office at 212-850-5600.

On the call with us this afternoon from SkillSoft are Chuck Moran, President and CEO; and Tom McDonald, CFO.

I would like to remind everyone that some of the comments made today or some answers in response to your questions may contain forward-looking statements. Any such forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from any future results encompassed within the forward-looking statements.

Factors that could cause or contribute to such differences include, challenges in integrating the operations of NETg, competitive pressures, changes in customer demand or industry standards, adverse economic conditions, loss of key personnel, litigation and any other matters disclosed under the heading Risk Factors in the company’s most recent annual report on Form 10-K filed with the Securities and Exchange Commission.

Forward-looking information provided by the company in this conference call represents the company’s views as of today’s date Monday, November 24, 2008. While SkillSoft may elect to update this forward-looking information at some point in the future, the company specifically disclaims any obligation to do so. This forward-looking information should not be relied upon as representing the company’s views as of any date subsequent to the date of this conference call.

With that, I’d like to turn the call over to Chuck Moran. Chuck, please go ahead.

Chuck Moran

Thanks, Michael. Good afternoon everyone and thank you for joining us. Today we will discuss our fiscal 2009 third quarter results. SkillSoft reported total revenue for our fiscal 2009 third quarter of $83.1 million representing an 11% increase over last year’s fiscal third quarter revenue of $75.1 million.

Please note that our reported revenue for the third quarter was reduced by approximately $2.2 million as a result of a negative impact in foreign exchange rates, that as we all know occurred rapidly and severely in the third quarter. Without the negative impact of the foreign exchange, we would have been at the high-end of our revenue target range of $84 million to $85.5 million. Our net income for the third fiscal quarter was $12.0 million or $0.11 per diluted share compared to $5.8 million or $0.05 per diluted share for the last fiscal year’s third quarter.

Please note that our net income for the third quarter was increased by approximately $300,000 due to the favorable impact of foreign exchange rates. Excluding the favorable impact of the foreign exchange gain we still would have exceeded our EPS target range of $0.09 to $0.10 per diluted share. We are pleased with our revenue achievements as well as being able to exceed our earnings target range of $9.5 million to $10.5 million for the third fiscal quarter.

We have continued our share repurchase program and in the third quarter we repurchased approximately 3 million shares for $29.3 million and for the first three quarters of this fiscal year we have repurchased approximately 5.7 million shares spending $56.5 million.

From an operational perspective, at the time of our last earnings conference call we had seven remaining NETg customers that were on the still on the NETg, LMS platforms. I am happy to say that all seven have been migrated over to SkillPort and we have no more customers to migrate. The migration effort was a very large endeavor touching over 1100 customers and I would like to thank all the customers for working with us and I’d also like to thank the SkillSoft team who helped make the transition as smooth as possible.

We continue to work hard in the business and as a result we are trying to work our way through the challenges of today’s economic and competitive environment. That said, although, we recorded good results for the third quarter I’m still not happy with our performance and I feel we can and should be doing better in landing new business and growth existing business from our core field sales team, the telesales effort and the new business field sales team. Our strategy is to continue to focus on all three of these groups to address our growth.

Relative to these growth efforts the inside sales team, is our telesales effort that focuses on small and medium-size businesses via outbound calling. We recently made some management changes in this area, because we were not happy with the results. Telesales is an area that we are not experts in, so we expect to learn as we go and to make some mistakes along the way. We will aggressively make corrections when we see that the results are not meeting our expectations.

That said we are encouraged that when done right sales can be achieved over the telephone and we can land new accounts. In fact we have been pleasantly surprised with some fairly large sized customers having been landed. We continue to target deals in the 5 K to 15 K range, but we have also found that we can land $50,000 deals and on occasion, $100,000 plus size deals.

We are starting to see some signs of success that are encouraging from our new business field sales team. As a reminder the new business field sales team is a group of approximately 14 to 16 US based reps that have no existing customers to support. Rather their sole focus is finding and landing new customers. We have seen some nice wins from this group, but we want to see how well they do in Q4 and next year before we get too excited about it.

The core field sales team needs to do a better job on finding new business, but here too we do see some signs of success. It just needs to be done on a much broader scale with all the reps contributing. We also continue to look for growth opportunities through small tuck-in acquisitions, similar to small ones we have done in the past like targeted learning, which is now rebranded leadership development channel. There are many opportunities out there but we do remain selective.

As we look into Q4, we are cautiously optimistic with regards to closing business. What we saw late in Q3 were a few customers that did pullback some of their spending and a few others that put things on hold. However, the good news is that there were many more customers that did not pullback their spending and there in lies our challenge.

