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Executives

Don Volk - CFO

Rudy Karsan - CEO

Troy Kanter - President and COO

Analysts

Brian Schwartz - Piper Jaffary

Joe Del Callar - Cowen and Company

Patrick Walravens - JMP Securities

Brad Reback - Oppenheimer

Bryan McGrath - Credit Suisse

Sasa Zorovic - Janney Montgomery Scott

Michael Nemeroff - Wedbush Securities

Andrew Johns - Raymond James

Horacio Zambrano - Jefferies

Kenexa Corp. (KNXA) Q3 2009 Earnings Call November 3, 2009 5:00 PM ET

Operator

Welcome to the Kenexa third quarter 2009 Earnings Call. (Operator Instructions)

It is now my pleasure to introduce your host, Mr. Don Volk, Chief Financial Officer for Kenexa.

Don Volk

With me today is Rudy Karsan, our Chief Executive Officer, and Troy Kanter, our President and Chief Operating Officer. Today, we will review Kenexa's third quarter of 2009 results and provide guidance for the fourth quarter and then we'll open up the call for questions.

Before we begin, let me remind you that this presentation may contain forward-looking statements that are subject to risks and uncertainties associated with the company's business. These statements may contain, among other things, guidance as to future revenues and earnings; operations; transactions; prospects; intellectual property; and the development of products. Additional information that may affect the company's business and financial prospects, as well as factors that would cause Kenexa's performance to vary from our current expectations are available in the company's filings with the Securities and Exchange Commission.

Also, I would like to remind you that today's call may not be reproduced in any form without the express written consent of Kenexa. We may refer to certain non-GAAP financial measures on this call. I will discuss the reconciliation of adjusted numbers to GAAP numbers, and a reconciliation schedule showing the GAAP versus non-GAAP is currently available on our company website, www.kenexa.com, with the press release issued after the close of market today.

I'll now turn the call over to Rudy Karsan. Rudy?

Rudy Karsan

Thanks, Don. Thanks to all of you for joining us on the call to review our third quarter results, which we believe provides further evidence that Kenexa's financial performance has reached the point of general stability. Our total revenue grew slightly on a sequential basis; deferred revenue continued to grow; and the company continued to generate solid cash flows from operations.

Most important from a long-term perspective, we see growing evidence of customers recognizing the power of Kenexa's unique value proposition, as evidenced by a series of high profile, highly competitive wins during the third quarter. Interest levels in our solutions remain high, and we believe Kenexa is well-positioned to reaccelerate growth when the unemployment rate eventually stabilizes and improves.

Taking a look at our results for the quarter, total revenue came in at $40.3 million, up sequentially from $39.5 million and above the high end of our guidance. Non-GAAP operating income was $4.3 million, consistent with our guidance, and essentially flat with last quarter. Deferred revenue was $44.2 million, an increase of $2 million sequentially and 20% on a year-over-year basis. Finally, we generated $6.1 million in cash flows from operations.

From a high-level perspective, our view of the market has not changed materially since our last call. While we do not believe the business environment is getting any worse at the moment, we are planning our business based on the assumption that the economic environment will remain challenging from a near-term perspective. There is growing optimism that we may not be far from an economic recovery as evidenced by Q3 GDP growth, which is encouraging; but the face and shape of such a recovery is still quite unknown.

As an example, the Kenexa Research Institute performs a rigorous statistical analysis that results in what we call the Employee Confidence Index, a metric that we have tracked for a couple of years now. A high level of employee confidence is achieved when employees perceive their organization as being effectively managed and competitively positioned and believe they have a promising future with their organization, job security, and skills that are attractive to other employers.

Employee confidence influences individual behavior and has implications for organizational performance and economic conditions. In fact, we have found the Employee Confidence Index to be highly correlated to multiple economic and business performance outcomes, including consumer confidence and GDP growth.

During the second quarter, the Kenexa Research Institute reported an increase of 5.3% in the US employee confidence from the first quarter. However, that figure declined by 1.2% from the second quarter to the third quarter. Moreover, nine of the 12 countries studied showed third quarter declines compared to the second quarter of 2009, an indication that we're not out of the woods yet. The positive news is that none of the countries completely lost the gains made in the third quarter. This is a figure that we will continue to track closely and report on.

