SuccessFactors Inc. Q2 2009 Earnings Call Transcript

SuccessFactors Inc. (SFSF)

Q2 2009 Earnings Call

July 27, 2009; 5:00 pm ET

Executives

Lars Dalgaard - Founder, President & Chief Executive Officer

Bruce Felt - Chief Financial Officer

Analysts

Sarah Friar - Goldman Sachs

Thomas Ernst - Deutsche Bank

Brendan Barnicle - Pacific Crest Securities

Adam Holt - Morgan Stanley

Michael Nemeroff - Wedbush

Phil Rueppel - Wells Fargo

Karl Keirstead - Kaufman Brothers

Sasa Zorovic - Janney Montgomery

Terry Tillman - Raymond James

Horacio Zambrano - Jefferies and Company

Michael Huang - ThinkEquity

Brad Reback - Oppenheimer

Brad Whitt - Broadpoint AmTech

Brad Mook - MKM Partners

Richard Baldry - Canaccord Adams

Kash Rangan - Merrill Lynch

Presentation

Operator

Good afternoon and welcome to SuccessFactors second quarter fiscal 2009 financial results conference call. (Operator Instructions)

I will now turn the call over to Bruce Felt, Chief Financial Officer of SuccessFactors.

Bruce Felt

Thank you operator and good afternoon and welcome to SuccessFactors second quarter fiscal 2009 financial results call for the quarter ended June 30, 2009. The primary purpose of today’s call is to discuss our Q2 and performance.

However, some of our discussion may contain forward-looking statements, which may include projected financial results or operating metrics, business strategies, anticipated future products and services, anticipated market demands or opportunities and other forward-looking topics.

These statements are subject to risks, uncertainties and assumptions. Accordingly actual results could differ materially. For a listing of the risks that could cause this, please see our latest Form 10-K and 10-Q filed with the SEC as well as the factors identified in today’s press release.

Unless otherwise stated, all references to spending margins exclude stock-based compensation, which are non-GAAP measures and reconciliations from non-GAAP to GAAP can be found in our press release.

Today’s call is available via webcast and a replay will be available following the conclusion of the call through Friday, August 07. To access the press release, supplemental financial information or the webcast replay, please consult our investor relations website at www.successfactors.com/investor. Following prepared remarks, we’ll have a Q-and-A session.

I’ll now introduce Lars Dalgaard, SuccessFactors Founder, President and Chief Executive Officer.

Lars Dalgaard

Thank you, Bruce. We want to thank our customers, partners and colleagues for a standout result in Q2, 2009. SuccessFactors numbers show that great companies can do well in challenging times. SuccessFactors deliberately built a business that is diversified, both globally and across a range of customers, small to large.

This has enabled us to execute more predictably in a tough environment. We saw some small indicators of a recovery, but most importantly in this quarter, the team in most segments and geographies has found a way to systematically get deals done in this market. Most organizations are being very conservative about technology spending and we have not seen that change.

SuccessFactors revenue grew 44% and true to the model and our promises, we drove strong margin expansion. First, gross margins expanded to 79%, up from 53% at the IPO. Cash flow positive continued and finally, SuccessFactors improved operate margin from negative 109% at IPO to breakeven. That’s operating margin profitable three quarters earlier than we promised.

In Q2, we improved our close rates, strengthened our pipeline, increased deal sizes, closed more large deals, gained business with marquee customers and very important, both new and total transactions were up sequentially and SuccessFactors achieved higher renewal rates. We took user group meetings on the road to accommodate customer’s budgets it was a success.

Over 1,000 of our customers and prospects from all over the U.S. joined us for our two-week events in San Francisco, Chicago and New York. As many of you who joined us there saw, the energy was electric with standing room only attendance and needed to kick out our employees to make room for customers in both Chicago and New York.

Executives from Vail Resorts, Ingersoll Rand and VWR International, to name a few key noted our events. Not only did customers and prospects show up in large numbers, they put their money where their mouth is and continued to invest in our offerings. As we explained in February, we reduced our sales and marketing fire power in Q4 while maintaining a dominant and larger sales force in the industry.

The new focus and reassigning of territories is paying off. During the quarter, we closed six deals over $500,000, up from three in Q1. These deals are spread across industries and geographies because of our diversification. We signed one of the world’s largest beverage company’s, signed Takeda Pharmaceutical, the largest pharmaceutical company in Japan, signed U.S. Investigations Services and BASF North America and Pon Holdings in the Netherlands, all bigger than $500,000 deals.

Specifically, the North American enterprise business was able to close important deals, a significant change from Q1 and Europe enterprise again showed up extremely strong. SuccessFactors Europe grew over 100% in Q1, 2009 and Europe also grew sequentially in Q2 2009.

This was helped not only by the Southern Soc Gen, Areva, Veolia and central Europe, Nestle, Deutsche Bank, Siemens, United Nations, Cofra, Hilti, but several large deals in northern Europe in Q2. Nokia up-sell and Fortum, also in Finland, and ING and Pon in the Netherlands, all 10,000 plus employee company’s.

In Q2, SuccessFactors signed, what we believe is the world’s largest Cloud Computing deployment in Europe with Siemens. They have over $110 billion in annual revenue and are planning on rolling out applications to 420,000 people, across 80 countries and in 20 languages.

I apologize for the length of the following quote, but who am I to stand in the way of an enthusiastic customer, Marvin Hausman at Siemens told us. “Our Board as a global vision, which is a worldwide strategic focus for us today, SuccessFactors will be instrumental and helping us achieve these core objectives by closing the gap between strategy and execution.