We’ve seen mixed reactions to the economic environment from our customer base. Some customers are cautious, some have pulled back spending and others have actually increased their spent with us. The one thing we do want to do is use it as an excuse to the economy or talk ourselves into believing that we cannot do the job because we can see the opportunities are out there, we just to work hard and execute.

Going into Q4, trying to figure out which customers will be okay and which ones might pullback their spend is not something I can tell you we can predict with a 100% accuracy, what we can tell you is that our customer base is very diverse and we do not have any significant revenue concentration in any customer or sector. We also have many customers who have multiyear deals, so that means they are not up for renewal in Q4. For those deals that are up for renewal, our strategy has been and still is to close the deals as soon as possible.

I’ve heard investors say in the past that I need to be more positive, so I want to temper my comments by saying that we are confident we can deliver our earning target in Q4 even if we encounter a headwind from some parts of our customer base. We also need to keep in mind that when budgets get tight, in some cases e-learning due to its cost-effectiveness may fair better than other training choices like ILT or custom, so that could play in our favor.

One final comment, we have to wait until we finish Q4 before we talk about next fiscal year. That said we as a management team are proactively looking into next year with a keen eye towards an EPS and net income earnings growth perspective, and during our fourth quarter we have already started reviewing our cost structure to ensure we are spending in the right areas and if there are any areas that should be reduced.

We cannot predict how the economy will be in the next year fiscal year, so to be prudent we want to have as many options for us choose from in order achieve EPS and net income growth. Reviewing expense and investment levers this quarter will position us well coming into next year.

With that, I’ll now turn the call over to Tom. Tom.

Tom McDonald

Thanks, Chuck. Good afternoon everyone. In the third quarter of fiscal 2009 revenue increased 11% to $83.1 million compared to $75.1 million in the third quarter of fiscal 2008. Revenue for the third quarter was negatively impacted by approximately $2.2 million, due to the significant variability in foreign exchange rates during the company’s third quarter as compared to the foreign exchange rates as of July 31, 2008.

The company’s third quarter net income was $12 million or $0.11 per diluted share. This compares to the year ago third quarter earnings of $5.8 million or $0.05 per diluted share.

Net income for the third quarter was positively impacted by approximately $0.3 million, due to the previously mentioned variability in foreign exchange rates for the quarter. This foreign exchange gain for the third quarter of fiscal 2009 included approximately $0.9 million, exchange gain resulting from U.S. denominated customer billings and cash accounts outside of U.S. currency based operations, partially offset by a net foreign exchange loss of approximately $0.6 million, related to the $2.2 million fiscal 2009 third quarter revenue reduction previously mentioned above.

From a sales channel perspective, approximately 75% of the total revenue was from domestic sales and 25% from international. Another perspective of our sales channel reflects approximately 88% of the total revenue from direct sales and 12% from reseller sales. The company’s total deferred revenue at October 31, 2008 was $142.6 million as compared to $140.6 million at October 31, 2007.

The 1% increase in deferred revenue reflects growth in order intake and billings from SkillSoft’s core business was also negatively impacted by approximately $7.3 million due to the variability in foreign exchange rates in the third quarter as compared to exchange rates at July 31, 2008.

As a reminder we consider our core business to be courseware, referenceware, and platform hosting. Gross margin was 87% in each of the company’s fiscal 2009 and fiscal 2008 third quarters. Gross margin in each of the fiscal 2009 and fiscal 2008 third quarters includes amortization of intangible assets related to acquired technology and capitalized software development costs of $1.7 million.

The technology in content and intangible asset amortization reduced gross margin in both periods by approximately 2%. The gross margin percentage is mainly impacted by the mix of royalty bearing content and SkillSoft hosting capacity needed to meet our existing and new customer solution requirements.

R&D decreased to $12.1 million in the fiscal 2009 third quarter compared to $13.7 million in the fiscal 2008 third quarter. R&D expenses were 15% of revenue for the fiscal 2009 third quarter as compared to 18% for the fiscal 2008 third quarter. The dollar decrease was primarily due to lower expenses related to contractors and outsourced partners, performance bonuses and facility charges as compared to the prior year.

Sales and marketing expenses increased to $26.4 million in the fiscal 2009 third quarter compared to $25.2 million in the fiscal 2008 third quarter. Sales and marketing expenses as a percentage of revenue decreased for the fiscal 2009 third quarter to 32% of revenue compared to 34% of revenue in the fiscal 2008 third quarter. This dollar increase was primarily due to additional personnel including additions to direct sales, telesales and field support as well as commission expense to support our customer base.