The face and shape of the recovery will also have an influence on the unemployment rate, which is widely expected to increase in the near-term, reaching a point of stability around the midpoint of 2010.

As we have commented in the past, our view is that we will continue to face headwinds as long as the unemployment rate is increasing. For this reason, combined with variability related to currency rates and our other revenue, we believe it is prudent for us to maintain a stable quarterly revenue guidance range that we have targeted in recent quarters, which Don will comment on later.

We believe the stability of our results around the streams during the first nine months of this year, combined with solid growth in our deferred revenue is positive evidence that Kenexa has weathered the most difficult part of the economic storm. As we look forward, we continue to be confident in Kenexa's market position, due in large part to our highly differentiated value proposition.

We see a growing number of large global organizations evaluating vendors based on the breadth of their offerings, global footprint, domain expertise, and ability to serve as a strategic partner to help customers implement best practices. We believe that Kenexa's unique combination of strong technology, science, and services positions Kenexa well to meet the evolving needs of these customers.

Another area for end-to-end product suite, which continues to enjoy significant success, is our Kenexa Recruiter BrassRing, or KRB offering. Feedback from customers and industry analysts relative to our KRB offering is very positive, including commentary related to our industry-leading reporting capabilities, redesigned user interface, and integrated hourly and high volume hiring capabilities that were included in the most recent release of KRB.

The strength of our technology was evident in the significant applicant tracking system win with a Fortune 100-type aerospace and defense company during the third quarter. In this situation, the overall landscape of vendors was reevaluated, including the incumbent vendor looking to move the customer over to their internally developed high-end offering. It was determined that Kenexa's roadmap and KRB solutions including our system security practices and protocols, was best positioned to meet their needs. This is just one example of the growing number of situations in which Kenexa is winning competitive evaluations based on the strength of our technology.

We have a couple of other customer examples that illustrate the strength of Kenexa's end-to-end value proposition. Standard feedback from customers continues to be that Kenexa (inaudible) of our long-term partnership focus, and because of our ability to link HR to actual income statement outcomes.

Our individual times environment equals success brand, reflects the fact that we are uniquely positioned to help customers hire the right person for every job. Create the optimal environment for each person, which has a multiplicative effect on business outcomes.

During the third quarter, we won a highly competitive selection with one of the largest home improvement retail chains in the world. In addition to selecting our KRB applicant tracking system, they also selected Kenexa's Onboarding and Assessment Solutions for enterprise-wide deployment. Kenexa will become the global ATS solution and we are building custom field level assessments for store hiring. This customer has an extremely well-respected organization in the HR community, and they felt a strong connection to Kenexa's strategic mission, vision, and values.

Finally, for those of you who attended our annual users group meeting in Dallas, you had the opportunity to hear one of our featured keynote speakers, Wal-Mart stores, who has more than 8,000 retail units under 55 different banners in 15 countries, and employs more than 2.1 million associates worldwide.

In addition to being one of the more forward-thinking companies from an HR perspective, one of the reasons that Wal-Mart was in attendance at that users group is because they are one of the latest companies to partner with Kenexa. It's worth pointing out that Kenexa now has relationships with three out of the five largest companies in the world.

During the third quarter, we also won competitive evaluations and added high profile talent acquisition customers such as Broadcom, Harvard University, and 24-Hour Fitness. In addition from a talent retention perspective, we added customers such as HEB Grocery, ADP, Caribou Coffee, SunPower, Scotts Company, and Colgate-Palmolive. In total, we again added over 20 preferred partner customers, which is consistent with recent quarters.

We believe the differentiation and quality of Kenexa's size and consulting is unquestionable, and this is important when we are competing with these vendors that are only able to deliver the software component of the value proposition. Large global organizations are looking for more than just a software package. They want a business solution and a business partner.

The aspects of our business that is most challenged as the result of a sluggish economic environment, however, is the services-related component. Across all technology sectors, service-related projects are often put on hold during challenging budgetary environments and this is no different in the HR solutions market.

We expect the consulting portion of our business to remain choppy for the next couple of quarters until the employment rate stabilizes. However, customers tell us their plan on moving forward with these strategic services when the economic environment improves and they have greater access to resources.

