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RightNow Technologies, Inc. (NASDAQ:RNOW)

Q2 2009 Earnings Call Transcript

July 29, 2009 at 4:30 pm ET

Executives

Greg Gianforte - Chief Executive Officer

Jeff Davison - Chief Financial Officer

Todd Friedman - Investor Relations

Analysts

Thomas Roderick - Thomas Weisel Partners

Brent Thill - Citigroup Global

Richard Baldry - Cannacord Adams

Terry Tillman - Raymond James

Joel Hammond - Robert W. Baird

Laura Lederman - William Blair

Mark Murphy - Piper Jaffray

Nathan Schneiderman - Roth Capital

Brendan Barnicle - Pacific Crest Securities

Brad Whitt - Broadpoint AmTech

Greg McDowell - JMP Securities

Keith Weiss - Morgan Stanley

Sasa Zorovic - Janney Montgomery Scott

Derrick Wood - Wedbush Morgan Securities

Analyst for Ross MacMillan - Jefferies & Company

Operator

Good afternoon. My name is Kevin and I will be your conference coordinator today. Just a quick note, today's call is being recorded. At this time I would like to welcome everyone to the RightNow Technologies Inc. second quarter 2009 earnings results conference call. (Operator Instructions)

Stacie Bosinoff will begin the call. Please go ahead, Stacy.

Stacie Bosinoff

Good afternoon everyone and thank you for joining us on RightNow's second quarter 2009 conference call. Joining me on the call today is CEO and Founder, Greg Gianforte, and Chief Financial Officer, Jeff Davison. Before turning the call over to the Company, I will read our Safe Harbor statement.

During the course of this call we may make projections or forward-looking statements regarding future conditions or events, which may drive our future business, current new products and services and their performance, the size and strength of our market, our future financial performance and outlook for the Company. These forward-looking statements may include but are not limited to, statements about revenue growth and profitability, our future strategic plans and perceived growth opportunities, market acceptance of our products, and other statements relating to our operating results. These forward-looking statements speak only as have today and are based upon the information currently available to us. This information will likely change over time.

By discussing our current perception of our market and the future performance of the Company and our products with you today, we are not undertaking an obligation to provide updates in the future. We caution you that such statements are just projections and actual event and results may differ materially from what we discuss today.

Please refer to the documents we file with the SEC, specifically our most recent annual report on Form 10-K, and quarterly reports on Form 10-K. These documents contain and identify important factors that could cause actual results to differ materially from those contained in our projections and forward-looking statements.

As a reminder, we are providing a supplemental data sheet, as well as an updated investor presentation, on the Investor Relations section of our website that contains historical information for easy reference. During the course of this call we will also be discussing certain non-GAAP financial results. We direct your attention to our reconciliation of GAAP, which can be found in our Company's earnings release, which is posted on the Investor Relations portion of our website.

And with that, I will turn the call over to Greg.

Greg Gianforte

Thanks Stacie. Good afternoon everyone. Q2 was a great quarter with strong revenue performance and EPS well ahead of guidance. We are once again raising full year EPS guidance. Just for context, through the first half of 2009, we have delivered $0.17 of non-GAAP earnings which is equal to our original full year guidance. We are especially happy with the profile of deals that we are winning as our momentum continues to build in the contact center and we expand our penetration from initial engagements.

In fact, we believe our focus on the needs of large consumer centric organization combined with our systematic quarterly releases has improved our competitive position in the market place. Jeff will provide the financial details in a few minutes, but in summary, we reported revenue in the second quarter of $36.3 million and non-GAAP EPS of $0.09. We also signed 10 deals over a million dollars, our highest in any quarter and we have some great customer wins that I will share with you in just a moment.

For today's discussion, I will focus on the theme Analyst Day in June. You will recall that there were three main takeaways. First, a CRM solution in a consumer centric organization has fundamentally different requirements than a CRM solution in a B-to-B organization. Consumer centric organizations have thousands if not millions of consumers with millions of interactions. These organizations are managing large complex contact centers often in multiple countries and in multiple languages.

This is what customer service initiative gets challenging in a B-to-C organization. How you satisfy millions of inquiries 24 by 7 while maintaining customer satisfaction and containing customer service cost. The secret sauce is empowering consumers in developing a solution that originates from their perspective. This is in start contrast to other CRM vendors that typically sell into B-to-B organizations where CRM is really about large direct sales forces, fewer customers and far fewer interactions. We are simply solving a different, more complex problem.

The second key takeaway from our Analyst Day was that we provide the most comprehensive end-to-end multi channel consumer experience platform in the SaaS industry. Our multi channel capabilities empower consumers to choose how they engage within organization whether it be the web, cell service, email, chat or phone call or Web 2.0 technology such as blogs or services like Twitter and YouTube. The ability to integrate all of these interactions helps manage consumers' qualifications and transforms the customer experience.