General and administrative expenses decreased to $9.1 million in the fiscal 2009 third quarter, compared to $9.4 million in the fiscal 2008 third quarter. General and administrative expenses as a percentage of revenue for the fiscal 2009 third quarter decreased to 11% of revenue compared to 13% of revenue in the fiscal 2008 third quarter.

This dollar decrease was primarily due to facility in bad-debt expense incurred in fiscal 2008, not required in fiscal 2009. This is partially offset by an increase in legal fees as well as professional expenses incurred in connection with an ongoing feasibility analysis related to our business realignment strategy.

Included in operating expenses for fiscal 2009 third quarter is approximately $1.4 million of stock-based compensation expense. For the fiscal 2009 third quarter cost of revenue, research and development expense, sales and marketing expense, general and administrative expense included approximately $52,000, $227,000, $412,000, and $731,000 of stock-based compensation expense respectively.

In the fiscal 2009 third quarter, cost of revenue included $4.4 million for intangible asset amortization as compared to $5.4 million for the fiscal 2008 third quarter. This decrease was primarily due to the amortization of NETg acquired customer contracts, content and trademarks assumed in the acquisition during the third quarter of fiscal 2008.

The amortization of NETg intangible assets related to required technology and capitalized software development costs is fully amortized as of October 31, 2008 which results in the reduction of approximately $1.7 million of quarterly expense and cost of revenues in future quarters.

The company’s interest and other income increased to $1.4 million for the fiscal 2009 third quarter as compared to an interest income net of other expenses of $12,000 for the fiscal 2008 third quarter. This increase was primarily due to the gain on foreign currency exchange. The company’s interest expense decreased to $2.5 million for the fiscal 2009 third quarter as compared to $3.9 million for the third quarter of fiscal 2008. This decrease was primarily due to a reduction in the company’s outstanding debt during fiscal 2009.

The company’s tax provision from continuing operations was $18.8 million, or 38.5% for the nine-month period ended October 31, 2008 third quarter fiscal 2009, which consisted of a cash tax provision of approximately $3.1 million or 6.3% and a non-cash tax provision of approximately $15.7 million or 32.2%. This compares to $7.9 million or 44.7% tax benefit for the nine-month period ended October 31, 2007 which consisted of cash tax provision of approximately $1.1 million or 6.2% and a non-cash tax benefit of approximately $9 million or 15.9% from continuing operations.

The increase in the current year effective tax rate is primarily due to the geographic distribution of worldwide earnings as well as the second quarter of fiscal 2008 non-cash tax benefit of approximately $25 million resulting from the reduction in the company’s US deferred tax valuation allowance. The upper-mentioned benefit was partially offset by non-cash tax adjustments required as a result of the purchase accounting for the NETg acquisition.

Regarding DSO on a net basis, which considers only receivable balances for which revenue has been recorded, DSOs were 10 days in our third quarter compared to 13 days in the third quarter of the prior year and 15 days in the second quarter fiscal 2009. On a gross basis, which considers all items billed as receivables, DSOs were 80 days in our third quarter compared to 118 days in third quarter of the prior year and 89 days in the second quarter of fiscal 2009.

The company’s average contract length was 17 months as of October 31, 2008 compared to 17 months as of October 31, 2007. The company’s 12-month average contracts value as of October 31, 2008 decreased to $117,000 as compared to $120,000 as of October 31, 2007. SkillSoft average total contract value as of October 31, 2008, decreased to $166,000 as compared to $170,000 as of October 31, 2007.

SkillSoft had approximately $77.3 million in cash, cash equivalents, short-term investments, and restricted cash as of October 31, 2008, as compared to $93.5 million as of January 31, 2008. This decrease primarily reflects a long-term debt repayment of $55.3 million, payment of $56.5 million to repurchase shares, investments of $18.5 million and purchases of property and equipment of $4.1 million.

These cash uses were partially offset by cash provided by operations of $75.4 million. Proceeds from the exercise of stock options and employee stock purchase activity of $19.5 million and investments maturities of $23.3 million in the nine months ended October 31, 2008.

From the nine months ended October 31, 2008 the company spent approximately $55.3 million to reduce long-term debt to approximately $143.7 million as of October 31, 2008. During the nine months ended October 31, 2008, the company spent approximately $56.5 million to repurchase approximately 5.7 million outstanding shares under its current shareholder authorized share repurchase program.

