WebSideStory Q2 2006 Earnings Conference Call Transcript (WSSI)

WebSideStory, Inc. (WSSI)
Q2 2006 Earnings Conference Call
August 4, 2006 9:00 am ET

Executives

Claire Long - CFO
Jeffrey Lunsford - Chairman and CEO

Analysts

Safa Rashtchy – Piper Jaffray
David Hilal – Friedman, Billings Ramsey.
Brad Whitt - RBC Capital Markets
Peter Schleider – Peninsula Capital
Troy Mastin - William Blair & Company
Mark May - Needham & Company
Sean Jackson - Avondale Partners
Chad Bartley - Pacific Crest Securities
Michael Huang - ThinkEquity Partners
Richard Baldry - First Albany Capital
Patrick Walravens - JMP Securities
Doug Campbell - Sierra Capital
Kyle Evans – Stephens

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2006 WebSideStory earnings conference call. My name is Gregory and I will be your coordinator for today.

(Operator Instructions)

I would now like to turn the presentation over to your host for today’s call, Miss Claire Long, Chief Financial Officer. Please proceed, Madam.

Claire Long

Thank you, and good morning. My name is Claire Long, Chief Financial Officer of WebSideStory, and welcome to WebSideStory’s second quarter 2006 earnings conference call. Following the live call, an audio archive of this call will be available on the investor relations section of our website at www.websidestory.com.

Today’s call contains forward-looking statements that are not a description of historical facts. For example, statements about future results of operations, growth opportunities, the anticipated synergies of WebSideStory, Adams, and Visual Sciences businesses, and about the projected future financial performances of those businesses, are all forward-looking statements.

You should not regard any forward-looking statements as a representation by WebSideStory that any of its plans will be achieved. Actual results may differ materially from those set forth in this release, due to the risk and uncertainties inherent in WebSideStory’s business. Such risks include, without limitation, the company’s reliance on its web analytic services for the majority of its revenue, the company’s limited experience with digital marketing applications beyond web analytics, the risks associated with the company’s indebtedness, the risks associated with integrating the operations and products of Adams and Visual Sciences with those of WebSideStory, the highly competitive market in which we operate that could make it difficult for WebSideStory to acquire and retain customers, the risks that WebSideStory’s customers fail to renew their agreements, the risk that the company’s services may become obsolete in a market with rapidly changing technology and industry standards, blocking or erasing of cookies, or limitations on our ability to use cookies, privacy concerns and laws and/or other domestic or foreign regulations that may subject the company’s litigation or limit our ability to collect and use internet user information, WebSideStory’s ability to defend itself against claims of patent infringement alleged by Net Ratings Inc., WebSideStory’s ongoing ability to protect its own intellectual property rights, and to avoid violating the intellectual property rights of third parties, and the other risks described in WebSideStory’s filings with the Securities and Exchange Commission, including WebSideStory’s annual report on Form 10-K for the year ended December 31, 2005, and quarterly reports on Form 10-Q. Do not place undue reliance on these forward-looking statements, which speak only as of the date of this call. WebSideStory undertakes no obligation to revise or update the information or forward-looking statements in this call to reflect subsequent events or circumstances.

Our presentation today includes information presented on a non-GAAP basis. We believe that this presentation of non-GAAP results provides useful information to both management and investors by excluding specific items that we believe are not indicative of our core operating results. The presentation of this additional information should not be considered in isolation, or as a substitute for results prepared in accordance with generally accepted accounting principals. We refer you to the press release we issued earlier this morning, which is available on the investor relations portion of our website, www.websidestory.com for a reconciliation of the differences between the non-GAAP presentation and the most directly comparable GAAP base measures.

During this call, you will hear us discussing the WebSideStory division and Visual Science division. The WebSideStory division is the reporting segment comprised of our HPX analytics, search, publish, and bid solutions, and all related services.

The Visual Science division is the reporting segment comprised of Visual Sciences LLC, with which we merged on February 1st.

Now, I would like to turn the call over to Jeff Lunsford, the CEO and Chairman of WebSideStory.

Jeffrey Lunsford

Thanks, Claire. Q2 was an exceptional quarter for us on the revenue growth and customer acquisition side. In Q2, all aspects of our previously discussed growth plan really started to gain traction and pay dividends in the form of record bookings across all product lines, which are leading us to raise full-year revenue guidance today.

Q2 was also the quarter where the margin compression driven by this growth plan and, more substantially by the absorption of higher accounting and legal fees into our G&A costs, bottomed out. In Q3, we anticipate renewed margin expansion, similar to the strong margin expansion cycle we experienced in Q2 through Q4 of 2005. This margin expansion is reflected in our updated guidance, which you will find in our press release, and which we will discuss later in the call.

In Q2, we continued establishing WebSideStory and Visual Sciences as the preeminent solution providers in digital marketing and real-time customer analytics. We surpassed the high-end of our guidance for revenue, and achieved the highest bookings levels we have ever achieved in all major areas of the business, HBX, Visual Sciences and our Search and Publish division.

We added over 130 new companies to our expanding base of customers, taking the total to approximately 1,400, and an average one-year relationship size of approximately $45,000 per year.

Our products are leading the market as the most innovative solutions available, and our customers are continuing to give us more great ideas for expanding the solution set and continuing to grow our business.

Our WebSideStory division continues to differentiate from all of our peer play web analytics competitors, based on the fact that we have an integrated suite of solutions that can offer unique website optimization capabilities, such as active ranking for site search and targeted content management based on site analytics metrics.

Our Visual Sciences division continues to differentiate from all web analytics pure play and alternative non-web analytics vendor providers in its ability to process and segment massive data storage comprised of web data and offline data, within acceptable timeframes, and with superior accuracy when analyzing a complete set of data rather than the sample data approach that other vendors take.

We feel great about the health of our markets and the strength of our product and service lines. Our digital marketing solutions, web analytics, site search, web content management and bid management, are part of a high-growth market sector which we believe will continue to fuel our expansion in the years ahead and, as stated, we are also expanding our solution set to broaden our footprint within the enterprise and benefit from other product opportunities beyond the digital marketing stack.

Notable operating highlights from the quarter included:

• Non-GAAP revenue of $16.8 million, representing 79% reported revenue growth, and 40% in organic revenue growth;
• 37% organic growth for the WebSideStory division;
• 93% organic growth for the Visual Sciences division;
• GAAP revenue of $15.2 million;
• A 12% non-GAAP net income margin, which notably would have been 15% without patent-related legal expenses;
• Combined corporate bookings growth in our targeted range of 30% to 40%;
• Customer renewal rates above our 90% target;
• WebSideStory Search wining the CODiE award for Best Enterprise Search Engine;
• Over 130 new customers signed, most in head-to-head wins against our usual competitors, including wins with great companies like MGM, BellSouth, Broadcom, Jobster, Nautilus, Total Systems, Answers.com, McGraw-Hill, Franklin Covey, Lee Jeans, Telecom Italia, and Orange;
• Strong up-sells in renewals from great customers like Palm, BMW, Verizon Wireless, Fox, Wachovia, New Egg, Accenture, Norwich Union, Best Western, The Guardian, News International, Auto Trader U.K., UAFA, and Swiss Com; and
• As stated above, booking strength noteworthy in its breadth, with record bookings quarters in HBX U.S., HBX Europe, Visual Sciences and the search and public sales force, globally.

We are proud of these accomplishments and pleased to raise revenue guidance for the remainder of the year, based on these strong results.

Regarding operating margins, our only disappointment in Q2 was that our G&A costs continue to grow more rapidly than we had modeled into our Q2 earnings guidance, and our travel costs got a bit away from us as our sales force flew around closing record business. This led us to deliver earnings at the bottom-end of our range, rather than at the top where you and we would all like to see them.

The growth in G&A came primarily from an increase in legal expenses larger than we had forecast.

Looking forward into Q3, we raised our legal expense forecast and are, we believe, doing a better job of managing those with our attorneys. We also increased the budget for travel, anticipating continued record sales force activity, combined with higher average cost for airfare and lodging.