In the third takeaway, we believe our focus on large consumer centric organizations gives RightNow a unique position and an opportunity in the marketplace because the bulk of contact center seats in the world are in fact in B-to-C organizations. One of the keys to maintaining and enhancing our competitive edge is our constant attention on innovating around the challenges of the customer experience. To keep our solutions and our customers' deployment at the forefront of the industry, we add new capabilities every quarter.

As we showed to you at the Analyst Day, RightNow May 2009 focused on business insight including enterprise analytics and cloud monitoring. Being able to monitor and capture data driven by consumers in the cloud allowed organizations to make data from social media actionable, enables organizations to proactively address customer needs and concerns. RightNow August 2009 will focus on business process management in the contact center. This functionality is designed to enable organizations to do a number of things.

First, capture the best practices of the best ages. Secondly, standardized them with a visual workspace design tool and third, lift the overall efficiency and productivity of the contact center as well as overall consumer satisfaction and in RightNow November 2009, in addition to other new features, we are making considerable improvement in accessibility for disabled users, both for agents and end users. For many organizations, especially our government customers, accessibility features for the disabled are in essential capability.

Looking further beyond November 2009, I believe the customer experience will not solely be owned by the customer care division but will be in interval part of an organization's identity. We see organizations shifting from a mentality that ask, how do I answer my consumer's question to more of a mentality about consumer empowerment. Instant messaging, texting, Twitter are contributing to the heightened consumer expectations increasing the need for immediate responses to their questions.

Companies need strategies to address these rising consumer expectations without driving up cost. As you could tell from our remarks, empowering consumers to resolve their own issues is the key strategy and communities are one effective tool. We are seeing open communities arise everywhere, FaceBook, LinkedIn, MySpace are just a couple of examples. Companies must develop methods to monitor and participate with these communities as to become more main stream.

Additionally, creating company-sponsored communities presents an opportunity to build loyalty with consumers and leverage enthusiast to reduce customer service cost, build loyalty and capture ideas from the consumers. We believe our unique position in the market creates an opportunity for us to innovate and be a leader addressing these challenges.

Now, let me drill down and share some of the more details in the second quarter. Q2 success was all about execution. In Q2, we signed 46 new customers and closed new and expansion business with customers including Abercrombie & Fitch, Belkin, Bowne, Husqvarna, Jackson Hewitt, K2 Networks, Snapfish, Wiley Publishing and Zynga. So far this year, I personally visited over 75 customers and partners across the globe. One of the things that I track to understand how discussions have shifted are the tittles of the people I met with, interestingly this year, a meeting with more CEOs and COOs than ever before. What this tells me is what we are doing for companies is gaining an importance.

Senior execs in the world's largest consumer organizations are not taking these meetings because they like taking meetings particular because customer experience is flat and center on their agenda, SaaS is front and center as well and we have earned the right to be there because of the impact we can have in the organizations. For example in Q2, we had great win with Jackson Hewitt tax service. They have a mandate from the CEOs office to improve customer experience so we run a pilot at the height of the busy taxes in Q1 demonstrating our scalability during peak times. You will recall that their CIO, Dana Michelle Brandon, sat on our CXO panel at our Analyst Day and she spoke about the importance of customer service and the need to retain customers.

We converted the pilot in Q2 and they are now using our solution for eService and more than 200 seats in their contact center. Once fully deployed, our solutions will provide a consolidated customer view, empowered consistent interactions across all channels and reduce operating cost. Also note that this was a replacement of their people soft system. We also had some significant wins against SalesForce.com in Q2.

One example is Belkin, a billion dollar consumer electronic manufacturer. Belkin's requirements map perfectly to our value proposition. They wanted to improve their customer experience and standardize support processes globally while lowering operating cost. We are able to demonstrate to Belkin that no other vendor could meet the multi channel contact center business requirement or had convincing customer references for a large B-to-C contact center.

We have always told you that if we and SalesForce.com are head-to-head in a deal, one of us is in the wrong place. This continues to be true and in this case, SalesForce.com was on the wrong place and another significant win this quarter, we replaced Sebo, an $800 million firm. The client was facing a large Sebo maintenance payment and we are able to sign a multiyear contract and increase the number of seats for less than the maintenance payment per year. We plan to have them live before the Sebo maintenance payment is due in September. Ultimately, this deployment will include about 600 seats.

We also continue to see success in landing directly in the contact center. Elsevier is a multi-billion dollar publisher and information provider based in the UK with operations around the world. They are one of the world's largest scientific publishers with a customer base of over 30 million scientists, students and healthcare professionals. We won the deal because of the global multi channel capabilities of our solution and our flexibility and configurability. This fuels also a competitive engagement which started out as a pilot in Q1 and was quickly converted in Q2.

Moving to a macro level, we continue to see heavy scrutiny around deal approvals. That being said, we believe our pipeline is healthy and as you can see from our results, we had executed well on this tough environment. We do however remain cautious in our outlook through the rest of the year and we plan to continue focusing on taking care of our customers and expanding profitability.