As a reminder an important leverage covenant included in the company’s credit facility is adjusted EBITDA. Adjusted EBITDA for fiscal 2009 third quarter was $28.8 million and our trailing 12 month debt to adjusted EBITDA ratio is approximately 1.37.

Adjusted EBITDA for the fiscal 2009 third quarter was calculated by taking net income of $12 million, adding back depreciation and amortization of $1.1 million, amortization of intangible assets and capitalized software development costs of $4.4 million, stock-based compensation of $1.4 million, the feasibility expense associated with the company’s business realignment strategy of $0.3 million, interest expense of $3.5 million and the provision for income taxes of $7.4 million and deducting interest income, net of other expense of $1.4 million.

Now I’ll spend a few minutes discussing our outlook for fiscal 2009. The company is now targeting fiscal 2009 revenue to be in the range of $328.5 million to $331.5 million. In the company’s press release dated August 22, 2008, fiscal 2009 revenue was targeted to be in the range of $335 million to $338 million.

Changes in foreign exchange rates during the third quarter reduced third quarter revenue by approximately $2.2 million and if foreign exchange rates continue after October 31, 2008 levels during the fourth quarter, the total negative impact on revenues during the third and fourth quarters will be approximately $6 million to $7 million.

As a result the decrease in our forecasted revenue for fiscal 2009 is attributable to fluctuations in foreign exchange rates during the third quarter. While it is the company’s practice not to take into account the impacts of future changes in foreign exchange rates when setting its financial targets, the company believes that it’s appropriate to reflect the impact of changes in foreign exchange rates during the recent quarter.

Among other factors further changes in foreign exchange rates during the fourth quarter could result in a reduction in international revenues beyond what is reflected in the targeted range of $328.5 million to $331.5 million.

The company’s fiscal 2009 net income target as set forth in its press release issued on August 22, 2008 remains unchanged. The company anticipates that its adjusted net income for fiscal 2009 will be between $38 million and $41 million or $0.35 to $0.38 per basic and diluted share.

Adjusted net income represents GAAP net income excluding foreign exchange gains or losses, in gains or losses from discontinued operations. For the fourth quarter of fiscal 2009 ending January 31, 2009 the company currently anticipates revenue to be in the range of $80.5 million to $83.5 million. The company currently anticipates adjusted net income for the fiscal 2009 third quarter to be between $5 million and $8 million or $0.05 to $0.07 per basic and diluted share.

The company’s adjusted EBITDA target for fiscal 2009 of $101 million to $103 million as set forth in its press release issued on August 22, 2008 remakes unchanged for fiscal 2009. Adjusting EBITDA for fiscal 2009 in this range is expected to result in a debt to adjusted EBITDA ratio of approximately 1.4. Adjusted EBITDA and the target range for fiscal 2009 will represent growth of approximately 26% to 29% as compared to fiscal 2008.

The adjusted EBITDA targeted range for fiscal 2009 is calculated by taking targeted net income of $38 million to $41 million and adding back depreciation and amortization of $5 million to $6 million, amortization of intangible assets and capitalized software development costs of approximately $16.5 million, stock-based compensation of approximately $6 million, restatement expenses of approximately $0.2 million, merger and integration related expenses of approximately $0.8 million, feasibility expense associated with the company’s business realignment strategy of $1.5 million, interest expense of $13 million to $14 million and the provision for income taxes of $23 million to $24.5 million, last income from discontinued operation of approximately $1.9 million and interest income and other income and expenses of $1.5 million to $2 million.

The company’s projected net income and adjusted EBITDA in fiscal 2009 including the fiscal 2009 fourth quarter does not take into account the following items; foreign exchange gains or losses, any settlement related to the ongoing SEC investigation or other litigation, potential restructuring charges or the potential impact of any future acquisitions for divestitures including potential non-recurring acquisition related expenses and amortization of any purchased intangibles and deferred compensation charges resulting from an acquisition transaction and any potential adjustments from the impact of our international NOL evaluation reserves, or international deferred tax asset utilization.

The outlook also does not take into account the effect of a public offering or other financing arrangements or share buy-back program or debt restructuring that could impact interest income expenses or outstanding shares and thereby the company’s EPS outlook.

SkillSoft is presented projected net income and adjusted EBITDA for both fiscal 2009 and the fourth quarter of fiscal 2009 with these items excluded, because it’s currently unable to estimate the amount of the excluded items and I believe that this measure presents investors with meaningful information about the company’s projected operating performance for fiscal 2009.