Correspondingly, we believe we have good visibility into the earnings guidance we are providing today. In weighing the dependability of this guidance, you could factor in that, since going public, we have never generated earnings or revenue below our published guidance ranges.

Turning to the product side of business, we are pleased with how our HBX team is executing, delivering new, industry-leading products that are driving robust sales activity and allowing us to continue differentiating in our core market of web analytics. Our intelligence indicates that HBX is the most operationally efficient platform in the industry for delivering world-class web analytics, as confirmed by third parties like Gartner in their recent web analytics overview, where HBX was one of the two top ranked solutions among the major providers in this sector in the U.S. and Europe.

Our HBX engineering teams in San Diego and Russia are both contributing nicely now to or continued advancement of that platform. We are adding over 100 customers per quarter to the HBX platform, and it will continue to be a major growth engine for us going forward.

We are also clearly pleased that Visual Sciences is performing so well. As mentioned, that division clocked in with growth of 93%. We believe this business holds great promise. This quarter’s strong performance is representative of how valuable we believe the visual sciences merger will prove to be to our shareholders long-term.

Visual Sciences has signed three deals worth over $1 million since December, and three worth over $500,000. This merger was a key component in our stated strategy of moving up the enterprise value chain and becoming more important to our largest customers. When you factor in the tax benefit from how we structure this transaction, we will have ended up paying approximately two to two-and-a-half times Visual Sciences 2007 revenue, while almost doubling our addressable market.

We are pleased with the innovative new technology being developed by our search and publish team based in the Bay area. WebSideStory Search 4.0 was released at the beginning of the quarter and promptly won the Software and Information Industry Association’s CODiE award for Best Enterprise Search Engine.

WebSideStory Search 4.0 introduced a number of industry-first capabilities into the market, including active ranking, a patent-pending capability that enables marketers to automatically drive site search results based on the full spectrum of website behavioral data.

Other capabilities in the new version include automating product submissions into comparison shopping engines, such as Frugal, and automating feeds into Google’s site maps.

This integration delivers on the core thesis behind our merger with Adams Corporation in 2005, which was that strong synergies exist between site search, web content management, and web analytics.

Our multi-product customers are excited about the capabilities this integration is delivering for them, and our site search pipeline is, we believe, directly resulting from the excitement around this release, now larger than it has ever been.

Our ability to deliver advanced solutions, such as active ranking, continues to be a key differentiator for our WebSideStory division as we compete with other point solution providers.

On the integration front, we continue to make solid progress on integrating Visual Sciences in our targeted areas of finance, HR, and legal, and we continue to hire aggressively and invest in the areas of sales, consulting, R&D, and operations. We began seeing good referral flow into Visual Sciences pipeline from our WebSideStory divisions sales force almost immediately upon implementing our referral program and grew the Visual Sciences pipeline nicely in the quarter.

We continue to invest in knowledge transfer and sales and consulting training that will position us to further ramp Visual Sciences distribution in 2007.

Company-wide, we currently have approximately 40 sales reps focused on new business, primarily in the U.S. and Europe, opening new doors for us and expanding existing relationships, and approximately 14 reps focused on renewal business and up-sells. We are continuing to grow that number every quarter.

In the product area, we saw strong acceptance this quarter of the advanced streaming media and mobile device tracking capabilities of HBX 3.5. We officially launched WebSideStory Bid in the quarter, and now have about 20 customers live or under contract on that keyword management service.

Advertising with an online video and user-generated content are two of the hottest growth areas on the web right now, fueling demand for rich media analytics. Online video ad dollars are estimated to reach $385 million this year, and are expected by E-marketer to compound that over 55% over the next four years. Demand is so strong for video ads the prices are now on par with television.

According to PQ Media, spending in the more nascent area, user-generated content, which includes blogs, podcasts, and RSS feeds, is projected to climb 145% this year to $50 million.

On the capital front, we ended Q2 with approximately $17 million in cash and investments, having generated $1.3 million in the quarter, and had over $18 million in cash and investments in the bank as of the end of July. Our current internal forecasts show us on track to have $19 million to $21 million in cash and short-term investments in the bank at year-end, and approximately $22 million to $23 million in the bank at the end of Q1 2007, when the Visual Sciences notes are first subject to repayment at the option of the noteholders.

We believe this cash, plus perhaps a small line of credit next year, represents sufficient capital to fund continued growth at current rates.

We ended Q2 well-positioned, with strong products, strong distribution, a healthy and exciting market, and the right resource loading. We are pleased with this performance, and our current strategic positioning.

I would now like to pass the call to Claire for a description of some key financial details.

Claire Long

Thanks, Jeff. The second quarter of 2006 was our 11th consecutive quarter of positive cash generation and non-GAAP profitability. We achieved record revenues and exceeded the top-range of our revenue guidance.

Jeff provided a comparison of Q4 in his margin discussion. I will focus on the changes from Q1 to Q2 of 2006.

In comparing results for the second quarter to the first quarter, please note that the first quarter included the financial results of Visual Sciences from the merger date of February 1st onward, whereas the second quarter includes the results of Visual Sciences for the entire quarter.

We achieved non-GAAP revenue of $16.8 million, and GAAP revenue of $15.2 million, achieving year-over-year growth of 79% on a reported basis, and 40% on organic basis for non-GAAP revenue.

The WebSideStory division contributed 81% of consolidated non-GAAP revenue, with the Visual Science division contributing the remainder. On a consolidated basis, revenue derived from subscription and hosting services decreased from 81% of consolidated revenues in Q1 to 77% of consolidated revenues in Q2, while standalone professional services increased from 5% to 7% over the same period. Licensed revenue, excluding non-GAAP revenue, accounted for 3% of our total consolidated revenues for Q2.

Of the $3.3 million of Visual Sciences revenue, 21% was professional services, 16% was reoccurring support and hosting, and 15% was license revenue. The remaining 48% of total Visual Sciences revenue was non-GAAP revenue, which primarily consists of license, maintenance, and hosting, that would have been recognized in the quarter, had Visual Sciences not been purchased, but was instead removed from the deferred revenue balance as a result of our purchase accounting for the merger.

As we have discussed in prior calls, we add that amount back into our non-GAAP revenue to show the performance of the company under the pro forma P&L that we are managing it by.

During Q2, we are finalizing the purchase accounting for the Visual Sciences merger. We capitalized billings that occurred this quarter, and are expected to occur in future quarters that relate to contracts that were in existence at the February 1st date of the merger.

This resulted in an additional on-billed accounts receivable asset of $1.1 million at the purchase date. This amount would have become revenue in 2006 as the work was performed. However, due to purchase accounting rules, only $200,000, the estimated cost to perform the work, was allowed to be recorded as deferred revenue at the purchase stage. The remaining $900,000, which would have been revenue in 2006 if Visual Sciences had not been purchased, will be added to the original deferred revenue haircut when calculating non-GAAP revenue for 2006. This did not impact our total revenue projection, as we have always assumed that we would recognize this revenue as the work was performed. Instead, it will move revenue from GAAP to non-GAAP revenue.

Our gross margin, calculated on non-GAAP revenue, and excluding stock-based comp and amortization of intangibles was 79% in Q2, which is a drop of 2 percentage points from the previous quarter. The gross margin excludes approximately $1.3 million of amortization of intangibles and stock-based compensation, compared to $913,000 in the prior quarter.

The 2% decrease was primarily due to the increase in professional services, both standalone and bundled as a percentage of total revenue, as professional service revenue has lower gross margin than other revenue sources. We expect our ongoing gross margins to be in the 78% to 80% range.

Operating expenses before stock-based compensation and amortization of intangibles, as a percentage of non-GAAP revenue increased from 65% of revenues to 67% of revenues. Sales and marketing as a percentage of non-GAAP revenue remained at 35%.

Product development as a percentage of non-GAAP revenue increased from 15% to 16%. The amount capitalized during the quarter associated with [Bid] and other new products that we are developing decreased from $195,000 in Q1 to $120,000 in Q2.

General and administrative expenses as a percentage of non-GAAP revenue increased from 15% to 16% due to legal costs related to our ongoing patent litigation, which increased from $140,000 in Q1 to $550,000 in Q2.