RightNow solutions provide the innovation and proven ROI to transform the customer experience. This is what makes our solutions so attractive to provide a fast path of success and the ability to expand the solution across all channels over time. Our customers achieved great results and we are very proud of that. With a great second quarter as we look to the second half of 2009, we expect to see expanded differentiation from our quarterly releases, continued execution with new customers and deeper expansion within our existing customers.

Before I turn the call over to Jeff, I wanted to mention that we will be having our Annual User Summit at the Broadmoor Hotel in Colorado Springs on October 26 through 28 and we encourage you to come and talk to our customers and learn how they are driving their customer experience initiatives. Because the summit is right in the heart of earning season, we will not be planning a formal investor agenda as we recognize the traveling during these dates will be challenging for most of you. But if you are able to make the trip, I think you will agree that hearing customer stories firsthand is invaluable. If you would like further information, feel free to reach out to Todd or Stacie at the BlueShirt Group and will get you the details.

With that, I will turn it over to Jeff.

Jeff Davison

Thanks, Greg. Revenue in the second quarter was $36.3 million, consistent with guidance. Looking at the breakdown of revenue, recurring revenue was $27.4 million, an increase of 5% from $26 million last quarter and a 7.5% increase over $25.5 million in the second quarter last year. On a constant currency basis, recurring revenue increased approximately 4% from last quarter and 13% from the second quarter last year.

Professional service revenue was $9 million for the quarter, a decrease of approximately $1 million from Q1 and in line with our expectations. The mix of revenue across geographies for the quarter was 72% Americas, 19% EMEA, and 9% Asia-Pac.

Bookings for the quarter were $48.7 million. As I have mentioned on previous calls, bookings will fluctuate quarter to quarter depending on several factors including sales in the period and the make up of renewals, contract lengths and the timing of renewals. That being said, we are very pleased with our record bookings this quarter.

For the second quarter, the average first year contract value was approximately $100,000, which is up from last quarter and Q4 '08. We had ten deals over $1 million, 60 deals between $100,000 and $1 million, and 421 deals less than $100,000.

The average contract length this quarter increased to 27 months. This increase reflects that several of the large transactions in the quarter were multiyear deals. Excluding the large transactions, the average contract term was consistent with historical averages. Our solutions enabled 701 million customer interactions this quarter compared to 606 million last quarter and 477 million a year ago.

Strong verticals in the quarter included entertainment media, high-tech, public sector, telecommunications and retail CPG. On expenses, note my comments are before stock-based compensation.

We continue to make progress toward our long term target with total gross margins at 70% for the quarter compared to 67% in Q1 and 64% a year ago. We delivered a 31% professional services gross margin consistent with last quarter. The increase in total gross margin is directly related to the shift in our revenue mix towards more of recurring revenue as we said would happen.

Total operating expenses for the quarter were $22.9 million or 63% of revenue compared to 60% of revenue last quarter. This was an increase of approximately $1.1 million over Q1. Headcount at the end of the quarter was up 756, up 2% from 742 at the end of Q1 and down 1% from the second quarter of 2008.

We very pleased to report in our operating profit for the quarter of $2.5 million or 7% of revenue, which is consistent with Q1. On the bottom line, for the quarter, we recorded a GAAP profit of $36,000 or breakeven on a per share basis. Excluding stock-based compensation, our non-GAAP net income for the quarter was $2.8 million or $0.09 per share well ahead of our guidance.

Next on the balance sheet and cash flow statement. Cash generated from operations was $2.1 million for the quarter. Capital expenditures were $1.8 million for the second quarter and $2.5 million through the first six months of the year. DSOs were 74 days for the quarter, an improvement from 79 days last quarter. Approximately 45% of the business this quarter included extended or periodic billing terms which is a significant increase from the last two quarters. This increase was driven in part by some of the larger deals this quarter which included periodic billing terms.

Absent of those large deals, it was 32% which is an increase from last quarter but consistent with what I have indicated in the past. Keep in mind the effect of this is to increase the amount of deferred revenue that does not appear on the balance sheet. We ended the quarter with total cash and investments of $94.6 million. Average weighted diluted share at the end of the quarter were $32.2 million.

Now turning to guidance. For the third quarter, we expect revenue to be in the range of $37 million to $38 million. We expect non-GAAP earnings per share to be in the range of $0.06 to $0.08 and GAAP earnings per share to be in the range of breakeven to $0.02.

For the year, we are maintaining revenue guidance and increasing earnings per share guidance. We expect revenue for the year to be in the range of $147 million to $151 million, consisting of 7% to 10% growth in recurring revenue and professional services revenue consistent with 2008.