It will also enable us to globalize on a single platform, clearly separates strategic execution in management from transactional HR. We conducted an in depth market evaluation of 30 leading vendors and seven system providers, Siemens already had over five months with our end-users stress testing this software quality, global stability and innovation potential.

SuccessFactors was a clear winner by a significant margin based on its usability, ease of integration and rich functionality. The Enterprise Cloud Computing business model is a strategic direction for us. It’s not only lowers IT costs and creates faster end-to-end processes, but can also grow with our requirements both globally and locally.”

Despite this complex deal just closing eight weeks ago, the SuccessFactors and Siemens partners have signed on and signed off on their first major implementation milestone of gold configuration, below budget and ahead of schedule. We plan to do a lot more in Europe. Today, I’m happy to announce Industry Veteran Peter Prestele, will be joining us to lead our business in EMEA.

Peter has a very impressive background that includes executive roles with IBM Software, Mercury Interactive and most recently running Hewlett-Packard’s German $290 million growing business. Under Peter’s management, the business grew three times the market. Peter will fit right in at SuccessFactors. Peter is wise, thoughtful, proven, strategic and aggressive. Welcome Peter Prestele.

Latin America, Australia and Canada also continued to have very strong deals. An additional TAML element of our diversification strategy is our alliances and channels business. IBM, GeoLearning and Trinet have been very productive for SuccessFactors in 2009, and Ceridian announced in a press release, their new performance management product powered by SuccessFactors, which was an important contributor to sales in the first half of 2009.

Our SMB Group is also key investment for us, which even though challenged by lack of credit and resulting reduced spending in this market fair to reasonably well with sequential growth. Our SMB Group has very large potential and as you know, most SaaS companies make their money in SMB and we find customers in this market definitely have very little support staff and really need our self service business applications even more than our enterprise customers.

Today, our user base stands at more than 5.4 million strong users, the same as the population of Denmark, up from 2.3 million two years ago. In all segments, we saw larger deals getting done than the previous quarter and the unit number of deals was slightly less year-over-year, but it was up sequentially. Customers that are bold about their future from many different geographies and industries decided to trust SuccessFactors to help them execute on the gap between their new strategies and results.

We have found that large customers trust us to prove ourselves as one of few investments they will make in this tough market, given SuccessFactors large, exclusive whitespace and a base for future growth. To dimension this, the 29, 5000 employee companies SuccessFactors signed in Q2 have a total of 1.4 million total employees working at their facilities.

SuccessFactors initial engagement is only 670,000 seats, giving us a large whitespace to sell into. These customers also purchase an average only 3.5 modules and based on history with veteran customers of this size, overtime we could and should have an opportunity to up-sell these accounts by a factor of eight or ten. This is illustrative of why our up-sell has now increased from 34% in 2008 to 38% in Q2.

Experienced SuccessFactors customers proved that point in Q2. For example, in this quarter, one of the largest package delivery companies got a positive blind reference from another division that had been a customer for two years, and went with 15,000 new seats. Also, at the same time, one of the world’s largest retailers and employers who already own 300,000 performance and gold management seats, signed up for an additional 100,000 seats of succession planning in the quarter.

Both these companies are now delivering well over $1 million in recurring value to SuccessFactors. These impressive numbers demonstrate the increasing value of the SuccessFactors brand. Make no mistake, we have a great reputation with HR leaders and we love our relationship with these great leaders.

Q2 results, boosted by the business results we can now prove based on the work done in Q1 with an outside strategic consulting firm also demonstrate great progress on partnering with HR to create a path to becoming a trusted partner to CEOs, COOs, CFOs and CIOs as well. As we look at the market, it appears that many executives are sorting out mandatory from optional applications.

Our customers tell us that they prioritize SuccessFactors’ investments ahead of others. As they grapple with this economy, they’re picking technologies with immediate business impact. Companies standardize on SuccessFactors to improve their execution. Our complete business performance suite is an investment that helps them survive now while positioning them to thrive as the economy comes back.

We also hear from our customers that while there are a lot of HR applications on the market and there sure are, SuccessFactors standalone as the company who can help their people and businesses perform at new levels. Based on this customer feedback, we believe that SuccessFactors is the only provider to go beyond automating HR in one department and deliver mission critical business performance capabilities to the whole company no matter where they are, no matter what size they are.

We still have strong concerns about the uncertainty in the economy. In fact, it appears that many of our customers are still really struggling with their businesses. With that said, we feel we proved we are the best positioned company in the industry to exploit our $16 billion market opportunity that we created.

With that, I’ll turn it over to Bruce, our CFO.

Bruce Felt

Thank you, Lars. Second quarter revenue was $36.9 million, an increase of 44% from $25.7 million a year ago, and a 5% sequential increase. The revenue is supported by net new customers, bringing our total customer count to 2,850, 419 total transactions, and strong renewals due to our enhanced focus on our current customers. We continue to experience greater than 90% customer retention rates and greater than 100% dollar renewal rates. In fact, renewal rates improved in Q2.

On spending, total spend for Q2 ‘09 was $36.9 million, down 4% sequentially from $38.5 million and down 15% year-over-year as we continue to manage all costs as we realize the benefits of the seasonal decrease in G&A. Gross margins again expanded from 77% in Q1 to 79% in Q2, which is up 26 full points from 53% since we went public. The margin expansion has been a result of our ability to continue to implement our products at customers with little to no staffing increases.

We have gone beyond our productivity model at this point in time and we’ll be hiring professional services headcount during Q3 to support the increase in business activity. As you recall how our model works, the hiring of professional services staff is a direct hit to gross margins, because those costs are expensed currently while the revenue associated with the work is spread over the life of the contract.