Net cash interest, excluding non-cash interest, was an expense of $70,000 in Q2 as compared to income of $21,000 in Q1, as the Visual Sciences notes were issued in February, Q1 only included two months of expense, while Q2 includes a full quarter’s run rate. In addition, Q1 included interest earned in January on cash balances utilized in the merger. These interest figures exclude non-cash interest expense of $256,000 and $171,000 for Q2 and Q1 respectively.

GAAP taxes resulted in a non-cash benefit of $1.8 million, while cash taxes were an expense of $74,000. We expect to remain at a cash tax rate of approximately 2% to 5% for 2006. Our pro forma EPS does not consider the GAAP benefit, and instead reflects the cash expense that we will pay. We expect our GAAP tax rate for the full year 2006 to be a non-cash benefit of between 30% and 40%, and we expect our cash tax rate in 2007 to be in the range of 2% to 5%.

Non-GAAP net income before stock-based compensation expense, amortization of intangibles and other non-cash charges was approximately $2 million, or 11.7% of total non-GAAP revenue in the second quarter, compared to 15.8% in the previous quarter and 19.8% in the second quarter of last year. The decrease from first quarter is due to the 2% decline in gross margin and the 2% increase in operating expenses.

Non-GAAP earnings per share before stock-based compensation expenses, amortization of intangibles and other non-cash items was $0.10 on a fully diluted basis for the quarter. GAAP earnings were a net loss of $2.4 million, or a loss of $0.13 per share. A GAAP to non-GAAP reconciliation is provided in our earnings press release.

Turning to the balance sheet, we generated $1.3 million in cash for the quarter.

We have historically guided you to look at our non-GAAP earnings as a yardstick for cash generation. For 2006, we are including the deferred revenue hair cut from the Visual Sciences acquisition in our reported earnings. However, approximately 60% of the adjustment is related to cash that was received prior to the purchase, and was either included in the opening cash balance, or used in the transaction.

Therefore for 2006 we will guide you to expect cash generation to approximate non-GAAP earnings, less this adjustment, which was approximately $800,000 for Q2 and will be approximately $1.2 million for the remainder of 2006. Our working capital decreased to a negative $9.4 million for Q2, due to the fact that the Visual Sciences notes moved from long term to short term this quarter. As Jeff mentioned, we believe we will have sufficient resources to pay these notes when they become due.

Our accounts receivable balance grew by $2.4 million with our days sales outstanding goes from 65 to 69. The increase in AR was due to a significant amount of invoices in the last month of the quarter and the timing of AR collections. Accrued liabilities grew in line with the business and incurred $600,000 related to the build out of new office space of Visual Sciences. Our deferred revenue balance grew from $15.8 million to $16.9 million during the quarter, an increase of 7%.

During the quarter, we spent $1.6 million on capital expenditures, as compared to $1 million in the first quarter. $600,000 of this increase was due to the one-time build out of new office space in Virginia for the Visual Sciences division, and we anticipate spending approximately $300,000 more on the build out in Q3. The only debt on our balance sheet remains the $20 million face amount in notes from the Visual Sciences merger which are reflected at a discounted rate of $19.2 million.

I would now like to pass it back to Jeff for some concluding comments, and a discussion of our revised guidance.

Jeffrey Lunsford

Thanks, Claire. As you can tell from these results, this business is growing at a healthy pace, and our invest in growth strategy is paying off in revenue growth ahead of our plan. We believe we are positioning ourselves for continued strong growth in 2007.

In the press release that we issued earlier today, we provided guidance on non-GAAP and GAAP revenue and EPS for the third quarter and the full year of 2006. You will note that we have raised full year revenue guidance by approximately $1 million to non-GAAP revenue of $68 million to $69 million, and are tightening our full year non-GAAP EPS range to $0.50 to $0.52 which effectively keeps our earnings guidance for the second half of the year unchanged.

For the third quarter, we are expecting to achieve non-GAAP revenue in a range of $17.9 million to $18.5 million, and non-GAAP EPS of $0.13 to $0.14 per share. The GAAP correlates to these numbers are provided in the press release. As mentioned earlier, we believe that Q3 will be the quarter where the margin compression, which resulted from our invest in growth strategy stops, and operating margin expansion begins again. You will note that the mid-point of our guidance represents an approximate 15% non-GAAP net income margin. You should also note that this 15% includes substantial forecasts of legal expenses; we would be anticipating an 18% margin without patent-related legal costs.

Regarding revenue visibility, our model is still largely recurring in nature with approximately 90% of our quarterly revenue goals already being contracted entering any particular quarter. The addition of Visual Sciences licensed business to our mix hasn’t materially changed this, because most of their larger contracts have multi-quarter delivery plans, and we don’t recognize the licensed revenue until certain delivery milestones are met, so we can usually forecast that revenue flow with good accuracy.

We had already, as an example at the end of Q2 signed a number of Visual Sciences contracts which start flowing into revenue in Q3 and Q4 and thus have good visibility in the Visual Sciences revenue for the second half of the year.

If you were modeling Visual Sciences as a standalone business unit, you should not expect to see continued 90% year-over-year growth since their business spiked up nicely in Q3 2005; rather, you should expect to see a more normalized growth rate of approximately 60% going forward, as we opt for controlled, high quality growth over uncontrolled hyper growth.

We are excited about the prospects before both WebSideStory and Visual Sciences as we look into Q3. We anticipate renewed margin expansion; our products are leading the industry and setting the bar by which all solution providers are measured. Our sales force is executing well. Our consulting teams are delivering real value to our customers, and lastly, our customer base is expanding rapidly and we are moving up the value chain and signing larger deals with them as our solution set expands.

This is a company that is truly differentiated from its many competitors based on three major facts:

1. We are delivering real profitability to our shareholders while growing at a 40% rate.
2. Visual Sciences is in a category of its own when it comes to real-time enterprise analytics. No pure play web analytics provider even comes close.
3. Our integrated suite of solutions in the web stack, the WebSideStory suite, can provide intelligent site optimization functionality that no point solution web analytics vendor can offer, leading to an impressive head-to-head win rate against all of the other point solution providers.

This is a profitable, high growth differentiated company participating in multiple growth markets with a bright future. At this point, we would be happy to take any questions you might have. Gregory, over to you for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Safa Rashtchy – Piper Jaffray.

Safa Rashtchy – Piper Jaffray

Good morning, Jeff and Claire. Good quarter.

Jeffrey Lunsford

Good morning, Safa. Thank you.

Safa Rashtchy – Piper Jaffray

A couple of questions. First, can you give us a sense of how much the cross-selling of various products and the fact that you have solutions beyond web analytics was helpful for you? Is there a way to even quantify that, or can you give us some more color on that? Then I have a couple of follow-ups.

Jeffrey Lunsford

Sure. It is probably not scientifically quantifiable, but we look at our win/loss reports. I am down in the trenches with the sales folks every Monday morning and out in the field with them. We are just seeing a lot of interest in what the WebSideStory suite can bring to bear. Things like targeted site search, targeted content based off of all of the behavioral data that we store in HBX. That really resonates with people that are trying to be smart about how they optimize their online presence.

Likewise, with Visual Sciences, we are seeing large enterprises rapidly, as I talked about in our merger announcement call with them, rapidly moving towards situations where web analytics is interesting, but what I want to do now is take the best practices that you guys have developed for our team in the web analytics sector, which is only 5% of our business, and we have got that great ROI off of that little 5% of our business. I now want to spread that ROI lever across the whole enterprise. Visual Sciences is a platform that was built day one to accommodate that. That is resonating as well.

Neither suite, the WebSideStory suite nor the Visual Sciences suite are point solutions, and we are really competing against, in all of those areas, point solution providers.

Safa Rashtchy – Piper Jaffray

But given that, do you think you have gained any market share from competitors or are you positioned to do so, given that you do have these advantages in integrated solutions?

Jeffrey Lunsford

I think if you look at web analytics as a whole, we are gaining market share. I think that if you look at the enterprise analytics business, we are almost creating a market. That is an interesting sector that is at the intersection of business intelligence, data warehousing, real-time transaction monitoring and a few other areas, are in what I would call vertical application analytics. So call center providers have call center analytics. Web site providers have web analytics, and so on and so forth.