We now expect full-year non-GAAP earnings per share of approximately $0.29 to $0.33, and GAAP earnings per share of $0.06 to $0.10. We expect stock-based compensation to be approximately $1.8 million for Q3 and $7.7 million for the year. We expect capital expenditures to be approximately $6 million for 2009. We are forecasting 32.5 million fully diluted shares outstanding for the third quarter and the full year.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Tom Roderick - Thomas Weisel Partners.

Thomas Roderick - Thomas Weisel Partners

Congratulations on the number of large deals you did this quarter. I wanted to ask you guys, was there any conscious decision Greg this quarter in terms of offering perhaps better terms for customers willing to sign longer term engagements and larger engagements? Was there any structural shift that you made with the SalesForce or this is a simpler matter of closing more big deals and these term lengths are consistent with what you typically see out of big deals?

Greg Gianforte

Okay, good question. No change in compensation. No change in incentive in any way. What this larger number of big deals reflects is really our movement into these contact center arrangements that contact center decisions that companies make, they tend to have longer horizons on them. That is a good thing for us and it is really this focus on the larger B-to-C contact centers and the customer just want to sign longer deals and that makes them bigger.

Thomas Roderick - Thomas Weisel Partners

Okay and you talked a little bit qualitatively about the pipeline. When you look into that as far as what holds there for the second half of this year, do you feel like you closed a good chunk of the bigger opportunities in that pipeline or you just qualitatively speak to what is left in the pipeline as far as your big deal opportunities here?

Greg Gianforte

Sure. So, as I said, pipeline is healthy. I do not want to get into too much color. I would say it is sufficient to get the business done. The pipeline in terms of mix of deals and the size of the pipeline, it is very similar to what we had going into Q2. That being said, Q3 is seasonally a slightly weaker quarter for us just because EMEA is on vacation and we are still in an environment where it is tough to get paperwork signed.

Now, we executed extremely well in Q2. We are not seeing a change. We are seeing a similar environment here in Q3.

Thomas Roderick - Thomas Weisel Partners

Okay and just one last follow up there, Greg, in terms of these deals, can you characterize how many of the 10 seven-figure deals were with the 'land and expand' type of deals where you have structured pilot and you had been in there in previous smaller engagements?

Greg Gianforte

Sure, of the 10 deals, three would be once that you, they were really the first significant transaction with that customer. They might have been those three, I think two of them were pilots we started in Q1. So, they were not new customers in Q2 but the first real transaction is within Q2. You could say three of them and then seven of the ten were expansion with existing customers.

Operator

Before we move to our next question, just a quick note, we do have a fairly large roster so if it all possible, we will ask you to limit yourself to one question and a follow up. Your next question comes from the line of Brent Thill - Citi.

Brent Thill - Citigroup Global

Greg, can you just comment on some of the big deals, the characteristics you saw, US versus Europe and I guess just to the earlier question on the large deals, you looked kind of year over year on the first half, I think you are up only one deal over a $1 million, above what you had in last year. So, I guess just from the perspective of how many deals were just a push from first quarter and again your visibility in the second half with these large deals. It sounds like you feel good about it but maybe not as good as what you saw walking into Q2.

Greg Gianforte

Okay. So, the first part of your question, split between US and international, two of the ten deals were outside the US so we cater them here in the US although in serving large multinational consumer organizations, a fair amount of those eight deals include an international deployments, right? So, you sell to the multinational part of that but otherwise looks like domestic business is really outside the US. But two were actually signed outside the US. And the second part of your question, again, the pipeline going into Q3 here is similar to what we had in Q2 both in order magnitude and number of larger deals.

Brent Thill - Citigroup Global

Okay, so you expect the overall smaller transactions than to pick up to help mass potentially a lighter close rate on some of the large deals. I was just trying to get a sense of your texture where you are looking in terms of large versus small.

Greg Gianforte

No, I think we will continue to see a mix of deals across the three categories we gave you. I think that the up tick in larger deals reflects in part the fact that we are moving aggressively in the contact center and these are pretty much complex problems our customers are solving and there is higher price tags associated with them.

Operator

Your next question comes from the line of Richard Baldry - Canaccord Adams.

Richard Baldry - Canaccord Adams

Can you maybe talk about the implementation cycles on the larger deals sort of give us a concept of the time to get them up and ramp so we can see how they would layer on the revenue side? And then maybe talk a little bit about what the services line is probably up a little in the second half it looks like but I might have thought it would be a little more substantial given the number of large deals you did design? Thanks.

Greg Gianforte

Okay. Let me answer the first half of that and I will let Jeff to take the second half around the PS line.

In terms of the deployments, we are not seeing a big shift in time to deployment. Certainly, large, large deals can take longer depending on the level of integration but I look back. We have stood up thousand-seat contact centers under 90 days with our average being more like 60 across all of our deployments.

So, we are not talking about a doubling to do these larger transactions. We still tend to face the work to get early success for our customers and remember that given these large deals often they are coming off as a pilot. So, in a sense, when we sign the deal, the customers already implement. We have implemented them during the pilot phase and this is a real advantage in the current environment.