Consequently, we are modeling gross margins to decrease slightly through the rest of the year, but still hit our 2009 target of 77% for the year. Operating expenses decreased 3% sequentially to $29.4 million from $30.3 million. Operating efficiencies and cost controls have resulted in operating expense declining 15% year-over-year, even though revenue grew 44%.

As Lars mentioned, SuccessFactors crossed a very notable threshold by achieving non-GAAP profitability. Non-GAAP operating margin improved 90 full percentage points, sequentially more than 70 full percentage points in the last four quarters from minus 70% in Q2, 2008 to approximately breakeven in Q2 2009.

SuccessFactors plans on maintaining non-GAAP profitability. We ended Q2 with headcount of 618 and are continuing to hire selectively. SuccessFactors continues to build development capabilities in high quality, high productivity, low cost geographies. We are pleased with the return on investment we have made thus far in these geographies.

We expect tomorrow morning for Ireland’s Deputy Prime Minister to announce SuccessFactors new multi-lingual business center to be open in Dublin, where we plan to build our small and medium distribution channels in conjunction with our European expansion.

On earnings per share for Q2, 2009 EPS, our non-GAAP net income per share was $0.00, which excludes stock-based compensation expenses of $2.4 million, improved quarter-over-quarter from a non-GAAP net loss per share of $0.06 in Q1, 2009 and a year-over-year improvement from non-GAAP net loss per share of $0.33 in Q2, 2008. We are using 56.8 million weighted average shares outstanding during the quarter.

Next, cash flow on the balance sheet. SuccessFactors continued reporting cash flow profitability. Cash flow generated from operations was $939,000 for the quarter, following the pattern we suggested on our Q1 call, with Q1 being the expected highest cash flow quarter of the year. Because of our stronger than expected top line for Q2, we do expect cash flow for the next two quarters to be slightly higher than our Q2 cash flow amount.

SuccessFactors has a capital efficient new customer acquisition model resulting in CapEx of only $275,000 in Q2, following a $73,000 Q1 CapEx outlay, because of the strength of our EMEA business, including the closing of Siemens and Deutsche Bank and increased usage by Nokia Siemens and many other customers, we intend to increase our capacity in our European data center.

We also plan to increase U.S. capacity to accommodate our growing customer base, so expect some capital investment associated with that over the next two quarters at an average of approximately $1.25 million a quarter. On the balance sheet, total cash, cash equivalents and marketable securities continued to grow and we ended the quarter at $107.8 million, up sequentially from $105.5 million.

One of the primary themes during this downturn is to continue to maintain a strong balance sheet. Accounts receivable increased slightly to $36 million from $35.4 million in Q1. However, our adjusted DSOs decreased by 13 days to 83 days as we had a very strong collection quarter and received payment from the large customer balances that carried over from Q1.

On our outlook, we are initiating guidance for the third quarter of 2009. We expect revenue for Q3 2009 to be in the range of $37.2 million to $37.5 million, which equates to approximately 26% year-over-year revenue growth. Excluding the impact of stock-based compensation expense, we now expect Q3, 2009 non-GAAP net income per share to be about breakeven.

This estimate assumes a weighted average share count for the quarter of approximately 57.2 million shares. For the full year 2009, we are raising our prior guidance from $145 million to $146 million, or 30% growth, to the range of $147 million to $148 million, representing annual growth of approximately 32%.

Non-GAAP net loss per share, excluding stock-based compensation expense, is now expected to be in the range of net loss of $0.06 to $0.07, better than our prior guidance going into Q2, 2009 of $0.18 to $0.22. This estimate assumes the weighted average share count for the year of approximately 57 million shares.

Let me turn the call back to our operator and open it up to your questions.

Questions-and-Answers-Session

Operator

Your first question comes from Sarah Friar - Goldman Sachs.

Sarah Friar - Goldman Sachs

Could I ask a question just first on the top line? Lars, when we saw your at the success connect event, clearly you were talking about some of these larger deals in the pipeline like the Siemens deal for example, but low confidence in terms of when you could close them. Could you give us a little bit more color of how much more confidence you’re feeling given the slight turn. Are you starting to see sales force accuracy going up, better ability to predict closure rates, just to gives us some sense of what to expect over the next couple of quarters?

Lars Dalgaard

I think the important indicators that give us confidence are that close rates really did increase. Unfortunately, predictability did not. We also saw a real strengthening of the pipeline, and we saw significant deals close that we did not expect. So, the predictability is certainly not what it used to be a year ago. In fact, the number of customers are less than they were both in total transactions and new from the same time last year, but they were increased sequentially and then that’s very exciting for us.

Particularly, important for our model, of course, is that we achieved higher renewal rates and that was an extremely important indicator. As you know, we have reworked our sales force to focus on that partially, and that work has really paid-off.

Sarah Friar - Goldman Sachs

When you say higher renewal rates, can you give us any kind of sense of size of the shift?

Lars Dalgaard

No, I guess the biggest message is that it’s not backwards, which it could have been in this market. It’s just very tad, but we’re just excited that was up and not back, because it’s been a lot of work. Having companies like Wachovia renew inside of Wells Fargo and having those types of indicators and many other businesses renew that have troubled businesses, but decided that SuccessFactors’ software was important to get them through the situation they were in. So, the team has really stepped up their game in making that happen.

Sarah Friar - Goldman Sachs

Then, Bruce, just on the margin side, so you made the comment, clearly the G&A number was amazing this quarter, but you said there was a seasonal impact there. Could you give us a sense of what that might be, just as we think of what to model off of as we look forward?