Let me spend a moment reviewing the final component of our business, our recruitment process outsourcing services, or RPO. During the third quarter, our RPO revenue came in at approximately $9 million, which was essentially flat to up slightly from last quarter. The sequential decline in our RPO revenue has been increasingly small in recent quarters, and the third quarter represented the first time in six quarters that our RPO revenue was flat to up.

We're encouraged that our RPO revenue has stabilized. Not only have we had some customers move off their contracts (inaudible) during the quarter, but we also added LSG Sky Chefs as a new RPO customer. We continue to invest in the strategic part of Kenexa as evidenced by recently adding topnotch RPO sales talent and we have a solid pipeline of opportunities as a result.

However, with the unemployment rate not expected to peak until the middle of next year, we continue to believe that it is appropriate for Kenexa to have measured expectations relative to our RPO revenue from a short-term perspective. As such, we continue to forecast our RPO-related revenue to be flat to possibly down for the next couple of quarters. When the economy recovers, we're optimistic that our RPO-related revenue will rebound, and it's important strategically because it provides Kenexa with unmatched domain expertise and helps us to develop deeper relationships with our clients.

A common metric that we share, which includes our RPO services, along with other consulting services and technology solutions, is our P3 metric, which measures the average annual revenue contributed of our top 80 customers. This metric came in at over $1 million during the third quarter, which was consistent with recent quarters.

From a summary perspective, we're not out of the woods yet, as it relates to the macroeconomic environment. There is growing optimism that a recovery is around the corner, but we believe it will be a couple of quarters before it translates into customers moving ahead more aggressively with software and service engagements in the HR organization.

That said, we continue to grow more bullish about Kenexa's position in the market and our business prospects from a 12 to 18-month perspective. We are encouraged that Kenexa's total revenue has stabilized in recent quarters, while the solid growth of our deferred revenue reflects the stabilization in our renewal rates combined with the momentum of our sales activities.

Large global organizations are increasingly valuating vendors on their ability to deliver total value propositions. That means having both a broad integrated suite of HR solutions, as well as the domain expertise, science and services to serve as a strategic partner and advisor to the client. We believe the strength and differentiation of Kenexa's solutions and business model is evidenced by highly competitive wins with some of the largest companies in the world among others. We continue to believe Kenexa will be a primary beneficiary when the unemployment rate eventually stabilizes.

With that, let me turn it over to Don to review our financials in more detail. Don.

Don Volk

Let me begin by reviewing our results for the third quarter, starting with the P&L. Total revenue for the third quarter was $40.3 million, above our guidance of $37 million to $40 million, and up 2% on a sequentially basis. Subscription revenue was $33.2 million, and represented 82% of our third quarter total revenue. Our services and other revenue came in at $7.1 million, representing the remaining 18% of our third quarter total revenue.

We continued to expect our subscription revenue mix to be in the upper 70% to 80% range from a long-term perspective and in a more healthy economic environment. From a geographic perspective, our revenue mix of domestic versus international revenue was 77% and 23%, which compares to the previous quarter of 81% and 19%. Movement in currency rates did not have a material impact on our geographic mix during the quarter.

From a detailed perspective, RPO represented approximately $6 million of our subscription revenue and approximately $9 million of our total revenue in the third quarter, which compares to $6 million and $8.7 million in the quarter, respectively.

Our clients typically purchase multiyear subscriptions, with an average length of approximately two years. During the third quarter, overall renewal rates for our suite of solutions were over 70%, consistent with our expectations and the previous quarter.

Turning to profitability, we'll be providing non-GAAP measures for each third quarter 2009 expense category, which exclude $1.4 million of share-based compensation charges associated with FAS 123R, and $1 million of amortization of acquired intangibles. All comparisons will be using the non-GAAP current period results. Non-GAAP gross margin was 67.5% in the quarter, which was up from 65.7% in the prior quarter.

Non-GAAP sales and marketing expense came in at 8.8 million or 22% of revenue, compared to 20% of revenue last quarter. Non-GAAP R&D expense came in at 2.3 million, or 6% of revenue, consistent with last quarter. Finally, non-GAAP G&A expenses were approximately 9.3 million, or 23% of revenue, also in line with last quarter.

Our non-GAAP income from operations was $4.3 million for the quarter, consistent with our guidance and representing an 11% non-GAAP operating margin. Of note, our non-GAAP operating expenses in the third quarter included legal and professional fees that were approximately $300,000 higher than our original estimate.