It also helps us to support our pricing because the customers know the impact on their business before they actually make the purchase decision. We saw that for example with Jackson Hewitt where they were live during their tax season.

Jeffrey Davison

So I think just to tie into what Greg said on the phasing. So, a lot of projects are faced, where they will roll out eService and they will turn on one contact center maybe then they will roll out further, that kind of flows in with your question on the potential services.

So, over the last six quarters, we have been working through a pretty good amount of backlog related to the, right now, eight release and getting customers up on that, getting new implementations done and so this quarter we have the decline in professional services revenue really as a result of we have worked through a lot of the backlog and we have less hours worked on projects.

So that is kind of where we saw that decline. We finished up some of the larger projects that we were finishing in Q4 and Q1. This quarter around $9 million going forward into the latter part of this year, I expect the pro services to be pretty consistent right around that $9 million level for the latter part of the year.

Operator

Your next question comes from the line of Terry Tillman - Raymond James.

Terry Tillman - Raymond James

Just two questions, Greg first, in terms of the enterprise analytics and the cloud marketing solutions. I think you had talked about those at the Analyst Day and maybe I have this wrong but the idea maybe you have carve-outs there where you can actually monetize those add-ons or am I wrong on that and they are not necessarily separate revenue generators; they are just helping you competitively with your traditional products?

Greg Gianforte

They do represent new revenue and I would just comment, if that is your question, I mean we have just finished a worldwide Analyst Road Show and Customer Road Show around kind of our longer term roadmap and the response to cloud monitor has been fantastic now. It is amazing. You can walk in to a client there and they are not conscious of how much conversation is going on about them out in the social web and you show them the hundreds of messages that are on Twitter talking about how poor their service is and you can get their attention pretty quickly, and being able to connect the dots there is other services to do that. But being able to connect the dots between that customer intelligence and business processes within the organization to apply service levels in queuing and routing, which are the traditional thing we have been solving for customers in a contact center for many years. It is the secret sauce of integrating that cloud monitor with our multichannel contact centers. So, I am not sure I answered your question exactly but that is the color on those new pieces.

Terry Tillman - Raymond James

You did, yes. And just the follow up question, this relates to Jeff, in terms of I mean it is a good thing that you had a lot of big deals closed but your point was that there were some different terms of this and more extended payment terms. I guess the one thing is, I mean any help at all for how we model the cash flow now going forward this is going to change it more, trying to get a sense on how we should be building cash flow assumptions? Thank you.

Jeffrey Davison

Sure. On the cash flow, I talked about that I think the last two quarters since we did not provide any guidance. I really think looking out; we should be looking for operating margin to be the best measure for indicating what cash flow from operation is going to be and then adjust that for non-cash items.

On the specifics of your comment, 45% of the business is having the deferred billing? Yes that definitely can impact cash on the short term basis but overtime it is just timing of cash payment. So, I would point you back to looking at operating margin on the longer term.

Operator

Your next question comes from the line of Steve Ashley - Robert W. Baird.

Joel Hammond - Robert W. Baird

This is actually Joel Hammond filling in for Steve. Downwardly-revised full year revenue guidance in the Q1 call incorporated some increased customer churn. How did the churn in Q2 compared to that in Q1 and was in line with your expectations and also have your expectations for churn in the back half of the year changed at all since your Q1 call?

Jeffrey Davison

Sure. Churn in Q2 pretty much the same as what we saw in Q1. No real change there. To answer the other part of your question that is what we kind of adjusted our sales to, was that expectation and so it was similar churn to Q1 and we are kind of expecting that to be about the same for the rest of the year. This is a tough environment and what we have seen is some small companies got a business. We have seen some companies get acquired and we are seeing some behavior of renewal, upon renewal, just renewing a little bit less and I do not think that that is going to change year over the near term so that is kind of baked into our expectation.

Greg Gianforte

Okay. And then as far as professional services margins, those were again solid in the quarter and, should we be looking at services margins closer to 30% on a go forward basis?

Jeffrey Davison

Yes. I am expecting around 28% to 30% on the PS margins.

Operator

Your next question comes from the line of Laura Lederman - William Blair.

Laura Lederman - William Blair

The first one is if you look at the $10 million deal in the quarter end even like $2 million to $3 million or they are all pretty much $1 million in size and I guess following up on what other people were asking, I will ask the same thing in a different way. If you look at the large deals in the pipeline now, are they less mature or maybe less far along than the larger deals that closed in Q2? And then I will follow up with another one. Thanks.

Jeffrey Davison

Sure. On the mix of deals, they are all over a million. It was a good mix of expansion. The terms, some were short and some were long term but they were some longer term deals in there. We are very pleased. Other color on those 10 deals, I looked at the verticals that they were in and they were across a good handful of verticals as well.