Bruce Felt

Yes, it tends to be related to the fact that Q1 is pretty heavy in expenses. We have a lot of our audit fees falling into that, other related accounting fees, tax fees. So, that just tends to be one of the drivers. We also had some tax expense last quarter associated with some sales tax adjustments that we don’t believe will repeat itself. So, anyway, that’s why we called it seasonally high in Q1 and more moderate in Q2.

Sarah Friar - Goldman Sachs

So, Q2 is maybe the right level, though. If we model off of that, we’re not going to be out by a couple million or anything like that?

Bruce Felt

Yes, that’s a basic, let me just step back. We generally think of expenses in total when we model the business and not any particular line item. So, you could find that you’re off if you just take run rates and extend them out, but the level that you saw G&A is generally a level that we plan to spend through for the rest of the year, possibly a little bit of increase.

Sarah Friar - Goldman Sachs

One final one, just the interest income level seemed to jump up a little bit this quarter, which also helped on the bottom line. Is there anything as we model forward, again, is that the right level, or was there anything extraordinary that fell into that other income line?

Bruce Felt

No, there was nothing extraordinary that fell into it. I think that’s a basic run rate for what you can expect.

Operator

Your next question comes from Thomas Ernst - Deutsche Bank.

Thomas Ernst - Deutsche Bank

Lars, Bruce, you both have talked about, how your growth rate and your margin are an arbitrary choice and inversely correlated. Now you’ve hit this milestone of breakeven. How do you think about beyond the second half? What is your strategy? Is it to maximize the growth or do you plan on driving margin expansion as you get into next year?

Lars Dalgaard

It has a lot to do with what happens in the market, right? I mean, this was probably a surprisingly strong quarter for us and so we have to watch very carefully what happens to the businesses across the globe. We’ve put an operating system in place that’s very metrics driven, very sophisticated, very much like operating a submarine, if you’re familiar with that. That’s what we use to get indications on how and where we’re going to go.

If we see the opportunity to invest in a lot more growth, we will accelerate it. We’re already investing a lot in growth right now, but it’s surgically in the specific segments and markets where we believe there’s more opportunity. You just saw us make a big hire, he’s an expensive guy, so that’s a big investment. Like that, we’re investing in different markets that are giving us response.

It’s a very big milestone for the whole company, its not only be cash flow positive four quarters early, but also be non-GAAP profitable three quarters early and it’s quite important for us to maintain that. It’s important for us to be a real company in that sense and then it’s a very important metric for all of us.

Thomas Ernst - Deutsche Bank

If I could follow-up on the previous questioner, you mentioned renewal rates are up. That is striking in this market, particularly as you’ve gone through a lot of organizational changes in the field. Is there anything you did tactically to support that? How did you achieve that?

Lars Dalgaard

Frankly, the whole organization is just energized behind the need to not lose any customers and so we do whatever the hell it takes and anybody will get on a plane and the whole organization is wired around it, whether it’s our engineers or it’s our professional services, who’s first line job it is, but we also tactically did take our best reps, at least the majority of our very, very good reps, and we put them focused on existing customers to really give them a lot of love, a lot of attention and not miss a beat.

Then we organized an internal surge around these customers and gave them what we called internally crazy love. We just made absolutely sure, we took complete care of these customers and they had a breakthrough experience in these very tough quarters for them and made sure that they really understood that we were there for them. “What do you know?” They’ve returned in kind and have given us more business.

Operator

Your next question comes from Brendan Barnicle - Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities

It was a nice return to growth in the bookings in the quarter. Do you think that’s sustainable for the back half of the year?

Bruce Felt

It’s too hard to say anything about the back half of the year at this point. We gave an increase in guidance on the revenue that you saw, but I think it’s too hard to talk about the back end of the quarter at this point. There’s too many moving parts and for sure customers are still really struggling.

Brendan Barnicle - Pacific Crest Securities

Lars, you’d mentioned that your up sell potential still looked like eight to ten times on the installed base. Can you guys quantify that as to what kind of TAM that would be?

Lars Dalgaard

Well, if you just apply it toward what we’ve generated as business so far. I mean, we’re talking certainly over $1 billion just in our installed base. Obviously, the TAM for what we’re going after and this is were we touch on, not only fully exploiting human capital management, but moving it beyond the business execution, business performance results for our customers that really focus on CEOs, CFOs, COO’s, then we think we’ve just increased the market that is available for us to address.

In fact, we think we’re the only company that’s focused on doing that and in an extremely unique position to capitalize on that. So we’re pretty optimistic with what business we can go get, but as Lars pointed out, we’re still being muted in our enthusiasm because the economy is still tough as reflected in kind of the dialogues we have with our customers who still are very tight on spending and still struggling themselves. We just think we have kind of the right solution for them, which is why we think we posted a reasonably good quarter.

Brendan Barnicle - Pacific Crest Securities

That leads to a follow-up that I had around sort of the collaborative nature of the way people are using the products and I think you highlighted that on the last call, Lars, some examples that way. Can you guys give us any sense of sort of what percentage of the business is being used sort of in these maybe what would you call like nontraditional ways, the business execution side and maybe what percent of the business is still kind of at core performance management?

Lars Dalgaard

I would say it’s taken us a very long time to train all of our people on really be consistently strategic in how we engage with our customers, its not easily done. McKenzie rose over about 100 years of excellence in building that type of expertise up and we’ve just been around for eight and a half years, but I would say it’s 20% to 30% of the accounts that do it today, strategically.