We are really creating a new category there with that platform, and the technology needs to work at the terra scale and it needs to be able to answer deep segmentation questions within seconds. That is the use case.

We are finding that when people are looking for that type of solution, we are the only platform that can handle their data volumes across the breadth of data that they want us to analyze within the query times that they want us to analyze them.

Safa Rashtchy – Piper Jaffray

Great. One last question on margins, if I may. Could you tell us what is contributing to the growth margin decline? You talked about the operating expenses, and I believe you said that you expect operating expenses to stay at this level and not increase from here on. So if you could clarify that.

On the gross margin, if you could talk about what is going on in there?

Jeffrey Lunsford

The gross margin line is purely professional services – well almost purely professional services. Both the HBX business, the professional services or consulting component is growing a little bit, but Visual Sciences, most of it is just the baking in of the Visual Sciences business model into our numbers over Q1, which is two-thirds of a quarter, and Q2 which is the full quarter. They have a higher consulting component to their business, so it is primarily that.

Then there is a little bit of, once you capitalize R&D, when you start amortizing that, it goes into the COGS line.

Safa Rashtchy – Piper Jaffray

Thank you.

Jeffrey Lunsford

Thank you.

Operator

Our next question comes from David Hilal – Friedman, Billings Ramsey.

David Hilal – Friedman, Billings Ramsey

Great, thanks. A few questions here. First on Visual Sciences, it looks like that business was quite strong in the quarter, but can you help – Claire, you may have alluded to these numbers, but I want to understand how much of the subscription revenue line item consists of Visual Sciences?

Claire Long

Sure. When we look at the total subscription line, when we look at the total revenue about $3.3 million of the total revenue comes from Visual Sciences. Inside of that $3.3 million, 60% was recurring support and hosting.

So their breakdown, what you have to look at is 48% of their revenue right now is coming from non-GAAP revenue, which because prior to the merger, we couldn’t take that revenue and split it out by license and subscription. We need to give you just the total there, but it is mainly subscription, maintenance and license in that line item.

A piece of the 48% is support, and then of their standalone revenue, 16% was support and hosting.

David Hilal – Friedman, Billings Ramsey

Great. Jeff, you talked about all facets of the business meeting or exceeding. I want to talk a little bit about Adams. It sounds like that business, particularly with the new products maybe troughed last quarter. Is that reaccelerating? How would you characterize that business?

Jeffrey Lunsford

Good question. Adams is now integrated into the WebSideStory division, and you will see in the financial reporting we have got the WebSideStory segment and the Visual Sciences segment. So we are not running them on a separate P&L anymore, but we are clearly managing those products to bookings goals.

In Q2, Adams, their global bookings number was a record number. Their pipeline in Q3 looks real solid. I think as I said in the script, that is largely because of the great release -- that was WebSideStory Search 4.0. The neat aspects of that release all really revolve around the fact that we took our site search, we wrote to the HBX API and are able to do now more intelligent search based on the data that we have in the analytics database.

So the market thinks that is smart, they like it and are very interested in that. It is a clear differentiator against a lot of these other point solution providers in the site search business. If you are selling site search, then it is a differentiator against the point solution/web analytics providers if you are selling web analytics.

David Hilal – Friedman, Billings Ramsey

On sales capacity, it looked like the quota reps was about flat, you had great revenue with not much increase in sales capacity. Why didn’t sales grow? If you have any quantitative growth plans on reps to share with us for the rest of the year.

Jeffrey Lunsford

The sales reps were, I can’t remember what it was last quarter, but I think we might have added one or two. We cleaned out a little bit of dead weight in the quarter, you are always looking at that. You have to be very selective in who you hire and when you hire them. So we have really turned the heat up now on getting additional world class enterprise capable sales reps in here. We have hired a few in Europe recently, a couple more in the U.S. One of them closed $150,000 deal yesterday after being here for 2.5 months. So if you get the right people in here and they start winning business right away, because the technology is so differentiated.

David Hilal – Friedman, Billings Ramsey

Now let me shift to guidance and a couple of questions there. You gave us a revenue guidance, but how should we think of the split between licensed – I am assuming licensed should grow faster than subscription, just because of Visual Sciences is growing faster, but can you break those two out for us?

Jeffrey Lunsford

The way I think of it is as the WebSideStory division and the Visual Sciences division. Not so much as breaking it down by licensed, because for this year still a big piece of Visual Sciences revenue is going to be deferred revenue, which is one big blended bucket.

But what you are asking would be intuitively correct, yes. If that business is growing faster and if two-thirds or three-quarters of their deals were licensed deals, then the licensed lines would grow faster than the overall subscription revenue line, which is still growing obviously pretty fast.

David Hilal – Friedman, Billings Ramsey

So that is how we will model that. And then on legal, two questions as it relates to that. The $550,000 what are you modeling for the rest of the year? This is running – your earnings look like it could be $0.10 higher per year if you got rid of this $550,000 a quarter of expense. At what point does it get too much to where settling might be more appealing? The other part is, is it going to continue to be around $0.5 million a quarter going forward?

Jeffrey Lunsford

We are modeling higher than $0.5 million a quarter going forward right now, and we continue to believe that their case has no merit and we are monitoring other cases and watching how those progress that are ahead of us in the process. That lawsuit or the actual trial will be in Q4 of 2007 right now, as it is calendared. We believe their case has no merit and thus it should be defended against. We believe that they are infringing on our IP and so the assertion of our patents is still the right way to go.

The amounts of money that other folks have settled for seem to us to be – the fact that you would settle at all when someone is throwing a lawsuit at you that doesn’t have much to do with your business, if anything, it just is paying the lawyers to go away. We believe the right thing to do is to continue to dispute that and fight in court.

David Hilal – Friedman, Billings Ramsey

I will turn it over. Thanks guys, good work.

Jeffrey Lunsford

Thank you David.

Operator

Our next question comes from Brad Whitt - RBC Capital Markets.

Brad Whitt - RBC Capital Markets

Good morning, guys.

Jeffrey Lunsford

Hi, Brad.

Brad Whitt - RBC Capital Markets

David hit on a lot of my questions, but what about the CapEx expectations? That picked up a little bit this quarter. What are your expectations for Q2 and Q4?

Jeffrey Lunsford

Claire, do you want to take that?

Claire Long

It ticked up a little bit this quarter because of the build out at Visual Sciences. We don’t expect that to reoccur, but we do expect to spend about $3.5 million for the next two quarters combined.

Brad Whitt - RBC Capital Markets

Claire, if you could walk us through again the revenue recognition for Visual Sciences now and the licensed part? I believe it is milestone-based. And then also on the professional services, how do you recognize the professional services? Is it simply time and materials or is that milestone-based as well?

Claire Long

The professional services is time and materials, and then licensed is going to be milestone. We need to go through installation, sometimes training and sometimes acceptance before we can recognize that revenue. We have pretty good visibility because obviously that takes a period of time to get from contracting to acceptance.

Brad Whitt - RBC Capital Markets

Jeff, to follow up on the litigation situation. One of your competitors is out there saying that they have 136 patents now. Do you anticipate more in litigation in this sector going forward? Have you had a chance to review any of those patents? Just to get some color there.

Jeffrey Lunsford

We have valid IP of our own and more in the pipeline. We did a nice cross-license with WebTrends which was the other early pioneer for log file analysis in this space. There are hundreds of companies out there with thousands of patents, and we are just going to run our business. We also could potentially begin a strategy of monetizing our own IP.

I think that it is a very expensive way to go about making money, and so we just try to innovate and get our own IP rights established and focus on building great technology rather than feeding lawyers. I certainly wouldn’t rule it out either way.

Brad Whitt - RBC Capital Markets

Final question Jeff, around the HPX and Visual Sciences. It seems like to me that most customers – you are going to have Visual Sciences at the high end and HPX at the mid to high end. Are there scenarios where customers are going to want both, or do you think in most cases it is going to be either/or?