When I look the large deals and I think it is just a great performance of us getting into the contact center and it is really good evidence of companies making decision to sign up for two and three years. So, I give you that color obviously all over a million and, I cannot remember the latter part of your question.

Laura Lederman - William Blair

The latter part of the question was if you look at the big deals in the pipeline for the second half, are they less far along or maybe less mature than the big deals that you closed in the second quarter?

Jeffrey Davison

I cannot really say that they are a lot different. I think the color what Greg gave on the pipeline is similar to where we were in Q2 and we think it is a pretty healthy pipeline. That is about all the color I can give on that.

Greg Gianforte

Yes. Our pipeline, Laura, they have a level of maturity that would give us some confidence that they might close this quarter.

Laura Lederman - William Blair

Have you guys done any analysis on the total available market of the big B-to-B, B-to-C call centers and how big that market would be? Is it above at X-size that you are targeting in terms of those companies?

Jeffrey Davison

Well, yes, we have. My comment there would be the bulk of contact center seats are in B-to-C organizations and they tend to be in larger enterprises and if you look at historically, the bulk of the revenue in the space today goes to the Oracle Siebel platform with others like historical Vantive, Scopus, Remedy these others. All of that adds up to about $3.5 billion a year.

Clearly, given the evidence we have with this one account that I mentioned where we replaced Siebel in a 600-seat deal for less than their annual maintenance payment, we can deliver at a lower cost to the customer that should significantly increase the size of the market. But if you use Gartner’s numbers or IDC numbers the contact center market, the agent desktop market that we are squarely in is about $3.5 billion a year.

We believe the disruptive nature of SaaS should significantly increase the size of that marketplace because we can serve 30, 50, 70 seat call centers where that would have crushed under the weight of historical Siebel product.

So if that a minimum $3.5 billion a year, that excludes the eService work we do and also excludes the market expansion that will occur because of the disruptive nature of SaaS.

Laura Lederman - William Blair

I guess the final question I would like to squeeze which is, what percentage of the revenue is now call center or maybe a better way to look at bookings, is that now over 50% about where is it sort of staying now?

Jeffrey Davison

I would say it is probably 50% to 60% still were of the revenue, of the bookings this quarter, for me to give you a real good number on that, I would not say it is significantly different but I would say all kind of the large deals had a call center aspect to them but they also have an eService aspect.

So the line actually between the two is, for us anyway, get a little bit gray and I think Laura this is a really important point because it is the combination of eService, which is the external facing part with the traditional CSS, the Contact Center Software. It is the combination of those two that gives us such unique differentiation in this multichannel contact centers because they call a contact center rendering they cannot do the end user stuff. They call in a niche service vendor. They cannot do the agent desktop and we are the only vendor that has got this unique capability.

Operator

Your next question comes from the line of Mark Murphy - Piper Jaffray.

Mark Murphy - Piper Jaffray

Your reference bookings of $47 million in the quarter, I am just wondering, how did that compare to year-over-year versus Q2 of ’08?

Jeffrey Davison

Actually, the booking was $48.7 million and bookings a year ago I gave the number was $43 million.

Mark Murphy - Piper Jaffray

Forty seven versus 43, okay.

Jeffrey Davison

Forty eight versus 43.

Mark Murphy - Piper Jaffray

Thank you. And then Jeff, you also commented back in Q1 that you saw all customers reduced their solution needs at renewal time and that some of the smaller organizations went out of business and so I am trying to understand that apart from the fantastic large deal closure that you have this quarter, could you comment on whether some of that other behavior intensified or maybe abated during Q2?

Jeffrey Davison

Yes. The behavior, I would say, is consistent with Q1. There are still some companies that upon renewal their business cycle is down and so they are reducing a little bit on renewal. The customer churn was 10% again this quarter. So the numbers are pretty consistent with what we saw last quarter.

Greg Gianforte

Ten percent on annualized basis.

Mark Murphy - Piper Jaffray

Okay. And then just finally, Jeff, I am trying to understand that some of the commentary on the contract terms. When we look at, you had this very large increase in the receivables in Q2, can we connect the dots and assume that you are keyed up for a very healthy cash flow quarter in Q3 as you collect those receivables or is it not really that simple this time around?

Jeffrey Davison

Well, cash flow for the quarter, if the bookings went on the books in the receivables, then you have that, that is cash that should be coming due over the near term. The 45% that we are talking about that is not recorded on the balance sheet. So that would not be collected in the fairly near term.

Without providing guidance for Q3, because of this increase in the deferred billing I would not equate the $48 million of bookings to a huge cash flow quarter in Q3.

Operator

Your next question comes from the line of Nathan Schneiderman - Roth Capital.

Nathan Schneiderman - Roth Capital

First one for you is - last quarter you spoke to a pretty good start for big deals during the month of April and I was just hoping you can share with us, do you have similar success in July?

Greg Gianforte

We are off to a good start for the quarter. We, in part, gave you that color because we have had seen a soft Q1. I do not think we are going to get in the habit of giving specific current quarter information.