It’s massively improving and increasing and the dialogue that we’ve been able to create after all this in-depth training and marshalling of resources and directionally particularly the proof points we’ve been able to uniquely share with customers, that has really increased the ability to access the sea level and get results there and we are not planning on slowing that down. It’s a real success.

Brendan Barnicle - Pacific Crest Securities

Then just last, Lars, you mentioned SMB as a market you guys were continuing to focus on and the budgets there. Any sense on where that market is in terms of recovery relative to the big enterprise market? We’ve, in our survey; we’re seeing more weakness there than other parts of the kind of the global segments that we survey. Any sense on where that is in its kind of relative recovery?

Lars Dalgaard

Also similar to the other businesses as we said and that’s one of the reasons that we are cautious about the rest of the year, our fire power is down, as we said in February as we talked about Q4, but that being said, we are seeing productivity increases in that segment also and so that is an exciting change, but is not enough to make us feel like it’s an easy run from here.

We were just very excited to see that the sequentially the stars and the majors business did better. We have quite a sizeable investment there we started a lot later than the enterprise investment, so it’s still playing catch up in terms of share, but it’s a really strong set of leaders we have and the reps in those areas are fantastic reps working very hard and getting great results and had a nice sequential increase in Q2, but still, it’s not a slam-dunk very hard to work with that type of customer group, which really has been hit harder than any other group.

Operator

Your next question comes from Adam Holt - Morgan Stanley

Adam Holt - Morgan Stanley

A couple questions on the comment, Lars that you made about the pipeline strengthening. First of all, if you look at what’s in the pipeline, is it still more oriented toward up-sells becoming a larger percentage or are you starting to see some signs that the new business activity might actually reaccelerate over the next several quarters?

Lars Dalgaard

So, we track a bunch of different things, as I said, like running a submarine, because we just can’t take any chances. So, we double check and triple check and 360 all of our numbers. So, we track both late stage and total and new to pipe and lots of other indicators and these indicators were positive, they really were. Like what we particularly saw though was that sequential increase in up-sell was not as fast as it has been and so that does definitely come from the fact that there was a quicker increase in new, but still, we rely on up-sell as being an important future driver, for sure.

Adam Holt - Morgan Stanley

As you think about your sales capacity to address the pipeline over the next several quarters, it would look like from the expense guidance that you are not planning to really start to ramp sales expense in the back half. So, does that imply that you feel like you’ve got plenty of incremental sales capacity and at what point would you expect to start to invest? Would you like to see the economy stabilize for a couple of quarters before you start to ramp hiring again on the sales front?

Lars Dalgaard

As Bruce said on the last earnings call, we are spending a lot of money and we should be profitable and I think with that amount of money we are spelling the efficiency and the management strength that we have in this company, we believe exactly as you’re saying, that we can get a lot out of the people we have. I was quite proud when visiting a customer on Friday, a very large one here in the Bay Area.

Afterwards, took a little bit of time with the Sales Manager regionally and he had been one of the top guys at Siebel, if not the top guy, and he told me that he has never seen a stronger sales force in his life than the one we have here across the country. I think that’s equal in other countries too.

So, I’d rather make, my reps really make a lot of money and everybody is happy and then that’s exactly what we’re doing right now, but we have hired new reps. We hired two reps last week and we’ve done that all year. We’re just not doing it at the speed and the capacity that you saw SuccessFactors do it in 2007.

Operator

Your next question comes from Michael Nemeroff - Wedbush.

Michael Nemeroff - Wedbush

One, is crazy love the technical term for what you guys are doing? Seriously, the questions are around renewals. You talked about an increase in the rates. Was that a customer seat or dollar or all of the above?

Bruce Felt

Yes, we saw both and we think we did see the results of the fact that as a company we clearly made a decision early, keep who you have and make sure that in this economy that we’re in fact over-servicing these customers and in cases where we saw any risk factors that we got very good at by putting systems in place that helped identify it. We basically converged on that and made sure that that company was a happy user, was a productive user and therefore renewed.

So, it was really that effort by the company that really helped us, one, keep who we had and obviously when you do that, what ends up happening and I saw a few remarkable examples of this, companies that really had some of these risk factors, for example, they got bought by somebody where there was turnover in the complete management team. We’ve had examples where they turned around and renewed; not only renewed, but bought more product.

So we’re really learning a lot by focusing on current customers and even though we’ve been very good at it, that really wasn’t our focus in the first seven years of the business. That was all about getting net new customers. So, what this has allowed us to do is systematize the process of getting customers to be happier and buy more sooner so when the net new customer accelerates again when the economy gets better, they’re going to be that much more profitable for us.

Operator

Your next question comes from Phil Rueppel - Wells Fargo.

Phil Rueppel - Wells Fargo

A couple of things on sort of the new business, if you take away some of the big elephant deals like Siemens, would you say that sort of the sweet spot for deal size was deals staying constant or even trending up maybe as you saw last quarter?

Lars Dalgaard

So, I think that the most important thing to just get clear there is that Siemens didn’t contribute at all in the quarter, as we’ve been clear and maybe you want to describe that a little more, Bruce, and then we can get to the…

Bruce Felt

Yes, just on the mechanics of Siemens, it was maybe, in terms of what was actually billed in the quarter, maybe number six or seven in size. So, it counted in the top ten, but I will say we had no invoicing in the quarter greater than $1 million, which we are very pleased with the fact that this was a very well distributed quarter. Many deals contributing, no large deals in terms of invoicing, but obviously as you saw the size of the Siemens contract was very large, in fact the largest in our history, but that will invoice as we roll it out, kind of as we mentioned on the last call and…

Phil Rueppel - Wells Fargo

In terms of revenue?