As we have disclosed in our filings, we are pursuing litigation against one of our competitors that we believe has infringed upon one of our patents, and we intend to continue to aggressively pursue this matter. Even after this higher expense, non-GAAP EPS was $0.18, which was above our guidance of $0.13 to $0.16, due to a lower than expected tax rate contributing $0.02 per share.

Turning to our results on a GAAP basis, the following were expense levels determined in accordance with GAAP; cost of revenue, 13.1 million; sales and marketing, 9.1 million; R&D, 2.5 million; and G&A, 10.2 million. For the third quarter, GAAP income from operations is 1.9 million. Net income applicable to common shareholders is 1.6 million, resulting in GAAP net income per share of $0.07.

The reconciliation of non-GAAP to GAAP expenses and income from operations can be found in our press release and current report on Form 8-K filed with the SEC. Kenexa has cash, cash equivalents, and investments of 50.2 million at September 30, 2009, an increase from 47.2 million at the end of the prior quarter. Positive cash from operations of 6.1 million during the third quarter was partially offset by capital expenditures.

Accounts receivable DSO were 66 days at the end of the quarter, compared to 62 days at the end of last quarter. Our deferred revenue at the end of the quarter was 44.2 million, up $2 million from the end of the second quarter, and up 20% from the end of the third quarter of 2008.

I'd now like to turn to guidance for the fourth quarter of 2009. We are targeting revenue in the range of 38 million to 40 million, which increases the low end of our guidance range from last quarter and is consistent with Rudy's commentary regarding stabilization of our results.

In addition to the fact that we believe it is prudent to allow for a level of variability in our other revenue and currency rates, it is worth a reminder that while several of the larger, higher profile wins contributed to the growth of our deferred revenue, we do not expect to begin recognizing revenue related to these relationships until mid-2010, most likely, due to the multi-element nature of those deals.

We are targeting non-GAAP operating income to be $3.3 million to $3.9 million, which includes an expected sequential increase in our legal and professional fees of approximately $300,000 to $500,000 related to the previously mentioned patent lawsuit that we are pursuing. Our current expectation is that our fourth quarter legal expense run rate will continue into 2010, as we believe we have a strong case that is worth continuing. Assuming a 15% effective tax rate for reporting purposes and 22.9 million shares outstanding, we expect non-GAAP income per diluted share to be $0.13 to $0.15.

In summary, we are encouraged by the continued stability in our financial results, while solid growth in deferred revenue, and numerous high-profile customer wins support our growing long-term optimism. When the unemployment rate stabilizes and improves, and HR organizations increase their spending on technology investments and related services, we believe that Kenexa will be a primary beneficiary.

We'd now like to turn it over to the Operator to begin the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Mark Murphy with Piper Jaffray.

Brian Schwartz - Piper Jaffary

This is Brian Schwartz for Mark Murphy. Don, wanted to dive in your comments, you sound like there is stabilization improvement. I wanted to see if you could comment on the trends of purchase orders that you're seeing from the staffing companies and the consulting companies. Are you seeing any improvement or any interest to increase purchases from that customer base?

Don Volk

None that can point to a trend.

Brian Schwartz - Piper Jaffary

Okay. It looks like the International segment of the business picked up here as a percentage. Wonder if you could comment where the strength was coming from, what type of regions?

Rudy Karsan

The strength is coming primarily from Europe, which makes up 85% to 90% of our international revenues with a little bit of business in the rest of the world. I would say the rest of the world makes up less than $1 million, less than 2% of our revenue base.

Brian Schwartz - Piper Jaffary

Great. Don I wanted also just touch in on the gross margins here. We've had a couple of quarters now of improvement. Do you think that that has pretty much bottomed here a couple of quarters ago and there's still some leverage on that line here, as we move into [2010]?

Don Volk

Well, one of the reasons that our gross margin improved in the third quarter was because we reached more than minimums on some of our RPO contracts. Those reward fees have high gross margins. So that contributed to most of the improvement to 67.

Brian Schwartz - Piper Jaffary

Okay. Then last question for me here. The patent case that's going on here and the additional legal expense here, Rudy, can you give us any more color possibly on the time length that you think that this may go ongoing? Possibly why you think that you have a strong case here? That's all I have. Thanks.