Jeffrey Davison

But we are off to a reasonable start with the healthy pipelines.

Nathan Schneiderman - Roth Capital

Okay. And then I am just curious on your revenue guidance with the impressive bookings number of the quarter, I might have thought on that kind of number you would have been able to push up revenue guidance for the year or so. Should we assume this is conservatism or is it the timing of when these larger customers are going to go live or some other issue?

Greg Gianforte

Well, I think there is a little bit of both there, Nathan. We are obviously going to remain cautious on the rest of the year given the environment. Also when you look into the $48.7 million of bookings, with the good portion of that being longer term, the declining of revenue is a little further out. So, it is not all hitting near term revenue.

Nathan Schneiderman - Roth Capital

And just quick final one for you, hoping you could speak to different trends and changes that you are seeing geographically may be comparing to Q2 to the experience in Q1. Thanks very much.

Greg Gianforte

Sure. So, to comment on that, I mean in Q2 here the standout was North America. That is where we saw the strongest performance. Asia Pacific had good solid performance in Q1 and Q2. I would say that EMEA had a softer Q2 following a very strong Q1. Although we saw a great customer acquisition in Europe and some good pilot starts and their setups are a reasonable Q3. So, pretty good performance across all regions with North America being the standout in Q2.

Operator

(Operator Instructions) Your next question comes from the line of Brendan Barnicle - Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities

Greg, in the past, you talked about the public sector particularly the federal government. We are coming to the end of the federal government’s fiscal year and so I am wondering what your outlook is in terms of federal government potential contribution coming into the third quarter and what kind of deal activity maybe in that pipeline?

Greg Gianforte

Yes. We continue to have a very strong public sector business. Q3 is the fiscal year end for federal government. We do tend to see a little more strength there relative to the other quarters in public sector. It is offset somewhat by EMEA being on vacation during Q3. So, those tend to trend off against each other. I think the work we have done also earlier this year with our government specific hosting solutions was really a breakthrough in the industry. No one else has a Department of Defense Certified hosting facility and we do and so I think that is helping us as well. But again, we should see seasonally stronger public sector business in Q3 offset somewhat by EMEA being seasonally slightly weaker.

Brendan Barnicle - Pacific Crest Securities

Terrific. Jeffrey, just quickly remind me again on the gross margin targets that you guys have setup.

Jeffrey Davison

Yes. In our three-year model, our margin targets are 70% to 75% and our operating margin is 18 to 20 percentage points.

Operator

Your next question comes from the line of Brad Whitt - Broadpoint AmTech.

Brad Whitt - Broadpoint AmTech

Quite a few has been answered. But I guess Greg, since you have visited so many call centers in the last couple of months, maybe you can give us kind of general idea how you see the appetite for IT spending in general in call centers and what the condition is there, were they adding headcount, reducing headcounts, opening new call centers, just kind of what you are seeing out there?

Greg Gianforte

Yes. A couple of major trends, I think first, nobody is spending money if they are not solving a problem and that is the headline. So, there has to be a problem. I mentioned people facing, one organization facing a Siebel maintenance payment, that was a compelling event because honestly it is not hard to find a Siebel deployment when the customers are not happy. These maintenance payments are large and I think if they can find an alternative solution that actually meets their business requirements, there is willingness to spend there.

We also see an uptick in alternative agents and by that I mean both work-at-home agents and offshore agents and I would say with more emphasis on work-at-home. Traditional client server contact center solutions do not support work-at-home agents very well. You need a cloud delivered solution that just requires an internet connection.

So that is another compelling event. I would say generally call centers today have fewer people at home than they did 6 or 12 months ago just because the businesses we are talking to are under pressure to reduce costs. That means they tend to be more willing to spend money on the self service technologies to kind of offset maybe any labor reductions they have entertained. So those are some of the trends.

Brad Whitt - Broadpoint AmTech

Very good that is helpful. And Greg, just following up on some of the customer churn questions. I mean just in general, when a customer renews, are they typically renewing for less, have more, about the same and what do you see generally?

Greg Gianforte

One thing historically we have always seen a 100% of the available dollars at renewal time from the people, if there is a bucket of renewals; we tend to get a 100% of the dollars. Q1 was the first time we saw a slightly less than that. We saw a similar result in Q2. I would not say that the majority of the customers renewed for less but a minority of them do and that is where the fall out is.

Operator

Your next question comes from the line of Patrick Walravens - JMP Securities.

Greg McDowell - JMP Securities

This is actually Greg McDowell for Pat. Could you just talk about what the growth rate of this business could be in a more normal economy?

Jeff Davison

That is a good question, to a more normal economy.

Greg Gianforte

And is that the way is that going to be? Our guidance and what we have been looking at is 7% to 10% growth recurring revenue over last year. If you normalize that for foreign exchange rates compared to the first half last year, it is more of a 15% growth which…

Jeff Davison

That is what we are doing in the current economy.