Jeffrey Lunsford

Well there is not even a mid to high end kind of scenario, because Visual Sciences is about analytics across the enterprise. We have customers managing many other data stores beyond web analytics on that platform. So it really becomes a question of, what are you after in your enterprise analytics initiative? Is this just a web-only initiative, or is it Visual Sciences?

The products are integrated such that we can run them together and you can have HBX for web analytics and use Visual Sciences for everything else and integrate the web stuff from HBX into Visual Sciences, or you can run pure Visual Sciences implementation, or you can run a pure HBX implementation.

We sit down with our customers in a very consultative process to understand what their business drivers are, and then walk them through the capabilities of each platform. It is usually very clear to them and us which way they would like to go. It is great to have those two capabilities in those discussions.

Brad Whitt - RBC Capital Markets

Great, I will pass it on.

Operator

Our next question comes from Peter Schleider – Peninsula Capital.

Peter Schleider – Peninsula Capital

Hi Jeff, Claire. Good quarter. I am curious about the Visual Sciences customer. Can you give us an example of a customer in the quarter, or maybe from the first quarter, but preferably the second quarter, what they are doing with the product and what they are expecting to achieve?

Jeffrey Lunsford

Sure, Pete. Let’s take an example of a large money management firm is using Visual Sciences to track all of their online web activity, all of their call center activity, coalescing in some of the portfolio and customer data, warehouse data so they get a real 360 degree of their customer. Another large retailer is taking Visual Sciences data and has a massive terra data installation, and they are taking big slices, terabytes worth of data off of that and importing that into Visual Sciences to use it as a dynamic querying tool. The executives in that company are just lit up with excitement with all of the new insight they have now into their data.

A large global hotel chain is using Visual Sciences and combining web data with reservation system data, and this particular gentleman stood on stage in Washington D.C. at Visual Sciences Viscom forum and said “I, in one insight, increased the revenue for my company, the bookings revenue, by $40 million by an insight I gained through this technology that we hereto before had not been able to see.”

A large e-commerce company, publicly traded and taken from one of our high profile customers were about to publish a case study where they increased revenue by 1%. 1% doesn’t sound that big, but this is an $800 million a year business that is growing quite rapidly. So them adding $8 million in revenue ongoing, based on the insight they have gotten from that platform is a nice return on the investment as compared to what they paid us for Visual Sciences.

Peter Schleider – Peninsula Capital

I think some people believe that this is just an extension of a module-type technology that you would add to HBX. It is significantly more encompassing than that, and brings in a whole, really an additional market space. You mentioned enterprise market space. I think that probably describes it better than I had heard before.

Jeffrey Lunsford

You are correct, Pete. It is really almost laughable, our competitors are running around trying to say Visual Sciences is a data mining plug-in to HBX, and nothing could be further from the truth. That is why we have called this a merger from day one. We have said it doubles our addressable market from day one.

A lot of analysts have been asking me, what are you going to do? How are you going to integrate Visual Sciences? It is not about integrating Visual Sciences with HBX, it is about the fact that these guys are brilliant, they have created a technology platform that was two to three years ahead of anything anyone else in the industry had and they are continuing to advance that platform daily. They have a massive scale threshold that they had to meet for the dark ops side of the U.S. government, that was one of their investors. They way they have built this platform is very open and very flexible.

So you can take this platform and you can apply it to any enterprise data set that you want, and you can have your system up and running in 30 days with all of the visualization, all of the ad hoc segmentation. We are talking terra scale segmentation here in sub-minute time. There is nothing else out there like it that we see. We see big huge data warehousing solutions which are all great and which we are actually synergistic with. We see interesting little data visualization companies that have good ways to visualize the data, but if you try to put 10 or 20 terabytes of data in, they choke.

What we have built is a platform that top to bottom just performs like nothing else that we have seen. When someone gets to the point of looking at that technology, we are rarely competing against anyone. All we are doing are waiting for budget dollars. The minute the executives see what the technology can do, we get the budget dollars freed up. So it is absolutely a completely different market segment and product base and platform for us. It is not a little bolt-on module to HBX.

Peter Schleider – Peninsula Capital

Great, that is great. Claire, is it right to say that if you put both the non-GAAP deferred revenue from Visual Sciences with the revenue that you recognized, if you were to look at – I guess the best way to ask this, is if you were looking at this revenue stream six months from now when all of this non-GAAP stuff goes away, what would be the run rate of the Visual Sciences business on recurring or subscription type revenue?

Claire Long

We think about one-third of the business to be licensed, and two-thirds to be recurring items.

Peter Schleider – Peninsula Capital

So next year, that is what we should be thinking about? Two-thirds of it is recurring?

Claire Long

Recurring, which would include things like professional services as well. So about one-third licensed, two-thirds everything else.

Peter Schleider – Peninsula Capital

Then, on the expenses going forward, are there any other things that you guys can do to make sure that these margins are going up?

Jeffrey Lunsford

That is a good question, Pete. We are, as I said, we have raised and are very confident in having good conservative, meaning high, estimates for our legal this quarter, next quarter and accounting properly scoped out and all that fun stuff, travel budgets raised substantially to accommodate all the record sales activity, so we feel real good about that forecast.

The other dynamic in our business is that as you get to the second half of the year, the bonus structure, how Claire and I get paid, becomes self-correcting. Our management team is paid a bonus that is driven half off of revenue and, as you might imagine, we are full-on revenue around here, and half on earnings. The earnings target for our bonus kicks in at $0.52, and it is fully earned at $0.54, so below $0.52, we would not earn half of our bonus, so that becomes self-correcting around $0.52. At $0.52, we would earn 75% of half of our bonus, so you basically have about $0.02 a share there that gets self-correcting in the way that we have structure that.

Sorry about all the detail, but in the spirit of executive compensation and full transparency that I read about every day in the Wall Street Journal today, I thought I would give you a little of that.

Peter Schleider – Peninsula Capital

That is very helpful, because it gives us about $0.02 of a cushion in the second-half of the year, is that a way to think about it?

Jeffrey Lunsford

Yes, and we just hope we do not have to give it to you.

Peter Schleider – Peninsula Capital

I do too. Thanks a lot.

Operator

Your next question comes from the line of Troy Mastin with William Blair. Please proceed.

Troy Mastin - William Blair & Company

Thank you. Good morning. I wanted to first ask about Visual Sciences. We have kind of touched on this, but I wanted to get a little more detail on the growth, grade acceleration to 55 I think from 93. You mentioned six deals. I am curious if that is the key driver of that acceleration. Should we think of that as a sustainable growth rate? Maybe that is a little bit high, but just some context on a year over year basis, how the visibility looks for sustained growth at that kind of a pick-up level? Is there anything yet that you can attribute to any sort of cross-selling synergy from the combination of the companies?

Jeffrey Lunsford

Yes, Troy, so I mentioned six deals, three over a $1 million, and three over $500,000 since December, and they have closed a good bit more business than that. Heck, I think two of those deals, those bigger million plus have not even begun to flow through revenue yet.

As I talk, we have big contracts signed where we have deliverables, and so those things I think will start kicking into revenue in Q3, Q4, so the growth this quarter was just good up-sell activity, great consulting delivery activity, some license, a lot of the business they had booked that revenue, that deferred revenue flowing through, and as stated, they had record bookings, all-time bookings. By the way, on this whole call, when I keep saying record bookings, it is not just record Q2 bookings, it is the highest bookings ever in the history of all three companies -- Adams, Visual, and WebSideStory, this quarter. Everything worked on that on the sales side.

What was the second part of your question?

Troy Mastin - William Blair & Company

I guess it just related to the visibility in cross-selling. Is there any cross-selling that came into this? Just give us some context on visibility, on growth rate in Visual Sciences.

Jeffrey Lunsford

On the cross-selling, their pipeline has grown, as I mentioned in the script, their pipeline has grown at a nice rate since we closed it. Some of it is because of their just continued good job, because they are a great operating team, but some of it is directly attributable. You can see four or five of our largest customers in their pipeline looking at the product, points, proof-of-concept type of work going on, them asking us for proposals and that type of things.

I would anticipate beginning to see some of that stuff, maybe Q3, probably definitely by Q4, because these are big-ticket items. They have to wind their way through the budget cycles, but like I said, once those senior executives, once we get up to those guys, they see it and they want it.