Bruce Felt

In terms of revenue, we’re saying don’t expect any meaningful contribution anytime soon. It’s a very complex deal and then the [revive] growth will tied for a quite a bit and that for quite sometime.

Phil Rueppel - Wells Fargo

It also sounds like sort of the bread and butter business was in terms of new customers was also very strong.

Bruce Felt

Yes, it was strong because the deals we did close did see an increase in user size and that was kind of the first thing that took a hit when the economy really slowed down. I guess maybe related metric is, there was a very wide participation from the sales force. We didn’t rely on just a few kind of heavy hitters I would say, there was just a lot of production from many sales reps. So, both those statistics we were quite pleased with because that shows overall health of the business. It’s kind of a very, again, very healthy set of metrics, kind of how we exited this quarter.

Lars Dalgaard

I guess there is nothing to be able to be relied on here and there’s nothing like it’s back, what really happened is what Bruce said is that, the whole team came together to close incredible deals. There was just great people doing extraordinary things and honestly, we did not expect to close as many deals as we did.

We closed 80% sort of mid to large deals and we closed 100% of our large deals. That’s just extremely unusual, but the team just went completely amuck and together found away to get the deals done with everything we’ve got in our toolbox.

Operator

Your next question comes from Karl Keirstead - Kaufman Brothers.

Karl Keirstead - Kaufman Brothers

First question for Bruce, on the long term deferred, they were down again sequentially despite the up tick in the number of large deals. Could you just take a minute to explain that? Did the average contract term decline?

Bruce Felt

No, it did not and I just caution everybody to not over read the difference between current deferred and long term deferred. I’ll say, first of all it really has doesn’t have anything to do with the contract length. It has more to do with what is the professional services component of deals, which tend to be recognized over two or three years, and I guess from that point of view, contract length plays a part, but the contract length is generally not changed much.

The thing in terms of just how you model deferred revenue, all deals first go into current deferred revenue, until which time we provision our customer. At that point in time a determination is made as to what goes into short term and what goes into long term, so even the professional services component doesn’t go into long term until we provision our customers.

So, the point being, it’s very hard for an outsider to read any significance into what goes into short term and long term because of all the deals flowing through short term first and they could get held up there for awhile and then get re-classed to long term. So we’ll try to find a better way to actually help you guys model it, but don’t over read any classification change between short term and long term is my point.

Operator

Your next question comes from Sasa Zorovic - Janney Montgomery.

Sasa Zorovic - Janney Montgomery

My first question, you could provide us any sort of commentary regarding the pace of business if you could for verticals? Was there any specific difference there, industry verticals or not really?

Lars Dalgaard

No, not really. It’s really whether there is a leadership team there and whether they have some ambition about the future and that could be that they are in huge trouble or it could be that they are leading their industry, but what we going to step up to the plate here, and we’re going to get some real business done focusing our business systems better and if that happens then we get a deal.

The great thing about this opportunity of course, is that (a) We have proven that we have no industries that are more than 10% and so this is as ubiquitous as is e-mail or the Windows operating system. (b) We’re not just selling into one specialist group, like a learning expert or a sales force admin or a recruiting admin. We’re selling to the business leaders and to the whole company. That is really the difference and so, that’s why I think we have a little bit of legs here and we’ll continue to have that.

Operator

Your next question comes from Terry Tillman - Raymond James.

Terry Tillman - Raymond James

I guess first question Lars, just relates to, has the Siemens deal done anything competitively, like maybe created a tipping point, where maybe some other mega enterprise opportunities start to become more tangible or would you really just contend this was more of an anomaly type situation? We shouldn’t see many of these 100,000 seat plus type transactions?

Lars Dalgaard

Well, there aren’t that many companies out there that size. So that sort of limits puts a linear constraint on the model, but I will say on the competitive piece that this really was a bit like the shot that was heard around the world and it doesn’t matter whether it’s our old friends at SAP, who look upon Siemens as their number one partner in the world and where they do the most money and so for them to lose this, flat lose this deal to SuccessFactors, that’s got to hurt. So that definitely was heard around the world.

Obviously, also, everybody else was put on notice that it doesn’t matter, which product you have been an expert in, when you couldn’t win this deal, that’s a problem and believe me, 30 people tried very hard, but the team in Germany and then the support team here in the U.S. just did a great, great, I mean, saying in general we have seen a bunch of these deals turn up and I think the most important reason that we could win it is because we could prove that we have done it with four or five other companies that are over 100,000 and then we could have that type of immediate success of implementation.

I won’t embarrass the company, but there is one of our 100,000 user companies that had tried many, many systems over the last thirty years and only had one internal system ever rollout successfully at the full company scale. The only other one that they’ve done is SuccessFactors. Apart from that, they’ve never had a complete business system rolled out to every single employee before.

That’s something everybody in the company knows. It’s not just the CIO that understands what that means. That’s something the CFO understands, something the VP of HR understands, and it’s certainly something the COO and CEO understand and so that’s why we have a dialogue with them and say can we trust you guys to roll this out globally and we will let you see how we’ve done it before and that’s why it makes a difference for us and I think that’s what we leverage in this situation.

Operator

Your next question comes from Horacio Zambrano - Jefferies and Company.

Horacio Zambrano - Jefferies and Company

So, Lars, I had a question just in terms of the types of marketing that you are doing from lead awareness to generate prospects. I know you’re changing your marketing from last year, but is there anything you guys are looking at to see if the market it starts to change in terms of new customers, just the metrics you might be looking at around lead generation? Are you seeing anything pick up I know you are focusing on existing customers, but what are you looking for internally and how are you thinking about that from a marking strategy standpoint?