With that, Chuck and I would now be happy to take your questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from George Sutton - Craig-Hallum.

George Sutton – Craig-Hallum

Chuck, could we drill down a bit more on the demand changes you’ve seen and by that I’m referring to looking at price versus volume, cross-selling, general training budgets, and thing like that?

Chuck Moran

We haven’t seen any significant impact on pricing. It’s always competitive, but that hasn’t been something that at least through Q3 and from where we are in Q4 has been an impact. We are anticipating that could be an issue. So, our plan and strategy is certainly to be proactive in terms of improving value, but also to show the extra assets that we have and if given the choice, which sometimes we may give a little more of the content to keep the price the same as opposed to just reducing the price.

We have seen companies that have actually increased their business with us by increasing both the products they buy from us, as well as increasing users and another thing that we’re keeping in mind when you’re talking about demands is that we have seen some company’s who have reduced their overall budgets, but as I mentioned in my opening remarks they would actually windup cutting from other areas like instructor-led training and potentially giving us some of those dollars, obviously not all of them but some of those dollars as well.

We continue to cross-sell and up-sell and I think did a good job on renewal rates for the quarter, although we don’t quantify it I think we are pleased where we were, that so far doesn’t seem to be an issue.

George Sutton – Craig-Hallum

You have always suggested that your part of the training budget is the most efficient dollars spent. How is that message playing in this environments and are you changing the way you present that logic?

Chuck Moran

I think playing well and a lot of people do get the message, but it’s certainly one of the first things we do talk about. One of the things that we are doing proactively is coming out so to speak with a couple of offerings, one in particular that will address displaced workers.

The concept there is that a company may still want to obviously treat out-going employees well, and giving them access to assets that we have there specifically focused for things that they would need, like interviewing or resume writing and things of that nature may be welcomed in this environment where companies are reducing their workforce.

So that’s, I’ll say a new initiative that we got going quickly on and will be announcing very shortly, if not today, this week and we also have another package to address the existing workforce. Then may have different priorities on them, whether they’ll be financially related or budget related or so forth.

George Sutton – Craig Hallum

Tom, could you just discuss the logic of share repurchases versus debt pay downs from the 2010 cash flow? How should we expect to see anything different next year than we’ve seen this year?

Tom McDonald

That is something that we are always evaluated from a standpoint of looking at what’s accretive to our bottom line, looking at where that share price might be and be an opportunistic when we can, but also looking at how reducing debt might favorably impact our bottom line also. So, those are things that we look at constantly to see what’s the best alternative for us to take.

Operator

Your next question comes from Bob Craig - Stifel Nicolaus.

Bob Craig – Stifel Nicolaus

Hey Chuck, regarding your comment in terms of the variability of client reactions to what’s been going on here, is there any commonality or concentration to those that have adopted more cautious stance here?

Chuck Moran

There actually is not and at least I’m smart enough to ascertain. Let me give you an example, someone that would fall under IT and hardware actually cancel their budget due to significant cost reductions and yes, we also have somebody else in the IT sector that has actually increased their business with us, upgrading an agreement that we had including more users.

We also have transportation where we’ve had some losses in that, but then some upsides, some increases in the automotive sector, which as you know is under pressure. So same thing in banking we’ve had a couple of financial services companies that have gone down a little bit, but then we picked up brand new customers in the banking area. So you can see right there that there is no commonality. It’s really on a case-by-case basis.

Bob Craig – Stifel Nicolaus

Yes, when you’re looking at demand patterns by geography or perhaps by major content area, IT versus SoftSkills anything jumping out at you?

Chuck Moran

Well, because IT and technology is so prevalent in the Silicon Valley and the bay area, you may look at that is being a little more sensitive to things, but there again we’ve actually had some feedback from people that maybe read headlines about that will be going forward with their spend despite that. I don’t want to create the impression that we are immune to everything, because we’re not and as I described earlier we have seen some reductions and some going to zero, but most of them that at least I’ve seen and I can remember, there will be reductions as opposed to going to zero.

Bob Craig – Stifel Nicolaus

Expanding a little bit on one of George’s questions, what would you expect to see based on past experience from customers in a downturn, a greater emphasis on short duration contracts, lower average deal size, just sort of reaching for things, anything would you highlight?

Tom McDonald

Yes. Well, one they may ask for an out-clause which may not necessarily be a reduction in the contract; because there could be a multiyear deal, it’s just that they want the flexibility. Sometimes they could ask for payment terms, which we’ve seen in the past, although we haven’t experienced yet any in a significant way, but historically I also want to caution people that I think we are in a different position today in the economic environment than we were years ago and by that I mean that years ago we had kind of a different scenario where IT had overbought and it was actually a penned lump swing back the other way to under buy and that isn’t the case in this economic environment.