Rudy Karsan

When you're looking at legal matters, the timeline is we just really don't know. It can take a quarter; it can take four quarters; it can take two quarters; we just don't know. As far as the level of conviction that we have, I guess the level of conviction is given by the fact that we're willing to invest the dollars. Then we basically have a policy in terms of, we don't really comment on the validity of the case while it's ongoing. Just so from an internal perspective we don't kind of discuss any legal issues.

Brian Schwartz - Piper Jaffary

Great. That's all I have. Thank you for taking my questions.

Operator

(Operator Instructions). Our next question is from the line of Peter Goldmacher with Cowen and Company.

Joe Del Callar - Cowen and Company

This is Joe Del Callar for Peter Goldmacher. So I was just wondering if you could like provide any additional color as to the sequential guide down in revenues. I also had another question on if you could give us, like, some more color on sort of what people are interested in, like sort of add-on applications and services when you're sort of as you go forward, now that all of the HR market has potentially been turning towards outsourced HR.

Don Volk

So Joe, on the guidance question, we've been consistent in our messaging that we expect the company to face headwinds as long as the unemployment rate is increasing. So even though there are signs that make us more bullish on the longer-term outlook, we believe that that's the case. Our subscription revenue is stable. Our renewal rates have been stable to improving. Our deferred revenue grew solidly on a year-over-year and a quarterly based and a quarter-over-quarter basis.

Troy Kanter

From a product category, where we're seeing demand and requests are. We announced this quarter what 20-plus preferred partner deals; over 50% of them were multi-element deals with the really large global complex deals, almost all of them were multi-element deals. You look at the applicant tracking or Kenexa BrassRing package being the lead platform on the hiring side, you'll see onboarding, analytics, assessments continually bundled into that. Same on the performance management side; if you think about as sort of a platform product, you'll see a lot of the analytics added on there.

We are seeing a lot of shopping or a lot of tournaments on the RPO side right now. We're as active as we have been in awhile in terms of the number of tournaments that are in play. I think we're optimistic on those. We're hoping for more decision points or conviction around decision points, as our prospects and client organizations start to see stability in their revenue models. As they can better call their revenue, then the hiring initiatives will kick in.

Joe Del Callar - Cowen and Company

Then are there any other services from you, that they have been inquiring about, from you guys?

Troy Kanter

It's fairly consistent with the core portfolio that we have now.

Operator

Our next question is from the line of Pat Walravens with JMP Securities.

Patrick Walravens - JMP Securities

I was hoping you could just tell me when the trial was going to be.

Don Volk

Man, if you can't figure that one out, let me know.

Patrick Walravens - JMP Securities

Well, it was really supposed to be October 19, so I'm assuming that didn't happen. Is that right?

Troy Kanter

That's right.

Patrick Walravens - JMP Securities

Okay. You don't have any idea how long, the Judge must have set another date?

Troy Kanter

There's all sorts of other dates set, Pat.

Patrick Walravens - JMP Securities

There you also have, in that same court, you also have a case you filed in 2008 against Vurv and another one you filed also in 2008 against Taleo. Did those come to a resolution?

Troy Kanter

No, those are ongoing.

Patrick Walravens - JMP Securities

Those are ongoing as well?

Troy Kanter

Yes.

Patrick Walravens - JMP Securities

So can you just quantify for us exactly how much the sort of incremental legal expense is going to be? I heard the 300 to 500, but I wasn't sure if we were supposed to be adding that to some other number from Q3?

Don Volk

Yes, in addition to what we have from Q3 and it indicates that, that's why we are giving consistent revenue guidance and dropping from 4.3 to, or to 3.3 to 3.9.

Patrick Walravens - JMP Securities

Okay, so I must've missed it. How much did you spend in Q3 on legal for the trial?

Don Volk

We said $300,000 more than we anticipated. Then we expect it to be more than in Q3 and Q4 …

Patrick Walravens - JMP Securities

Okay.

Don Volk

…by 3 to 500.

Patrick Walravens - JMP Securities

Right. So we're sort of 600 to 800 for this particular litigation in Q4? Is that a fair way to think about it?

Don Volk

It's fair.

Operator

Our next question is from Brad Reback with Oppenheimer.

