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Executives

Nate Swanson - VP of IR

Mike Gregoire - Chairman and CEO

Katy Murray - EVP and CFO

Taleo Corp. (TLEO) Q3 2009 Earnings Call October 28, 2009 4:30 PM ET

Operator

Hello, ladies and gentlemen and welcome to the third quarter 2009 Earnings Call. I would now like to turn the call over to Mr. Nate Swanson.

Nate Swanson

Good afternoon and thanks for joining us for Taleo’s third quarter 2009 earnings results conference call. This is Nate Swanson, Investor Relations for Taleo, and with me on the call today is Mike Gregoire, Chairman and Chief Executive Officer, and Katy Murray, Taleo’s Chief Financial Officer. Mike and Katy will offer our prepared remarks and then we’ll host the live Q&A call at 5:30 PM Eastern Time.

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

Taleo undertakes no obligation to update these forward-looking statements to reflect events or circumstances after today. Our forward-looking statements are subject to a number of risks and uncertainties that can cause actual results to differ materially. We refer you specifically to the risk factors set out in our Form 10-Q/A as filed with the SEC on October 27, 2009, which is available through the Investor Relations section of our website at taleo.com or through the SEC’s website at sec.gov.

In addition, today we’ll be discussing GAAP and non-GAAP numbers. Our GAAP numbers and the reconciliation of our non-GAAP numbers to our GAAP numbers are contained in our Q3 2009 earnings press release in an undownloadable file on the Investor Relations section of our website.

In addition, please note that the replay of today’s call will also be available on our website.

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

Katy Murray

Thanks, Nate and good afternoon everyone. As you’ve already seen in the press release issued earlier today we continue to execute and for Q3 we exceeded both application revenue and EPS guidance. We believe that Taleo management space continues to increase in importance and are pleased with our ability to execute this quarter.

Q3 was an important quarter for Taleo, as we launched several significant new products including Taleo 10 and the Talent Grid, while also recording strong non-GAAP operating margins and significant operating and free cash flow. We had a strong quarter in terms of application revenue growth with our application revenue up 5% sequentially to $44.9 million versus our guidance of $44 million to $44.5 million.

The growth this quarter did benefit from the recognition of a milestone acceptance of a few hundred thousand, which was originally forecasted to be received and recognized in Q4. On a year-over-year basis total non-GAAP application revenue is showing a 9% growth rate and there are some specific factor that led to this growth. When we acquired Vurv on July 1st 2008, we acquired certain product lines that we decided that we would no longer be supporting specifically the Optimize and Staffing Edition product lines.

These two lines have since been divested or wound down, however, from a revenue impact, the revenue has gradually been declining over the last 12 months and now in Q3 2009 when comparing non-GAAP application revenue to Q3 2008, the calculated revenue growth rate is impaired dramatically.

If you exclude the these two product lines from our Q3 ‘08 non-GAAP application revenue our organic application revenue growth rate is in line with the growth rate for deferred application revenue. Our services revenue of $5.8 million was better than our guidance of $5.5 million and was driven from an increase in standalone service engagements.

As we stated on our Q2 conference call, demand for engagements related to new application software purchases has been consistent with prior quarters. However, we are still experiencing weakness around standalone services work such as education and business process optimization.

While standalone projects are recognized as delivered, engagements tied to new software purchases are recognized ratably over the software subscription term. Our enterprise renewal rates were consistent with prior quarters at 95% plus on a pure dollar-to-dollar basis, not including up sells and we continue to see our same high customer-for-customer renewal rates.

Operating expenses were in line with our expectations, as we continued to make investments in sales and marketing and R&D this quarter, with our annual user conference and the launch of Taleo 10 and the Talent Grid. Our Non-GAAP operating margins came in at over 13%, up from 11% in Q2 and 10.8% one-year ago. For Q4, we expect our non-GAAP operating margins to decrease as operating expenses will be more closely in line with our Q2 run rates.

Amortization expense totaled $3.6 million, in line with last quarter and we had $3.4 million of depreciation expense. Our non-GAAP effective tax rate was in line with expectations at an expense of roughly 5% and our non-GAAP EPS for the quarter was $0.20 versus our guidance of $0.16.

Turning to the balance sheet, we ended the quarter with more than $76 million in cash, compared with $62 million at June 30th. We generated just over $13 million in cash flow from operations and free cash flow of $11 million. Year-to-date, our cash flow from operations is $30 million, compared to $14 million for the same period last year. We’re very pleased with the growth in cash flow and our ability to continue to show strong collections in this environment. This combined with our strong renewal rates is evidence of our strong customer satisfaction.