Secondly, because of our acquisition strategy as well as growth strategy I think we have a more competitive offering and have a broader offering and more things and therefore more value to offer companies maybe than our competitors do, so we hope that that would fair more favorably to us than in the past.

Third, as you probably all remember, we had a very crazy market, years ago from a pricing perspective. It was driven more than from a competitive standpoint which we always encompass and it’s always healthy and by that I mean there was over funding by venture capitalists of companies in the space and they realized that they couldn’t go public as an equity events and the VCs were not giving any more money out. So they have to literally keep their doors open and would sell at any price. Again we don’t see that environment today; so comparing history really isn’t the same today as it was back then.

Bob Craig – Stifel Nicolaus

Okay and lastly and I’ll turn it over then. You mentioned, taking a look at the cost structure, thing don’t really change all that much during the course of the next few months. What are the areas that you would really focus on there?

Tom McDonald

Well, we have a lot of flexibility in a number of areas. We certainly are a large company and just by that our spent is very large and when we started this fiscal year off, we had initiatives in place, some were experimenting, some were for growth and some were to keep the steady business going.

Obviously, we’ll continue to invest to keep the steady business going, but some that were maybe going to bear fruit if they bore fruit at all, maybe a year or two years out, would be things that we would either reduce or cut back. We would also be more frugal in I’ll say investments for travel, investments for increased headcount and always look at working our supplies for having them help us how we can do our job better at a lower cost.

So, in essence it’s across the board and we do, as you know have a lot of experience in controlling and managing costs and I think that’s a strength right now that we would play to.

Operator

Your next question comes from Trace Urdan - Signal Hill.

Trace Urdan – Signal Hill

Chuck, I am going to ask more of these questions that are all kind of similar around these conversations you have with clients and that is, when you see a client tear down their spend, not go to zero obviously, but try to cutback in some way, is there any pattern to how they do that? Do they try to cutback from certain types of titles? Do they feel like they can do without, do they attempt to kind of restrict access to the content in some way? How do they think about doing that?

Chuck Moran

I think that number one maybe just to decrease users. Normally, because it’s aligned with people maybe reducing their overall headcount significantly, but it’s also interesting because we have seen the phenomena where companies are taking advantage of this economic environment and find it easier to just reduce costs overall and I’ll say the employee ranks kind of expect that.

So, although we may hear and see and read about some expense reductions that may not always trickle down to us simply because it’s more of a housecleaning than it is; their business is under pressure and then it’s done more in a selective way, in a strategic way as opposed to, I don’t mean this in a negative connotation at all, but more in a desperate way or a firefight, which some companies maybe in, others aren’t.

Trace Urdan - Signal Hill

Right and I know you guys do a good job of this anyway, but as you’re looking at those longer term contracts that are not at risk in this renewal cycle but might be 12 months from now, do you have any efforts in place to try to underscore the usefulness of your content with those companies to try to kind of forestall any of those activities down the road?

Chuck Moran

We do. In fact we have programs called early renewal that will focus on someone getting a deal done that isn’t up for renewal this quarter, but either extending term or adding new product and extending term for something that may come up Q1, Q2, Q3 or Q4 of next year. That’s a practice that we’re especially focused now in this economic environment but one that we’ve always done.

We also are proactively promoting more products within I’ll say the same budget that we are having people buy with us from and that way they can articulate a better value proposition when justifying the expenditure inside or internally.

Trace Urdan - Signal Hill

In this environment I’m wondering if it might become more attractive to look at acquiring content than maybe it had been previously just because maybe price expectations in the market have changed. Is it fair to think that you guys might be on the prowl for additional content more than you would have been otherwise or not necessarily?

Chuck Moran

I think your last point which is that the value is certainly there more now than ever because it is a down market and there aren’t a lot of companies going public and not a lot of VCs funding companies without that horizon. So it definitely does make entrepreneurs a little more humble and being able to take advantage of that we certainly will.

That being said though, we haven’t lowered our threshold of what we expect and what we want and need. So, although it may be cheaper if it’s not something we want we still won’t go forward with it.

Operator

Your next question comes from Brandon Dobell - William Blair.