Then, as far as visibility, because of the size of their contracts and that revenue gets recognized upon delivery in a lot of cases, and that is six, nine months out from signing, and because delivery is defined as full training. I mean, we will usually have them live with test systems and everything, like 30 days after they sign a contract, but you have to go through all these accounting hoops to get the revenue.

We have great visibility into their business, and I think it has not materially changed the visibility of our business overall, which is what I mentioned in the guidance section. When you look at our revenue guidance for the quarter, we feel very solid about that.

Troy Mastin - William Blair & Company

It is fair to say that growth rate might be a little more lumpy at Visual Sciences, just due to timing maybe of full delivery?

Jeffrey Lunsford

Well, that is what I said, 90% -- their business really picked up from Q2 to Q3 of ’05, so the comparison gets a little harder, but I think 60% going forward is about right for now. We have real good visibility into that growth rate.

Troy Mastin - William Blair & Company

Great. I wanted to dig in a little bit more on professional services revenue, I guess more notably at Visual Sciences, but overall in the rest of the business as well. How should we think about this line item in context of the overall Visual Sciences revenue? Is this something that will be a relatively fixed percentage of their total revenue? Are you seeing, maybe as a result of owning Visual Sciences or expanding product line of HBX, more professional services as a mix of your revenue in the rest of the business? I would like some context on where we should expect to see professional services go over the next couple of years.

Jeffrey Lunsford

We are in the Visual Sciences model trend, to kind of give you a sense, but broadly the trend is that our business at WebSideStory, we were growing professional services. It has not been a dramatic impact because it is a much smaller piece of our business. Visual Sciences is more like 15%, 20% of the business, or something like that. I would expect that mix to hold going forward. That is what Claire said in the $3.3 million of revenue, 21% was PSO, of the part that was outside the deferred revenue roll-forward.

Troy Mastin - William Blair & Company

Maybe just a couple items off the cash flow statement -- cash flow from operations, D&A, and I missed the cap-ex number earlier.

Claire Long

The cap-ex number was $1.6 million. We generated total cash of $1.3 million, so cash from operations was around $2.9 million, $2.8 million, because obviously you need to take out that cash we spend on cap-ex to get the total cash.

Troy Mastin - William Blair & Company

Do you know the D&A number?

Claire Long

The what?

Troy Mastin - William Blair & Company

Depreciation and amortization?

Claire Long

Not offhand, but I can certainly get back to you on that.

Troy Mastin - William Blair & Company

Thank you. I will get it later.

Jeffrey Lunsford

We had $18 million as of the end of July -- over $18 million at the end of July in cash and investments.

Operator

Your next question comes from the line of Mark May with Needham & Company. Please proceed.

Mark May - Needham & Company

Thank you. A couple questions. You mentioned a number of new customers that you signed in the quarter, I think MGM, BellSouth, et cetera. I am wondering if maybe you could give us a sense of the number of modules that a new customer is purchasing out of the gate, and how that has changed over the last year?

Second question, I know that you guys gave 37% year over year growth at WebSideStory division, 93% growth at Visual Sciences. I am wondering if you could recast the WebSideStory division on a pro forma basis, including Adams and tell us what that number is? Then, for total company pro forma, including Adams and Visual Sciences year over year.

Jeffrey Lunsford

It is hard because we are not breaking Adams out anymore, Mark. If I had to guess, or estimate, it is the HBX business is growing at about 40%, Adams is growing about 20%, and that is I think what we had last quarter. Actually, I think HBX would probably be growing at 45%’ish, and then Adams would be growing at 20%. Then you have that ad revenue that is shrinking at whatever, 10%, 15% a year. That all blends into that 37% organic for WebSideStory.

We have really now too many combined contracts with Adams search and web analytics and too much consulting going on, back and forth within those groups to accurately track either bookings or run a P&L, and that is why it is part of the same reporting segment.

Going forward, if I was going to try and figure it out, I would probably think that the Adams, with the strong pipeline we have built for them, based off the four [inaudible], their growth would probably kick back up a little bit.

Mark May - Needham & Company

Then on the average number of modules for a new customer?

Jeffrey Lunsford

The way we track that is average products per customer across the customer base. We are still at about 1.1, we are still kind of in the mode of beginning to do a lot of cross-selling and upselling. So we expect to improve on that metric. I do not have that number for the new contracts signed this quarter.

Mark May - Needham & Company

What about if you recast the 130 new modules sold in the quarter in terms of number of new customers added?

Jeffrey Lunsford

That is all customers added. Every quarter, our new contracts added is customers new to the WebSideStory family. It is not a net add number because you do have some customers that you lose every quarter. We have about a 90% renewal rate, so with a thousand customers, that means you will lose 25 customers a quarter.

What we are doing is driving our business up the value chain into those larger relationships. We are still doing a great job in the mid-market as well, when in business there. But we are not diving aggressively down market, where we see other web analytics guys diving, because if you go too far down market, you just run dead into Google.

Mark May - Needham & Company

The number of new contracts signed at Visual, was that the six number? I do not think it was. That was a different number.

Jeffrey Lunsford

Yes, we did not break that out. We just said the six number was since December, so we did not break them out of the 130.

Mark May - Needham & Company

Another person on the call earlier made a 55 to 93, referring to Visual Sciences -- is that the number of ending customers at Visual Sciences?

Jeffrey Lunsford

That was their growth rate last quarter, and then their growth rate this quarter.

Mark May - Needham & Company

Okay. Thank you.

Operator

Your next question comes from the line of Sean Jackson with Avondale Partners. Please proceed.

Sean Jackson - Avondale Partners

Good morning. The average deal size, you mentioned on a consolidated basis, $45,000 -- how does that break out with Visual Sciences versus WebSideStory?

Jeffrey Lunsford

Visual Sciences is larger on average than WebSideStory, but we do not really break it out that way. We just throw it all in one big bucket.

Sean Jackson - Avondale Partners

Okay, but just qualitatively, just from the website HBX business, pricing I assume is holding steady here?

Jeffrey Lunsford

Yes, pricing has really, as I said I think in our last earnings call, it has really solidified around three or four market leaders. Some of the unhealthy, irrational pricers have gotten bought and sort of disappeared inside the big companies that bought them.

The pricing is pretty stable. I think we and our other competitors in web analytics have a good sense of where the other guys are going to come out. You know, you still, like any technology business, your price varies pretty dramatically off the list, depending on the account and the situation, but if you look at it on a blended basis, we feel like pricing is stable and that the segment is very healthy.

When I talk to the other CEO’s in the space, see them at trade shows and whatever, they all seem to be growing. [Armatur] had a strong earnings call last week and had great growth numbers. Core Metrics is growing quite rapidly. Web trends is doing well. The entire space is just a fantastic place to be in business right now.

Sean Jackson - Avondale Partners

Also, you mentioned briefly some international activity that is ongoing. Do you have any metrics, whether it be bookings or revenue that you could put to that?

Jeffrey Lunsford

International, are you talking about the revenue percentage?

Sean Jackson - Avondale Partners

Yes, correct.

Jeffrey Lunsford

Okay, so we are at what, 13%, Claire?

Claire Long

Yes, for the three months, we were 13% of our total GAAP revenue came from Europe.

Jeffrey Lunsford

Yes, and then we got a little bit in Asia-Pac, but…

Sean Jackson - Avondale Partners

How does that compare to previous quarters, if you could give some kind of…

Claire Long

It is actually a little higher this quarter than first quarter because most of Visual Science revenue is not in Europe. It is mainly the U.S.

Jeffrey Lunsford

Yes, so it is lower this quarter, because it was at 15%...

Claire Long

Well, yes, Sean, it was higher in Q4, it went lower in Q1 because of Visual Science coming into the mix, and now it has kind of come back up a little bit.

Sean Jackson - Avondale Partners

Thank you.

Operator

Your next question comes from the line of Chad Bartley with Pacific Crest. Please proceed.