Brad Reback - Oppenheimer

I think I missed it during the prepared comments and I'm not sure if it was Rudy or Don, there were some comments around the RPO business, existing customers. Are they all running at their minimums right now?

Rudy Karsan

They've started to move off their minimums, but as we've explained in the past, when they anniversary, the minimums drop in a lot of these contracts. So when we were talking about this two or three quarters ago, we said make sure you build in kind of a dip every quarter in your modeling. We're not saying the same thing, because a lot of these companies have now started moving off their minimums. Hence, you saw the number climb, but the number climbed even though there was a reduction in some of the minimums.

Brad Reback - Oppenheimer

Okay. As we think about it, just so I'm clear on this, all those annual renewals are pretty much now behind us or there's still a handful out there that could put some…

Rudy Karsan

No more this year. We're pretty well done for this year.

Brad Reback - Oppenheimer

As we head into next year, as long as the activity remains where it is, we should be okay on that front?

Rudy Karsan

I would say you kind of look at the portfolio being 15 to 20 companies, three to five renewals, so you get the kind of the three to five renewals every year.

Brad Reback - Oppenheimer

Then Don, on your comment around the increase in the deferred revenue, obviously you signed a bunch of contracts in the quarter, you had talked about not being able to recognize revenue there until middle 2010. Are you doing different things in these most recent contracts to cause that to happen?

Don Volk

Well these contracts are multi-element contracts and we don't recognize revenue until the final element is delivered.

Brad Reback - Oppenheimer

So when you say multi-element that includes aspects of RPO and ATF?

Don Volk

They would more include ATS and onboarding, and possibly survey, possibly testing.

Operator

Our next question is from the line of Bryan McGrath with Credit Suisse.

Bryan McGrath - Credit Suisse

Two questions, just from a competitive standpoint. Have you seen any changes on the landscape? I'm wondering if the tough macro we've had over the last call it, 12 to 18 months has shaken out some of the smaller guys that were out there?

Rudy Karsan

Yes, we've seen a little bit of that. I think since the start of the year, we've probably, if we look at kind of our win/loss record, I would say that we can count on the fingers of one hand now who have lost two rather than if you look at '07 and '08, where you would have double-digit names of companies. So you've got the Kronos/Unicru, you've got the Virtual Edge/ADP, you've got Taleo/Vurv; and then you've got the Peopleclick and you've got the Stepstone.

Bryan McGrath - Credit Suisse

Don, real quick, given the, I guess, overall the strong bookings you saw in this quarter, the 20 partner customer additions and the deferred revenue growth. That gives you pretty good visibility, obviously, into the next couple quarters. How confident would you be in saying that maybe a $38 million quarterly revenue rate is probably the bottom or a flat bottom that you probably won't dip beneath going forward?

Don Volk

Well, as I said, I think, Bryan, there's an element of variability in our other revenue. So we believe it's prudent from a forecasting perspective to maintain the quarterly target that we've shared. Right? But we're encouraged by the strength of the market position and we're confident that the revenue run rate will begin to improve on a quarter-to-quarter basis, as soon as the unemployment rate stabilizes.

Operator

Our next question is from the line of Sasa Zorovic with Janney Montgomery Scott.

Sasa Zorovic - Janney Montgomery Scott

So my question would be regarding, if you could provide us an update on your M&A strategy and what your plans might be regarding that? You have not mentioned that in your prepared remarks.

Rudy Karsan

Sasa, the way we're thinking about M&A is that we would still be driven primarily by the added geography, we're driven by added solutions and we would be then driven by added verticals and we would want it to be accretive. We are not looking at very large acquisitions. We would be looking primarily at tuck-ins. We have the ability to raise that if we ran into a larger transaction, but we don't have that right now. We closed the line that we had with PNC in Q1. So the way we're thinking about it is we are expecting to be active in it, but primarily only for tuck-ins.

Sasa Zorovic - Janney Montgomery Scott

The bookings came strong and regarding your guidance, could you provide us with some kind of an insight into if we were to take some of these larger deals where the recognitions aren't going to be until mid next year, how much would that take away from the bookings, if you could give us some kind of a sense into that rest of the business?

Rudy Karsan

What's the number you're looking for here, Sasa?