Lars Dalgaard

So, we’re obviously not spending a lot on marketing as we used to and partially because a lot of marketing does not work at all and so, unfortunately, a lot of people just continue to try it, but it doesn’t, so we just stopped and had the discipline to do that. Our team is very creative and they are using a lot of unique tools and really proud what that marketing team has done for us in the last two quarters they’ve really done a lot.

I’m not going to reveal, it’s such a leading indicator and it’s a very important one, Horacio, but we are looking at very specific indicators for where to invest and where we can trust that there will be an ROI that’s measurable on marketing input. It’s just too competitive of a question.

Operator

Your next question comes from Michael Huang - ThinkEquity.

Michael Huang - ThinkEquity

So, number one, can you talk about the early activity that you are seeing around employee central, how many customers are up and running, what type of customers are the early adopters and do you have a target number of customers for the end of the year?

Lars Dalgaard

Employee Central has been a, we have another part I can internally call Success Central that we measure customer success with. So, Employee Central has been a surprise tick up. As you probably know, it was a product that was developed internally and we have been using it for two years and customers saw us using it and asked us if we could show it to them and sell it to them.

It’s been a real success because people are beginning to realize that they might actually replace their HR system with it, which has not been the goal at all and we are not positioning it like that, but there are interesting companies like, for instance, Mandarin Hotel Group out of Hong Kong where we won that deal decided in their new hotel in Barcelona they are going to have Employee Central run everything, and so that’s a pilot that they are doing, which just completely blows our minds, but that’s of course the phenomenal thing with sort of the cloud computing deployment is they can just do whatever the hell they want to.

So, even though we are speaking to them in Hong Kong, they decide that in their new hotel in Barcelona, they are going to use Employee Central to run the place and so going forward, we hope to see a lot more activity like that and we’re certainly not disappointed with the traction we are seeing, but this is a very opportunistic scenario for SuccessFactors. It’s completely unexpected the demand and the interest.

So, we’ve put a lot of cycles into it in launching it and we are pretty excited about what’s coming out of it and so there’s a lot of excitement around doing a true social network and collaboration product for the enterprise with all the security, scalability and dependability that we have learned to do work with that a company like, for instance, Facebook does not know about and so, it’s an opportunity we are excited about. At this time, we are not going to give any plans that we have around unit economics.

Michael Huang - ThinkEquity

Then my other question, is so given the strong close rate that you that was Q2, on the heels of a pretty tough Q1 and wanted to do get a better sense for what you’re assuming happens close rates in Q3 and Q4 baked into guidance. Is it something better than Q1, but more conservative than Q2? Just any direction around that would be very helpful. Thanks.

Bruce Felt

Yes, we think given what we still see in the economy and what we see specifically from our customers, that we still need to be conservative. It was a good quarter. We closed it out well. Good execution, but it’s really tough to overcome these macro issues. So, for now, we model not as favorable as Q2 and we think that’s just the right way to go until we actually do see a meaningful change in the economy.

Operator

Your next question comes from Brad Reback - Oppenheimer.

Brad Reback - Oppenheimer

Just a quick question on system usage, Lars as you look at existing customers year-over-year, can you talk about their activity level sort of this quarter versus last year this quarter?

Lars Dalgaard

Yes, that’s probably one of the most exciting things and is using Success Central to watch how they are using it is that particularly, troubled companies really are using the product a lot more and so it’s across the company that we’re seeing a really nice up tick. I guess that makes sense that, when companies are not spending a lot on new toys, they can use established successful business applications for their management.

So, we’re seeing a real trend up there. I guess we should have talked about that on the call. It’s a great point and it’s something that makes us all feel really good about the investment we’ve made in this company and the customers.

Operator

Your next question comes from Brad Whitt - Broadpoint AmTech.

Brad Whitt - Broadpoint AmTech

I wonder, Lars, if you could give us a little more color on the new Ceridian partnership? How fast that will ramp, kind of what the target market will be there, what Ceridian’s go to market strategy as far as who’s actually going to be selling it, just kind of how that partnership is going to work out?

Lars Dalgaard

So, we’ve partnered with every single company you can imagine partnering with that’s even partially related to this industry and it hasn’t always been successful, but we’ve done some deals with ADP and we are still doing some stuff. Particularly with Ceridian, they’ve just really stepped up to the plate. They’re just in execution culture there and they’re used to being a real fighter.

So they have a very strong team that’s very focused, if you just go to their website, it’s probably has something to do also with the great ownership they have there in Thomas Lee and others, fantastic CEO in Campanella and they’re just executing, they’re an execution machine and therefore they’re a great partner of ours.

So for them to launch this OEM product just massively opens up that channel for us in a way that we’ve not had such a fat channel before, which is why they made it onto the script, just real dollars being booked and being put in the bank, which is totally unexpected. So, great work from the Alliance and Business Development team in bringing that deal together and making it happen. They’re not our biggest contributor, so we mentioned some of the others, but they are just becoming a substantial contributor to us.

Operator

Your next question comes from Richard Baldry - Canaccord Adams.

Richard Baldry - Canaccord Adams

Given your number of new deals and large deals, or total deals were up in the quarter, retention was up in the quarter, really your growth metrics all stepped up. Can you talk about why your sequential revenue guidance would mute from what we saw from Q1 to Q2? It seems like the absolute dollar sequential growth we’d otherwise expect to be higher, are there some other moving parts to the model that maybe I’m missing in that? Thanks.