Chad Bartley - Pacific Crest Securities

I will just limit it to one question. I wanted to follow-up on your quarter [carrying] reps and renewal reps that was flat in the quarter. I think you guys had planned to do some hiring, so to follow up on a previous question, can you put any numbers to that for us? Can you quantify how many folks you expect to add in the third quarter, fourth quarter for modeling purposes? Thank you.

Jeffrey Lunsford

We are beginning to do a lot of, obviously, modeling for ’07, and the way we are thinking of it we probably want to grow that headcount by 40% over the next 12 months, so that would be something like four a quarter. That is a little bit of a lumpy metric, because we are very disciplined and discerning in who we hire. We are looking for only the best, and we are bringing on a good number, as I said, of only the best, but it takes time to find them. That is if you want to just look at a number over a 12-month period.

Chad Bartley - Pacific Crest Securities

That would be four per quarter, that would be quarter [carrying] reps as well as renewals aggregate in the business?

Jeffrey Lunsford

No, that would be the quarter [carrying] reps, the new business talent.

Chad Bartley - Pacific Crest Securities

Are you going to grow the renewal reps as well?

Jeffrey Lunsford

That grows. We have our quality metric of a number of customers or amount of revenue per sport head and various support thresholds based on contract size and that type of thing.

Chad Bartley - Pacific Crest Securities

Thank you very much.

Operator

Your next question comes from the line of Michael Huang with ThinkEquity. Please proceed.

Michael Huang - ThinkEquity Partners

Thank you, good morning. When you guys look at some of your largest HBX wins, how many of these do you believe are influenced by your Visual Sciences platform? Do you actually believe that HBX win rates are improving as a results of Visual Sciences?

Jeffrey Lunsford

I think that the overall company win rate is probably where it has been. I mean, this company has been growing at 40% for three years, right, Michael? I think it is people love the vision, love the direction. The HBX win rate is really, if it is improving, it is improving probably more because of things like the WebSideStory active marketing suite, the vertical stack within website optimization, where we can do nice, value-added things, as I discussed in the script.

That platform has great features that other vendors do not have, and when we get down into the head-to-heads, you know -- hey, won 110 or something like that, I cannot remember exactly how many of the 130 of the HBX deals, but we won a whole bunch of them head-to-head against the competition. Everybody has enough sales out there that pretty much all of these now are head-to-head, knockdown drag-outs.

Michael Huang - ThinkEquity Partners

I know you guys do not quantify bookings or bookings growth, but is it fair to say that organic bookings growth has picked up versus previous quarters, or maybe you could talk about how it has been trending qualitatively?

Jeffrey Lunsford

Bookings growth was in our 30% to 40% targeted range, and that is the one-year bookings number. That is usually about as far as we break it out, because A, there is no GAAP definition of a booking, and B, a booking for visual is different if it is in-house or on demand in a booking [inaudible], different. So there are way too many definitions of a booking.

What I just try do to, this is what this business unit calls a booking and it grew X from last year, and this is what this business calls a booking and it grew Y from last year. We use those booking metrics to drive obviously our sales headcount productivity numbers, which determines and sets our bookings goal for next year, how many people we want to hire.

Michael Huang - ThinkEquity Partners

Last question is looking forward, it is nice to hear optimism on the business, but when you look out over the next year or two, what do you believe represents your biggest challenge? Is it competition? Is it legal? Is it macro environment, or is it something else?

Jeffrey Lunsford

I joke with people that our two biggest competitors are the audit complex and the patent complex. Honestly, if you look at the P&L, those are our two biggest competitors.

I have never been in a healthy market like this where we did not have intense competition from great, feisty competitors like any of the usual suspects out there. They are all companies that I admire, managements I admire, and it has always been that way, whether it was Internet banking back in the day, which is the latest term, or really hot development tools with Togethersoft, I have always had intense competitors and that to me is a really healthy dynamic. It drives you. It gets you out of bed every morning. It gets your R&D team out of bed every morning. They see some feature someone else got in their before them and that cranks out, and you know who wins in all this? It is the customers.

We are very customer-focused. We love going out and visiting our customers and hearing the great way. If I can go in and add value to that customer and because we are building more, we are on an innovation treadmill and an innovation race with our other intense competitors, and every year they get more out of us -- that is a fantastic dynamic. As long as we run a disciplined business, our margins expand over time.

Honestly, yes we have great competitors. We have had them since the day I got here three-and-a-half years ago. I think we have been pretty much competing against all the same cast of characters. We seem to have scraped up 40% growth somehow.

So we feel comfortable about the competitive dynamic. We feel really strong about where the products are.

Our two biggest competitors are the audit complex and the patent complex, both of which are in need of dramatic reform, if you look at the wealth being sucked out of a small cap tech, and it really -- just the whole small cap land, how much these companies are having to pay to survive in that environment.

Michael Huang - ThinkEquity Partners

One last question, going back to the patent dispute, can you actually talk about why the legal expense ramped in such a fashion versus Q1? What changed in Q2 that was beyond your original expectations?

Jeffrey Lunsford

It was just the ramp of the actual case. The case was just ramping. The cases, we are asserting IP against them, and they are asserting theirs against us, so there are two cases going on, one in New York and one in California. They really just started to ramp more in Q2. Q1 was just the beginning, and so we are just kind of getting a sense of what is the work, what is the calendar going to look like, when are we going to be doing the work, and then let’s get the right budget in place.

Michael Huang - ThinkEquity Partners

Thank you.

Operator

Your next question comes from the line of Richard Baldry with First Albany Capital. Please proceed.

Richard Baldry - First Albany Capital

Thank you. From a real top-down perspective, if you were to hit your top-down for your own bonuses for the year on earnings side, if you looked at second half versus the first half, the $0.22, you would have to do about 30% to almost 50% growth in pro forma earnings in the second half. To what extent is that mostly driven by the 80% margin top-line expansion versus the fact that you had dipped some incremental spending in the first-half, particularly in Q2, that sets you up for maybe much greater leverage in the second half. Should we expect to see op-ex sort of flattish is the question, versus the top-line to model? Thank you.

Jeffrey Lunsford

The $0.13 to $0.14 range that we gave you, that is sort of like three percentage points of margin expansion. The bulk of that is from revenue growth, and just holding things where they are. All expenses across the board always grow when you are growing at 40%. They just grow less than revenue, so we will get some leverage next quarter.

That will continue in Q4, barring any unforeseen kind of strange thing that impacts the G&A line. The operating leverage, we believe, as I said, we are entering a margin expansion phase similar to the one we experienced between Q2 and Q4 last year, where you saw things ramp from 14 to 26 or whatever it was.

Richard Baldry - First Albany Capital

Thank you.

Operator

Your next question comes from the line of Patrick Walravens with JMP Securities. Please proceed.

Patrick Walravens - JMP Securities

Thank you very much. Claire, I think this first one is probably for you. Why is the cap-ex going up so much compared to last year? If I heard you right, it is going to be around 1.75 per quarter. Is that right?

Claire Long

The top-end is about 3.5 for the rest of the half.

Patrick Walravens - JMP Securities

That is a big acceleration. What is going on?

Claire Long

Well, if you look at last year, we did not own Visual Sciences, so that is a big piece of it, obviously, and then as we grow, we continue to add servers, hardware, et cetera. We are very efficient. Our platform is very efficient, but we do need to add that cap-ex to keep up with this high growth in both divisions.

Patrick Walravens - JMP Securities

Is it because Visual Sciences has sort of higher end, is it more hardware-intensive? Is there some dynamic like that going on?

Jeffrey Lunsford

Yes, well, it is from a platform efficiency standpoint, it is as efficient if not more efficient than HBX, but they will normally be storing 10 times the amount of data that HBX will be storing, and they will also be looking at a whole bunch of data. As I said, maybe they have come and sliced off of the terra data warehouse or whatever.

What is usually happening when someone is using Visual Sciences, and we are seeing a bit of an up-tick in people wanting us to manage that for them, so doing it in an on-demand model, just because they cannot get the resources, that is usually a more hardware-intensive kind of practice.

Just to give you one example of this, why people like to do things on demand, we had a company, one of their customers that wanted to license a number of servers worth of Visual Sciences license, and asked for internal hardware approval to run that software on, and the cost per server that their internal IT group gave them, fully loaded, was almost $100,000 per server, whereas these are servers we can go buy for $10,000.