Brandon Dobell - William Blair

Thanks guys, I just want to go back to Bob’s question for a second. If you think about the cost structure, maybe Chuck you could give us some more color on how you think about the sales force headcount in an environment like this where things are little more uncertain than they used to be. Do you continue to add people, because you can pickup good talent from competitors or bigger consulting firms, do you pull back in your expectations of what the sales force headcount, shift resources around, how should we think about you? How you guys might do the next two or three quarters from a sales perspective?

Chuck Moran

Sure Brandon. We will always add a good sales rep if we find one even in today’s environment and certainly we’ve always been looking for them. We are not planning on pulling back and reducing our headcount in terms of that. We may reallocate dollars or reallocate regions.

If some regions of the world are doing better than others; maybe some areas that are weaker we would take dollars from that perspective and move them around, but we think that in this economic environment we can still hit our EPS and net income targets that Tom watches very carefully without having to do any significant things to the field sales forces and that will be our number one focus. In fact in a perfect world how well we can do on our cost objectives, we would even look at potentially adding sales headcount.

Brandon Dobell - William Blair

As you look at the quarter that just ended, how did it play out from a timing perspective relative to the previous years? Was it more back end loaded, less back end loaded? There so many strange things going on, I just want to get some color on, kind of how it played out, probably most importantly in the context of the where you stand right now. Do you feel if this quarter ended January is going to play out like previous years have or is it going to be more January loaded than December? I’m trying to figure out how things may be trending these days for you guys?

Chuck Moran

Sure, second question first; we don’t see a significant shift in when the orders will be up when they’ll be renewed or negotiated for this Q4. For Q3, same answer, we didn’t see any significant change from the prior year’s quarter.

I think the only thing that was a little bit different and I think all you folks have heard this before from other vendors; maybe less of an impact from us, but we did see the last couple of three weeks in October become a little bit more challenging. I’ve heard investors say that talking with other software company’s things fell off a cliff. I wouldn’t say they fell off a cliff with us. That’s actually the wrong description, but things did get a little harder and we did see some deals slip.

Deals that slipped, calling that at 100%, I’d say approximately 85% of those deals we believe are still live and available for Q4. So 15% of them we would, I would categorize as lost meaning the budgets were frozen or they’re part of a merger or there’s been significant enough changes where we are not forecasting that into Q4, that tells us we are not falling off a cliff.

The other thing too is, I don’t want to have you forget that, I think we did some poor execution in some areas, in the custom area and in the telesales area are so that has a contributing effect on I think how we look at the overall business and we need to get sharper and crisper in that area which obviously we plan on doing.

Brandon Dobell - William Blair

And then final question is as you look at January, December and November; is it safe to say that the bulk of the business happens in December for you guys or is it pretty well split across the three months and do you anticipate any changes of that? Doesn’t sound like you do, but I want to make sure that I understand it correctly?

Chuck Moran

Yes, it’s mostly December and January. It typically would be the most in January prior to the NETg acquisition, but with the NETg acquisition their fiscal year was December, so that balanced it out a little bit more between December and January, but there isn’t a significant amount in November. It’s mostly December and January.

Operator

Your next question comes from Paul Condra - BMO Capital Markets.

Paul Condra - BMO Capital Markets

I wondered if you can just tell us what currency you have the most exposure to or where you saw the biggest impact coming from?

Tom McDonald

As far as, if I gave you like a percentage of revenue like in the third quarter, about 14% of the revenue was in the British pound, about 4% of our revenues was in Canadian dollar, about 4% in Australian dollar and about 2% in Euro. So, that’s where the majority of the impact is now. That can change by a percent or so depending on the quarter, but that’s basically how the mix has been for the first nine months, someplace in that range.

Paul Condra - BMO Capital Markets

Also in terms of your credit facility, could you go over that? Is that still the same deal there or is it similar.

Tom McDonald

That is 3.5 over a LIBOR, it’s 80% hedged. That hedge is through next year and so there aren’t any changes to that term.

Paul Condra - BMO Capital Markets

What about the bank you with?

Tom McDonald

The Credit Suisse is the one who consolidated that debt for us and there’s various banks that are part of that distribution.

Paul Condra - BMO Capital Markets

And then lastly just in terms of advertising, are you seeing any ability to cut costs there to get cheaper advertising and pricing coming down?

Chuck Moran

This is Chuck, Paul. We don’t do a lot of advertising but where we do have marking spend which I think is a more broader question for you, we are able to get I think some decent deals where we pay surcharge and things like that; so we are able to get some bulk rate purchasing power and it’s not as I said a lot of dollars in our overall spent because we are not a heavily indirect marketing organization; field sales is obviously direct, so it’s not a big number but there is some flexibility in it.