In regards to headcount, we ended the quarter with 923 employees, down slightly from 937 at the end of June. We have 80 individuals compensated on sales achievement, with 32 quota carrying reps focused on Enterprise, 24 focused on our SMB business and additional 24 individuals focused on renewals and up sell opportunities in our enterprise customer base.

Turning to guidance for the fourth quarter; we are expecting application revenue of $44.5 million to $45 million, services revenue of approximately $5.5 million, fully diluted non-GAAP EPS of $0.17 to $0.18 based on fully diluted weighted average shares for the quarter of approximately 34 million. This guidance does not take into consideration the planned equity offering announced earlier today.

A non-GAAP effective tax rate of approximately 5% and while we do not provide specific cash flow guidance, for the fourth quarter we do expect that stock compensation expense, amortization expense and depreciation expense will be consistent with the third quarter.

In terms of 2010, we will be providing 2010 guidance on our next earnings call and we will also be incorporating the impact of the new revenue guidance in EITF 08-1, which was recently adopted by the FASB. EITF 08-1 is an updated framework to the existing guidance in EITF 00-21. This guidance will be adopted on a prospective basis and will impact our services revenue recognition. We are pleased with the FASBs adoption of this new rule as we believe this guidance will lead to financial statements and reported results that are more closely aligned with the economics of our transactions.

In closing, we reported another solid quarter, and we continued to see that translate into earnings and cash flow growth, which further improves our competitive positioning relative to our smaller competitors.

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

Mike Gregoire

Thank you Katy, and good afternoon. I’d like to focus on three main topics today; first, the increasing importance of talent management systems and processes, regardless of the broader economic environment; second, Taleo’s position and growth strategies within the talent management market; and finally, our vision of how the market will evolve over the next several years. But first, I would like to review our Q3 results, as they provide a relevant window into how the talent management market has performed over the past year.

Q3 was another strong quarter for Taleo. We closed 17 new Enterprise accounts, and seven deals over 250,000 in annual subscription value. New Enterprise Recruiting customers this quarter include FEMA within the Department of Homeland Security, Cognizant Technology Solutions, Shaw Industries, US Cellular, Lifespan, Xcel Energy, Itron, Atmos Energy and Centegra Health Systems.

We closed joint Recruiting and Performance Management suite deals with several customers, including Penske Truck Leasing. We also signed a large Performance Management deal through IBM, and closed standalone Performance Management deals with RSC Equipment Rental, SavaSeniorCare and Talisman Energy. Needless to say, we’re pleased with the momentum we’ve built in Performance Management. We now have over a 160 Performance Management customers, up from roughly 120 at the end of Q2.

The pending acquisition of our new best-in-class Compensation Management solution should only help to strengthen our positioning and momentum going forward. We saw a nice uptick in our small and mid-sized business group, as we added 150 new customers this quarter, up from 134 in Q2. New Business Edition customers include Skymall, Medical Management Resource Group, Wesley Homes, vCustomer Corp., RQ Construction, Lakeside Schools, TIB Bank, Talyst, and Communication Infrastructure Group.

In terms of our financials, we grew application revenue, which increased 5% sequentially, and our non-GAAP EPS of $0.20 came in well ahead of our guidance of $0.16. We also had another very strong quarter in cash flow, generating $13.6 million in operating cash flow. This brings us to our year-to-date operating cash flow to $30 million, compared to the $17 million generated in all of 2008.

We believe Worldwide Compensation has also seen acceleration in its sales, which is encouraging to us. We’ve been very pleased with the comments and feedback from the field since we announced our intention to acquire Worldwide Comp, and in fact we’ve been reengaged in several sales cycles where we had been eliminated early on because we lacked ownership of this important technology asset. We believe Worldwide Comp will prove to be a highly strategic and valuable asset to us and our customers. We look forward to bringing them into the Taleo family early next year.

Now, let’s talk about the Talent Management market and our outlook for the next several quarters. While we believe the economy has stabilized from the levels witnessed earlier this year, we believe the strength of our business is more likely due to the increasing importance of the Talent Management category, than from the broad based rebound in economic growth.

It may be counterintuitive to some, especially with an unemployment rate nearing the 10% level, but usage of our systems continue to grow. In fact, Taleo customers hired half a million new employees in Q3, and our systems processed more than 15 million candidates during the quarter, our highest quarter ever.

As we’ve said for a while, our business is not driven by the overall level of employment, but rather by the rate of job velocity, the rate at which employee’s turnover. The Bureau of Labor Statistics reports that despite rising unemployment voluntary turnover alone remains near 20%, so on average, companies are losing one out of every five employees every year just from voluntary attrition. If you add in forced turnover the rate shoots up to 40%, so some companies have to hire 40% of their total headcount base every year, just to stay flat.