When you get inside these big companies and you have business people that want to use this technology, they get -- they really get whacked by internal IT service groups hitting them with some big fully loaded cost, and they come to us and we say we can do that, and we will do it on a managed service deal.

We still have many customers using that technology in-house, and many buying it to use in-house, but there is a really interesting dynamic, which is why the whole on-demand software movement I think exists to begin with. In many cases, it is a lot more efficient for them just to let us run it.

But you find that when you get into enterprise analytics, Pat, that people are not nearly as open-minded about sending their non-web data outside the firewall. Web data gets created outside the firewall, so tracking it outside the firewall, that is fine. You start talking about point of sale data, call centre data, branch data, that gets a little more iffy.

Patrick Walravens - JMP Securities

Obviously everyone is going through this, so I figure I should ask. Have you reviewed your stock option granting practices at this point? What is your thinking around that?

Jeffrey Lunsford

Yes, we have. We have done our internal review, as every good company out there would do. Our general counsel, Clair, our head of HR, our new internal audit looked at it, and we just briefed the audit committee on it at our last Board meeting yesterday. We have found no irregularities.

I think I am the poster child of hey, I have options at $21 a share, but we have no irregularities. We are very disciplined in how we do that, and we grant the incentive options for new hires on one day a month, so that is pretty easy to see. Then we do our annual merit grants basically one day a year. All that is really clean.

Patrick Walravens - JMP Securities

Good. Claire, can you give us an estimate. I think I heard you say it would be less than the non-GAAP earnings, but can you give us an estimate for what cash flow from operations will be this year?

Claire Long

We think we will end the quarter with between $19 million and $21 million. We ended the quarter with about $17 million, so that is somewhere between $2 million and $4 million and that is going to depend on the timing of these CapEx purchases.

The point I wanted to get across is, usually you can just look at our non-GAAP earnings and it should equate to cash flow. But this year is a little unusual in that deferred revenue haircut, about 50% of that was cash received prior to the merger. So it was either on the balance sheet or used. I would say somewhere between $2 million and $4 million, we are thinking $19 million to $32 million at the end of the year.

Patrick Walravens - JMP Securities

You said at the end of the quarter, you meant at the end of the year?

Claire Long

I meant at the end of the year, yes.

Operator

Our next question comes from the line of Doug Campbell with Sierra Capital.

Doug Campbell - Sierra Capital

In terms of head-to-head competition, you have won a lot of business, but the market is growing fast and some competitors have won a lot of business also. My question is, when you don’t win is that application-specific or is there any insight you can give us?

Have you lost any customers, any previously existing customers, to competition during the quarter?

Jeffrey Lunsford

We have attrition of roughly 10%, so if you have 1,000 customers like I said earlier, you are going to lose 100 a year which is 25 a quarter on average. What we do is we run the business to try and get that number lower, but you reach a point of diminishing return from investing in levels of support and that type of thing.

The question about why do we lose when we lose? I chalk most of that up to sales execution. If our sales team is not in the account first, you can sort of set the stage and build the mind share for your own particular platform and its particular strengths. We take those win/loss reports and we use them to improve how we are selling, and also to improve the product if there is some area of product functionality that the prospect was asking for that we were not able to give them.

Doug Campbell - Sierra Capital

Okay. In terms of the annual attrition rate, does that tend to cluster around either a vertical market area or a customer size category?

Jeffrey Lunsford

No, we are driving, as I said, up the value chain, trying to become more important to our bigger customers. I would say from a vertical market standpoint there is not really any particular vertical where we are notably weak. We are really strong in travel and hospitality and technology and e-commerce and health care. You name it. The financial services, we’ve got a marquee list of customers pretty much across all of the typical verticals as you typically segment them.

Doug Campbell - Sierra Capital

Last question. You mentioned earlier in the call that your customers are great about asking for options that they would like you to provide them. Is a lack of desired functions much of a factor in the win/lose ratio?

Jeffrey Lunsford

No. Like I said, I chalk that up to sales execution, really who is in the account first. The hustle counts in this market segment.

Doug Campbell - Sierra Capital

Thank you very much.

Jeffrey Lunsford

Thank you, David.

Operator

Your next question comes from the line of Kyle Evans – Stephens.

Kyle Evans – Stephens

Maybe a quick update on the ecosystem around AMS? I haven’t really heard much about who you might be plugging into on the functionality side, and who might be new on the distribution side.

Jeffrey Lunsford

Good question. We now have 16 stream partners connected to the platform with their integration complete and going to market, shoulder to shoulder with us. That is the product side. We have a very robust pipeline of potential partners that are wanting to sign up with us. What we are trying to do is control that and make sure that we have quality partnerships, rather than 150 thin partners we want 50 really thick, solid partnerships. Where we are doing joint marketing, we are presenting at their user forums, they are presenting at our user forums and that type of thing. Those are the kinds of partnerships that we are building and doing a good job of building.

Then on the distribution side, the interactive, that group there are a number of new agencies that pop up every quarter almost because the way that interactive agency market works is an agency gets to a size of about 100 and then 20 of them create a splinter and go off and start one of their own. We continue to do real well there and build solid relationships with AR. Key influencers in many accounts, and our team, we have been training folks. We will give them onsite training. We had a team from one real strong agency here.

The reason I don’t want to name them is they are all so competitive they don’t like it if we give one agency more prominent mention than the other. But we have had folks coming through for training and writing us emails as to how great it is. Then they go forth then, and because they know your platform obviously they are much more likely to recommend you.

Kyle Evans – Stephens

And what kind of opportunity is there to build that distribution ecosystem out around Visual Sciences on the integration and consulting side? I heard you say you think 60% growth, I heard you say 15% to 20% professional services, that is a pretty steep requirement for you to grow out your people to grow professional services at 60% is not an easy thing to do. How can you rely on some outside third parties on that front?

Jeffrey Lunsford

That is a good question. Visual Sciences has already partnered with a couple of systems integrator types and they also have some vertically specific application vendors that have incorporated Visual Sciences into their offerings. The telco space is an example. They are selectively working with integration partners. As you know, that business has grown up under a shroud of tight control of what our advantages are there. They are very cautious about who they partner with. Companies that have open partnerships with many, many other vendors in any of the areas that they compete area usually ruled out for that reason, and companies that are very focused and are willing to work just with the Visual Sciences platform then are signed up, sworn to secrecy and indoctrinated into what the technology is capable of doing.

Kyle Evans – Stephens

It sounds like you are selling bundled Visual Sciences boxed solutions to people today. First off, did I hear that correctly?

Secondly, what else needs to be done on the integration front from a technology perspective to put those two together?

Jeffrey Lunsford

The technologies have been integrated, they work together. We are not actively selling just Visual Sciences for the web stack into HPX customers. What we are doing is taking the Visual Sciences proposition of enterprise analytics into our larger HBX customers where Visual Sciences can add some value. We are seeing a very positive response from those discussions.

Kyle Evans – Stephens

Why aren’t you selling the Visual Sciences web solution into your HPX client base?

Jeffrey Lunsford

Because HBX, as I mentioned earlier, as ranked by Gartner one of the best two analytics packages on the market. If you just need web analytics, then in some cases you don’t need visual sight overlaid over HBX, right? If a customer is already using visual sight then we are not selling them HBX. So that is the one area that the platform is overlapping. We are not going in and trying to get double the analytics budget from somebody who is already really happy with what we are doing for them in that area.

Kyle Evans – Stephens

Thanks. Claire, have you had a chance to dig up that depreciation number for the quarter?

<Claire Long

No, I haven’t actually gone to get it but I will get that to you. It will be in our release in our Q as well, when our Q is filed. I will give it to.

Kyle Evans – Stephens

Great, thanks guys.

Claire Long

You’re welcome.

Operator

I am showing no further audio questions at this time.

Jeffrey Lunsford

Okay, thank you everybody for spending the time on the call today. Operator, at this time we are complete if you are.

Operator

Thank you very much sir. Ladies and gentlemen, this does conclude today’s presentation. Thank you for your participation and you may now disconnect. Have a great day.

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