Lars Dalgaard

No, it’s reflective of the caution we still see in our customers, the fact that they’re still facing issues to their top line, which is impacting their desire to spend. Until we really see that change, we think we need to be quite cautious in the guidance we give. Obviously, we did a good job selling to them. We actually have a very compelling value proposition, but we cannot say that, we saw a turn in the market.

I think we can say that, we as a business really did find out, figure out how to execute and kind of how to gain tackle, so to speak, customers, prospects and make deals happen, but is that really the formula for a long term sustainable growth, well it’s part of it, but we really would like to see change so to speak and our customers appetite to really want this and until that happens, I think you’re just going to see a conservative posture on our numbers.

The work that the team did on this quarter is indescribable. It’s just extremely proud, it sort of reminds me of the Federer tennis match, that everybody watched just pulled out and went way above and beyond the genetic potential.

Operator

Your next question comes from Brad Mook - MKM Partners.

Brad Mook - MKM Partners

I guess just a follow-up on your last question, is there a chance then for a let down if the effort was so substantial and close rates were so high kind of on the upper end of Q2, is there a chance that after that Federer match, you kind of have a little bit of a let down in Q3?

Lars Dalgaard

There is a chance of that, but I think we’ve got some things figured out here now, which is exciting, but there is definitely a chance, which is why we’re not letting this get away from us. It’s real tough out there, but I would rather be in our canoe than any other canoe.

Operator

Your next question comes from Kash Rangan - Merrill Lynch.

Kash Rangan - Merrill Lynch

Lars, I was wondering if you could talk about, it looks like the cycle may turn next year and if it does, you have certainly made significant improvements to your business model if you’ve reached non-GAAP operating margin breakeven. How do you view the tradeoff between growth and investing if the cycle gets better going forward?

Obviously, you want to grow faster, if you want to be a million dollar company. You don’t want to keep growing at the 25%, 30% rate. So I’m just curious to get your thoughts on how as the cycle bottoms out? How you view growth versus showing profitability.

Lars Dalgaard

This is the same question I think that Tom Ernst asked. I think I can only give you the same answer, because I’ve thought about it and that’s the answer we like, which is profitability is extremely important to this management team and this Board. We think it is an extremely important and responsible way to run a company.

As you know, it’s a lot harder for us to be non-GAAP profitable than it is for a normal company and particularly ours, because we have very long term deals that secure the customers. We don’t do them quarterly or annually, and so we spread the revenue way out in a flat pancake compared to other SaaS companies, but we take all the expense.

All that being said, we now have a really, really strong renewal stream and that is, as you know, the 68% operating margin on that renewal stream. So it’s actually a little bit hard to hold the cash back and frankly in this quarter, we really were rewarded with a lot of cash and it seems like that continues.

So cash is going to be strong, no doubt about it. We are a growth company and then we’ve created a brand new category and maybe one of the first new ones in a long time in software. So, it’s not like we’re cannibalize and see for somebody else. We’ve really come up with a new market and we’ve put out a very diverse, very distributive model in all geographies, in all segments, small, large, medium.

So we plan on continuing to leverage that model and get a lot stronger in those sectors when you can be rewarded by the market to do that in terms of the cost of acquisition, when the cost of acquisition is too high, then we will not do it. When the cost of acquisition comes down and we’re watching that like hawks, then we will do it. That being said, we have made real investments in sales and support and particularly in customer renewals teams in the last two quarters, just not at the same levels.

Operator

Your final question comes from Brad Mook - MKM Partners.

Brad Mook - MKM Partners

I just want to do ask about pricing, both short term and long term. If you’ve been using pricing at all to kind of throw some elbows in the market, if you are seeing anybody else getting more desperate and trying to use pricing as a tool short term. Then, longer term given that you are kind of defining a new category, do you think that will give you pricing strength going forward?

Bruce Felt

Yes, we have seen some aggressive pricing out there. I mean, I can just tell you some of the Siemens competitors with 30 of them there, some of were offering theirs for free and it’s actually not unusual that we tend to be the higher priced offering, but we are able to do that because we have just extremely compelling value proposition and what we are optimistic about is it gets more compelling overtime as we build out the suite and as we get even better at making sure we deliver strategic value to our customer, as we pointed out.

Last quarter, we offered, our customers get five times the value out of our products when they use it strategically and we also get a lot better pricing when they use it strategically. So, of course, if we are only doing that 20% to 30% of the time, we can move that up to 60% of the time. That has a significant impact on the pricing per user that we can get. On top of that, we are adding modules that are very appropriate for what our customers are facing today that also has strategic elements to that.

So you put that combination together, we do believe we will have a lot of pricing power going forward and we are able to compete against the lower priced offerings and the desperate offerings and frankly, the free offerings. So, that’s what we see right now and that’s how we think about it.

Lars Dalgaard

One of our key sales arguments from the beginning of the company’s life has been if a competitor came in and said they had a reference, we would say, “well, we will multiply it by ten, give you ten times more references, whatever number they come up with” and particularly, as this margin tightens and people get much, much more nervous about which money to invest, then you can come and put in references at an incredibly important differentiator and that’s how we are able to get premium pricing very often. Sometimes we can’t, but in most cases we can, and we’ve seen a good trend on that and the fact that we have these references that nobody else has is what makes us be able to do that.

So in closing out, I guess the key point here is that in a terrible environment, really in an environment that sucked, our quarter didn’t and we saw some small indicators of a recovery, but most important in this quarter, the team in most segments and geographies really found a way to systematically get deals done.

Most organizations are being very conservative about technology spending and we don’t really see that changing, but with that said, we feel we have proved we are the best positioned company in the industry to explore this really, really large market opportunities. Thank you, very much, for your attention and your trust in us. Thank you.

Operator

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

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