Sasa Zorovic - Janney Montgomery Scott

If we were to exclude some of these larger deals, these deals that you have closed recently where the revenue is going to be recognizing starting mid of next year, what the bookings number would have been without those?

Rudy Karsan

We don't disclose the bookings number. Are you talking about our deferred revenue, what would that be without the larger deals?

Sasa Zorovic - Janney Montgomery Scott

Yes.

Rudy Karsan

I don't know that number. I don't think we can disclose it client by client.

Don Volk

Right, we wouldn't want to exclude those deals. They make up the bulk of the difference between Q2 and Q3, if that's what you need.

Operator

Our next question is from the line of Michael Nemeroff with Wedbush Securities.

Michael Nemeroff - Wedbush Securities

Rudy, just a follow-up on the previous acquisition question. What areas are you looking at? I know they're going to be small and tuck-in. Is it going to be more on the software side? Is it going to be more on the services side?

Also as a follow-up to a previous answer, you talked about the minimums on the RPO business, relative to last year's minimums, what percent lower are currently the average minimums? Is it 20% to 30% lower than last year?

Rudy Karsan

We are looking at primarily software and content and very little services and most of the deals are tuck-in and real tiny. I'm not sure I completely understand the second question, so if you can kind of word it another way, if you don't mind.

Michael Nemeroff - Wedbush Securities

You said the people are coming off of the new minimums, but you said the minimums are lower than they were last year. Relative to last year's minimums, where are the new minimums, so that we can kind of get a sense of how far below they still are from last year's minimums.

Rudy Karsan

So the minimum is generally in the subscription number.

Michael Nemeroff - Wedbush Securities

From the RPO?

Rudy Karsan

From the RPO. If you think about it and you're modeling it out, you've got a portfolio; you have to assume that you've got about eight quarters, maybe 12 quarters, subscriptions and assume because you've got a large enough block, that it kind of grinds down to zero over a period of eight to 12 quarters. There's a natural downward pressure on your subscriptions as they either anniversary or don't renew and it's being refreshed by new business.

Michael Nemeroff - Wedbush Securities

No, I was referring to the customers that are still RPO customers, but they've lowered their minimums over the last year.

Rudy Karsan

I don't have the exact number here, Michael, but most contracts when they anniversary, they anniversary at a number that's lower than what it was in the preceding year. If you've got a block of 15 to 20, then four of them anniversary this quarter, then four of them would have a slight downtick.

Michael Nemeroff - Wedbush Securities

Don, was there a currency impact, a headwind or a tailwind during the quarter?

Don Volk

No, we said that there was none.

Michael Nemeroff - Wedbush Securities

A housekeeping question, did you mention what the subscription guidance was for Q4? Did you give guidance on subscription for Q4?

Don Volk

We said that it would be generally stable.

Operator

Our next question is from the line of Terry Tillman with Raymond James.

Andrew Johns - Raymond James

This is actually Andrew Johns for Terry. You talked about some improvement in ATS over the past few months. Can you give us any other specifics there, in terms of how units might have grown year-over-year or sequentially, specifically on BrassRing or maybe a contract value type of figure and how that's trending?

Rudy Karsan

We don't disclose unit by unit or I should say, module-by-module; but basically software has grown in that double digit number, don't know exactly where it is year-over-year.

Andrew Johns - Raymond James

You're not giving guidance for next year, but are there any particular line items that we should look to as potential points, maybe of operating leverage?

Don Volk

Could you repeat that?

Rudy Karsan

Operating leverage.

Don Volk

We've talked about the extra legal expenses. Eventually, we expect to be able to get back into our goal of 22% to 24% operating income on a non-GAAP basis, but in the next few quarters, we would expect that we would have revenue headwinds. We don't expect to be returning to those levels until at least through 2010 and further.

Andrew Johns - Raymond James

Then lastly, any update on your learning management product? Is that driving any new deal activity or is that more of a product for the future?

Troy Kanter

It's really a product for the future. We're in the R&D cycle on it now. There are components of it that we pull out and embed within our performance management, but as a standalone product, we're looking to see revenue on that sometimes in late 2010, most likely. Again, there are components on it now that are greatly enhancing the desirability and the functionality of our performance management product as well as some of our content products as well.

Operator

Our next question comes from the line of David Hilal with FBR.