Paul Condra - BMO Capital Markets

In the specifics of this market that we are in?

Chuck Moran

I’m sorry, you broke up on that?

Paul Condra - BMO Capital Markets

I was saying, you’re seeing that more so now in this market as opposed to the general market?

Chuck Moran

That’s correct.

Operator

Your next question comes from Dana Walker - Kalmar Investments.

Dana Walker - Kalmar Investments

Could you talk, is it the right number to look at from a deferred revenue standpoint, the 1% plus adding back to seven, so that year-over-year you’re up roughly six on a constant currency basis?

Tom McDonald

What about 7% if you added that exchange impact plus the $2.5 million increase year-over-year. So it’s about a 7% increase year-over-year.

Dana Walker - Kalmar Investments

All right and Tom how should one look at your Q4? I recognize that some of your guidance here is just a stub comparing what you had already got it to versus where you stand. I want to make sure that we are all looking at the same numbers, your year-to-date adjusted EPS, how that would compare to the Q3 numbers? How Q4’s assumptions would compare to Q3 as well as looking at EBITDA?

Tom McDonald

Well, based on the performance what we went through the third quarter and under the current business conditions, I didn’t want to change the guidance that we had given at the end of the second quarter for EBITDA or for net income.

So based on using the October 31 exchange rates and looking at the volumes that we anticipate coming in, I maintain all of the guidance and the targets that we set at the second quarter. So, that’s what brings me in at the $101 million to $103 million in adjusted EBITDA and $5 million to $8 million for the fourth quarter, that brings me in that $38 million to $41 million worth of net income.

Dana Walker - Kalmar Investment

Is there anything meaningful in a different sense though in the way your expense categories are likely to go play out or the effective tax rate that you’ll use in Q4?

Tom McDonald

The effective tax rate should be inline with where it is at the end of Q3. Obviously that is impacted by income, as they come in the various legal entities, but a change at this point after that and as far as my expense categories, at the end of the year we might be spending a little bit more in R&D but those are all issues because we’re on an outsourced model that we’re looking at constantly to see if those are programs that we want to commit to in our fourth quarter, so those are decisions that we are currently looking at.

Also, as I said we’re also looking at that IP migration; we’ve been working on that all year and are we evaluating just based on the current economics. Since everything changed so dramatically in the third quarter we’re looking at the valuation forecasting that we had on our IP and hopefully we will get that completed and see where we stand as far as implementing that strategy and that could have an impact on my tax rates.

Dana Walker - Kalmar Investment

It sounds though in the way you’ve just worked your way through that analysis that your annual or your Q4 EBITDA ought to at least proportionately be on a margin basis, fairly similar to where you saw Q3, recognizing that there is some currency revenue in play?

Tom McDonald

When you’re looking at the third quarter, we did extremely well in adjusted EBITDA. We came in a little over $28 million. In order for us to achieve that 101 to 103 we don’t have to achieve the same level of adjusted EBITDA earnings in Q4, but we also have additional expenses just because 45% of our business comes in, our commissions might be a little bit higher in the quarter; we might be spending a little bit more in initiating some R&D programs instead of holding back, it might increase those costs.

So, I wanted to make sure in my targets that I was giving us as much flexibility as possible to react to whatever the reality is with the business in the fourth quarter.

Operator

(Operator Instructions) Your next question comes from Bob Craig - Stifel Nicolaus.

Bob Craig - Stifel Nicolaus

I’ll be quick with this and Chuck, I’m not looking for any specificity, but if the environment doesn’t change from what you’re currently looking at right now, would you reasonably expect earnings growth in fiscal 2010?

Chuck Moran

Yes, EPS and net income growth, yes.

Operator

Your next question comes from Brandon Dobell - William Blair.

Brandon Dobell - William Blair

Tom, a question for you on the tax situation; if you guys were successful, I guess I’m not sure how to quantify successful without EBIT, but in moving everything on IP perspective and getting that whole thing squared away to your liking, how should we think about a long-term or sustainable cash tax rate for you guys?

Tom McDonald

Well, that we still have to workout, but I would anticipate and I don’t want to give the timing until we are finished with this new analysis based on how that might play out, because we are reevaluating that IP based on the current economic situation, but I would think at some point we should be in that 25% cash and book tax rate, at some point in time.

Operator

At this time we have no further question.

Chuck Moran

Well, thank you very much for your time and we look forward to speaking to you at the end of our quarter four. Bye.

Operator

This concludes today’s conference call. You may now disconnect.

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