Because of this trend, which is not only expensive but also disrupts a company’s ability to execute, we believe more and more companies are recognizing that Talent Management can help them both cut costs and drive growth. And they’re turning to Taleo to help them do just that. For example, North Shore Long Island Jewish Health Systems, which operates 15 hospitals and has more than 38,000 employees, utilizes Taleo Recruiting and Performance to drive their business by increasing the quality of care their patients received.

They did this through a combination of reduced employee turnover, and increased employee engagement and development. And they believe these improvements not only increased the quality of care their patients received, but also provided the organization with a 25 million increase in operating income, materially impacting bottom line profitability.

Or take Quantas Airlines, the second oldest airline in the world, with more than 36,000 employees. Quantas has reported saving more than $5 million year-to-date just in improving sourcing capabilities, and has also recognized significant soft dollar savings by increasing the efficiency of their hiring managers, and by reducing the time to hire and onboard new talent by more than 20%.

DaVita, another of our healthcare customers, which like many healthcare service providers’ is struggling with a nationwide nursing shortage. DaVita has stated that it was able to reduce their time to fill by 29%, resulting in a savings of over $12 million in overtime and contract nursing costs. According to their internal reports, DaVita was also able to lower their overall nurse vacancy rates by 19%, which resulted in the delivery of an additional 675,000 patient treatments.

These are just a few of the success stories our customers shared this past September at our annual user conference, Taleo World. We’re happy to report that we had record attendance at this event, both in terms of current customers and new prospects. We’re pleased with this for a number of reasons, as it brings our customers together to network and share best practices, and it demonstrates that our customers are committed to driving their business through Taleo’s suite of Talent Management applications.

It also provides us with an opportunity to showcase our newest solutions, which this year included the launch of Taleo 10 and the Talent Grid. Taleo 10 represents the next evolution of our market leading recruiting solution, and brings to market the same innovative usability features as our award winning performance application, creating the industry’s first unified suite of Enterprise Recruiting and Performance Management applications.

This release also serves as the foundation for our broader platform strategy, which is to be the best of breed vendor across the three pillars of strategic talent management; Recruiting, Performance Management, and Compensation Management. We’re already there with Recruiting, we’re quickly gaining momentum with Performance, and with the pending acquisition of Worldwide Compensation, we believe we’ll have the industry’s best in class Compensation solution shortly. This line-up of products will be tough to beat.

Our growth strategy is pretty clear. We’ve expanded our product offering to include Performance, we’ve been able to compete for more deals and our win rate has improved. As we bring Compensation Management to the market early next year, we expect this trend will continue and make our unified suite even more compelling. And as we round out our platform offering, we’ll not only be able to deliver the best products, but also the most value to our customers, which brings us to the Talent Grid.

We launched the Talent Grid in September, as a collection of three exchanges designed to service the needs of Talent Management practitioners, solution providers and candidates. This offering brings together our installed base of 4,200 customers, three million users, 175 million candidates and more than 70 partners in a common community. This first of its kind service will bring unprecedented value to our customers, candidates and partners, and further increases our positioning as the clear leader in the Talent Management category.

So we’re clearly in a position to capitalize. We have the products and are continuing to reinvest in new product development. We have the largest installed base in the industry, serving 46 of the Fortune 100 and more than 3,500 small and mid-sized organizations. And the market is ready, we’re seeing more and more multi-product RFP’s. And while we’re confident we’re taking market share through our sales and marketing successes, our model calls for a mixture of both organic and inorganic growth.

As we indicated at our Analyst Day event back in August, the acquisition of Vurv has been very successful, and we believe we can replicate that success going forward. We can replicate it because of our significant investments in R&D and our customer service and support over the past several years. This model not only adds scale to our operation, but it has also allowed us to double our operating margins from roughly 6% before the acquisition, to over 12%, while reinvesting even more money back into product development. In fact, initiatives such as the Talent Grid probably wouldn’t have been possible without the leverage and scale we obtained with the addition of Vurv customers, employees and revenue.

As a review, our philosophy around acquisitions is very clear, we’ll look to enhance our competitive position in the talent management market through transactions that allow us to migrate our competitors customers to the Taleo platform, or we may do smaller deals where we can add domain expertise to our core platform and solution offering. These strategies have worked very well for us in the past, and since we’re not looking to deviate from our game plan by branching out beyond our Talent Management DNA.

We’d like to thank all of our customers, partners and employees for another successful quarter, and looking forward to seeing many of you in the near future. This concludes our prepared remarks.

Question-and-Answer Session

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