Greg Gianforte

Exactly what we are doing.

Jeff Davison

To get out your question about longer term rates, I believe we are still in a disruptive environment. There is this shift in our curve from client server call center to SaaS call center. So, we are still in a disruptive area. I believe growth rates go back to between 20% and 30% at least to market growth in SaaS contact center. We just need a little more wind in company sales and we will see that comeback. That is the best crystal ball I have.

Operator

Your next question comes from the line of Keith Weiss - Morgan Stanley.

Keith Weiss - Morgan Stanley

I just wanted to talk to you a little bit about your investment outlook and how you are thinking about when stuff is turning around, if stuff gets better. How you think expenses come back into your organization and what kind of timeframe is it and I guess really, on two aspects, one is in terms of sales capacity, how much sales capacity you guys think you have? How much came from process in there? And two, just on newer organization, I mean you ticked at headcount a little bit but how do you see headcount trending throughout the year?

Greg Gianforte

Yes, so headcount come up a little bit and when we look at the rest of the year, our plan is to hire and to continue to invest through the end of the year. We are doing it cautiously and we have had some over performance from the first half of this year. So, we are increasing the investment as we move through Q3 and Q4. The real line that we did at the beginning of the year in the sales organization was to spend the sales marketing dollar more productively so we have kind of reorganized so that we are getting use of the sales dollar and by that, I mean, we shifted more of the business to lower cost channel like insight sales.

We think that there is still a lot of room for productivity improvement in our sales marketing organization and we will continue to realize that over at least the next year period. So, you will see us continue to add and continue to hire and invest and I really do think it is going to be fairly spread across the board but kind of in line with our theme this year which has been focusing on the customers and so, those projects tended to be in 2009 in our customer support, in hosting areas and R&D areas, not in sales and marketing necessarily.

Operator

Your next question comes from the line of Sasa Zorovic - Janney Montgomery Scott.

Sasa Zorovic - Janney Montgomery Scott

My question would be sort of more stable economic environment and so forth, how about doing some more of your share repurchases?

Greg Gianforte

So, on that, we certainly took advantage of the cash in the balance sheet last fall. We had looked at, there is no current plans for it. I mean I think also as we have mentioned in the past, we have been, we continue to look at potential assets that could augment the growth of the business. There is nothing to announce today but we continue to look at things and there is various uses for that cash we have on the balance sheet. We think we can apply that in a way where we can accelerate growth or add more mass to the business. We may well do that rather than repurchase sales.

Operator

Your next question comes from the line of Derrick Wood - Wedbush Morgan Securities.

Derrick Wood - Wedbush Morgan Securities

Given the higher churn rate in the mid market, have you guys changed your strategic focus in terms of your sales efforts in the mid market and if this is the case, do you think that this makes your bookings a little bit more volatile going forward if you have deal flow coming more from enterprise versus mid market?

Greg Gianforte

Yes, I would not say there has been a big shift in strategy. We have seen the slight up tick in the churn mostly related to the economy. So, there is not a big to report there.

Derrick Wood - Wedbush Morgan Securities

Okay and if you could just shed some light on what the, you have these metrics, with the average deal sizes and the call center deal versus just web self service only, on how that can vary?

Greg Gianforte

Well, we do not release it. The number we gave you is blended because often the transactions include both the serve and contact center. If I had to slag it, again, we can do a million dollar deal with eService only and we can do a contact center deal to a $100,000 but if you average them all, I would say in general, a contact center deal is two to three times in the service deal in the same size company.

Operator

Your next question comes from the line of Ross MacMillan - Jefferies & Company.

Analyst for Ross MacMillan - Jefferies & Company

Most of my questions have been answered but you mentioned the CapEx here at $6 million staying pretty flat with last year. How are you guys doing on capacity in general in your datacenters and what should we expect as we go forward in the future? I know you do not spend too much on extending capacity on that but any insights on utilization right now?

Greg Gianforte

Sure. Datacenters, we have pretty standard capital that just continues to go on maintenance and replacement of equipment. We did, the trend that you see in Q2 is actually related to the new government hosting facility that we are talking about and that were brought up and we are able to bring up a hosting center or more capacity within this $6 million range of spending that we do. So, the answer I guess is I think we are fine in capacity and we are able to expand as we need to with reasonable capital expenditures.

Operator

With that, ladies and gentlemen, there are no other questions holding so I will turn things back over to Greg for additional or closing comments.

Greg Gianforte

Okay, thank you. Again, we are really pleased we had a great quarter. I appreciate your continued focus and again, the primary driver is our focus on B-to-C contact centers and the unique offering we are bringing to market around multi channel. So, we look forward to continuing dialogue over the coming period. Thanks.

Operator

With that, ladies and gentlemen, we will conclude today's conference call. Thank you very much for joining us. Have a nice day and you may now disconnect.

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