Unidentified Analyst

This is [Michael] on behalf of David. Can you provide a little more detail on your comments about increased sales activity as something that you've seen over the past few quarters? Then specifically, how the close rates trended, and sales cycles, the deal sizes, and RFPs?

Rudy Karsan

Inbound RFPs continued to increase. Closed rates are flat to slightly up across the board. Unit sizes are down. Total contract value is down because duration is down.

Unidentified Analyst

With regards to the (inaudible) fees, can you provide some details on how large they are? Is that correct that's what drove the other bucket a bit higher this quarter?

Don Volk

That's correct, if you notice that the subscription is consistent at 6 million, so the additional amount is 300,000.

Operator

Our next question is from the line of Horacio Zambrano with Jefferies.

Horacio Zambrano - Jefferies

How many RPO deals did you guys close in the quarter? Would you characterize it as a large RPO deal, I think the one you mentioned on the call?

Rudy Karsan

As you try to model out RPO, think about RPO as being in the kind of $1 million to $2 million annual range.

Horacio Zambrano - Jefferies

It sounds like from your comments that the market is sort of stuck in this RFP mode, kind of kicking the tires, getting ready for engaging. As I do checks on some of the staffing companies and some of your pure play competitors, it feels like there are still deals getting done.

I'm just wondering from your perspective, about how many deals are up for bid or to close like in Q3 at this point in the cycle? When you lose, what do you think it is against the staffing firms and some of your other pure play competitors that people pick your competition for and how are you addressing that?

Rudy Karsan

We've closed and we've announced all wins this year so far. There are three or four wins so far this year. If you say that our block was in the teens, the number of clients we have had is up by 20% to 25%.

Troy Kanter

You mentioned pure plays, but they're not public companies that have to disclose stuff, but some of the things that I've seen announced in this space when we were visiting with some of those organizations, a lot of what's getting announced is contingency hiring or some block recruiting jobs. It's not what we refer to as true outsourcing kind of arrangement, where we are taking responsibility for the technology, taking over some of their people; moving our people on site; managing the process.

There are some things that we are aware of that are getting announced that are probably getting done at much lower margins. Not every one of them are, but they're more commodity type deals, ,but a large percentage of those announcements that we've seen would fall more into that sort of contingency recruiting, block recruiting kind of assignment as opposed to what we would think of as pure outsourcing.

Rudy Karsan

If you think about kind of the main reasons why we win as global footprint, reputation and kind of that technology/content backing. The main reasons why we lose are business mix, it's business we don't want. The second one is price and the third one is particular vertical expertise, so we might not have tremendous amount of expertise in the education vertical for example and those are the reasons we sometimes lose.

Horacio Zambrano - Jefferies

Do you think that we could look to the temporary staffing firms as a leading indicator? Those stocks have reacted positively recently, do you think that's going to be a leading indicator to the RPO business by maybe some amount of timeframe?

Rudy Karsan

Yes, I think we have mentioned in the past that unemployment rate stabilization was one of the external factors. If you look at the number of temp hours worked, if those have started to decline.

In the past, they have been a leading indicator to the unemployment rate stabilizing, and it's got about a six to nine month headstart on that, so I think there was one recession where it was only three months, but in all the others, it was closer to six, seven, nine months.

Operator

Our next question is from the line of Mark Murphy with Piper Jaffray.

Brian Schwartz - Piper Jaffary

This is Brian. I just had a one follow-up question. The contract durations were down, could you share what that metric, maybe what the average length was if that was less than two years, which I believe is the normal duration.

Don Volk

Two years is still our average contract duration.

Brian Schwartz - Piper Jaffary

No significant deterioration or possibly is there a certain percentage of the new RPOs that you signed in the quarter that opted for shorter durations?

Rudy Karsan

Yes, if you look at the whole block, it's two years, so what happens is in certain quarters you see a little bit of movement up or down from that two years and this quarter was a little bit down.

Brian Schwartz - Piper Jaffary

Nothing significant?

Rudy Karsan

No, nothing material.

Operator

There's no further questions in queue at this time. I'd like to turn the floor back over to management for any closing comments.

Rudy Karsan

I guess I'll end the call the way we normally have, which is we should thank the Street for their support and look forward to talk to you again in three months. Goodnight and good evening.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Kenexa Corp. Q3 2009 Earnings Call Transcript
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